DISSOLUTION OF LLP & TAXABILITY

BY SASHI KANTA PANDA

Winding up is different from dissolution. Winding up is a process which culminates into dissolution. During the period, when winding up commences till the dissolution takes place, the legal entity of LLP remains and so, such LLP can be sued. But on dissolution, the LLP loses its existence because its name is struck off from the register of LLPs and therefore, it is not possible to sue the LLP.

Procedure:

Declaring the LLP as Defunct

In case the LLP wants to close down its business or where it is not carrying on any business operations, it can make an application to the Registrar of Companies for declaring the company as defunct and removing the name of the LLP from its register of LLP’s.

The procedure is given below       
1. An application is required to be made in eForm 24 to the Registrar of Companies for Striking off the name of the LLP under clause (b) of sub rule 1 of Rule 37 of LLP Rules 2008 with the consent of all partners.

2. The Registrar shall publish a notice on its website as to the content of the application for a period of one month for the notice of the general public.

3. Application submitted to be supported by Indemnity Bonds to indemnify any person legally claiming after the LLP to be striked off and duly sworn Affidavits declaring all the information provided and statements given to be true, from all partners. 

4. Application filed also to be supported by approvals or No Objection Certificates from concerned Regulatory Authorities with which the LLP is registered. For eg. LLP engaged in or registered with RBI for Banking Business has to obtain NOC from RBI before winding up of its affairs. 

5. The Registrar, where he has sufficient cause to believe that the limited liability partnership has any asset or liability, satisfy himself that sufficient provision has been made for the realization of all amount due to the limited liability partnership and for the payment or discharge of its liabilities and obligations by the limited liability partnership within a reasonable time and, if necessary, obtain necessary undertakings from the designated partner or partner or other persons in charge of the management of the limited liability partnership.

6. On the expiry of period of one month, the Registrar may, by an order, unless cause to the contrary is shown by the limited liability partnership, strike its name off the register, and shall publish notice thereof in the Official Gazette, and on the publication in the Official Gazette of this notice, the limited liability partnership shall stand dissolved.

Guidelines:
a. There should have been no liability existing or obligation subsisted on part of LLP and its partners.

b. There should be no litigation pending for or against LLP.

c. The assets of the limited liability partnership shall be made available for the payment or discharge of all its liabilities and obligations even after the date of the order removing the name of the limited liability partnership from the register.

d. Liability of the Designated Partners subsists even after dissolution of LLP for payment of any legal dues to its creditors and other persons as if the LLP has not been dissolved.

Declaring the LLP as defunct is much easier process to close down the LLP as compared to wounding up because it does not involves high formalities and due to simplified procedure, the time consumed is comparatively very less.

Winding UP

As per section 63 of the LLP Act, the winding up of the Limited Liability Partnership could be either of the following-

Voluntary Winding up

Here the partners of the LLP, after consenting among them, agree to wind up its affairs and activities. And adopt the following procedure to windup the limited liability partnership. If the firm is not solvent the partners cannot start the process of winding up the firm. They also need to have creditors’ consent/approval for winding up the firm. And many more formalities have to be complied with for winding up the business.

i) Passing of Resolution-

An LLP can be wound up voluntarily only if at least three fourth of total numbers of partners pass such a resolution and file a copy of it with the Registrar within the next 30 days. It shall be deemed that the winding up has commenced from the time of the passing of such resolution.

ii) Declaration of solvency by designated partners-

The designated partners are required to make a declaration, which shall be verified by an affidavit, that their LLP is solvent and will be able to fully settle the debts out of proceeds realized from the sale of assets within a time period of one year starting from the date when winding up commenced. This declaration along with the Statement of Assets and Liabilities and Assets Valuation Report prepared by an independent valuer shall be submitted with the Registrar of Companies (ROC) within 15 days of passing of the winding up resolution.

iii) Approval of Creditors-

No winding up can take place voluntarily unless the approval of creditors is sought. The LLP shall intimate to its creditors, the estimated amount that it owes to each of these parties and shall give them an offer to approve and accept the claims. They shall be given a 30days time to accord their approval in respect of voluntary winding up or acceptance of the offer made to them. Consent of at least 2/3 in value of creditors is required for winding up. The LLP shall file the decision of the creditors with the ROC within 15 days of receipt of their consent.

iv) Publication of Resolution-

Once the resolution demanding voluntary winding is passed and approval of the creditors is obtained, then the LLP shall within 14 days of receipts of creditors consent give a public notice about its resolution. For this purpose, it shall place an advertisement concerning this matter in the local newspaper of the district where the principal office or registered office of the LLP is situated.

v) Appointment of Liquidator-

To administer the proceedings of winding up, an official known as LLP liquidator is appointed from the panel maintained by the Central Government within 30 days of filing of consent of creditors. Once the LLP liquidator gets appointed, all the powers of the designated partners as well as that of other partners shall cease. Further notice of such appointment of the LLP Liquidators shall also be given to the  Registrar.

Duties of LLP Liquidator :

The LLP Liquidator is supposed to discharge the following duties with regard to the winding up–

1. Perform such functions and duties as may be prescribed under the Act or Rules,

2. Maintain books of accounts in the proper manner,

3. Settle the list of creditors and partners,

4. Pay off the liabilities of the LLP and adjust the rights of the partners among themselves,

5. Observe due care and diligence while discharging his duties,

  

6. Give a quarterly report on the progress of winding up of the LLP to the partners and creditors in the prescribed form & manner,

7. Get the accounts of the LLP audited.

Preparation of Final Report by the Liquidator-

Once the affairs of the LLP get fully wound up, then the liquidator shall prepare a final report concerning the winding up accounts and explanations in the prescribed format. Thereafter, he/she shall seek the approval of the partners and the creditors, as the case may be, with regard to the said report and accounts in the meeting with the partners and creditors.

Further, all the above mentioned documents shall be filed with the ROC within 15 days of the approval by the partners /creditors.

vi) Passing of Dissolution Order-

If the tribunal is satisfied that the process of winding up has been duly followed, it shall pass the dissolution order within 60 days of the receipt of the application. The liquidator is required to file a final copy of the dissolution order of LLP with the Registrar of Companies (ROC), who shall then get this fact notified in the Official Gazette.

Compulsory Winding up

The firm may also wound up by the order of the Tribune/court. And this kind of winding up is known as Compulsory Winding up. The Tribune may order an LLP firm to wind up in the following circumstances as provided under section 64.

a) Petition by LLP - If the LLP firm has resolved to be wound up by the Tribunal, then it may file a petition to the Tribune under section 64 subsection (a).

b) Number of the partners below statutory minimum - If the number of partners in an LLP falls below two, and still it keeps carrying on for more than 6 months, then the Tribunal is bound to issue a winding up order under the provisions of Section 64 sub section (b).

c) Inability to Pay Debts - If the LLP is in a severe financial crunch and is unable to honour its obligations towards the creditors, the Tribunal may make a winding up order. The power of the Tribunal is, however, discretionary and it may desist from making a winding up order, if the majority of creditors in value oppose the petition in the hope that the LLP would be able to regain its financial position and must therefore continue to trade as referred under Section 64 subsection (c).

d) LLP acts against the National Interest - If the activities of the LLP put at risk the sovereignty, integrity and security of India, then the tribune may make a winding up order under section 64 sub section (d).

e) Default in submitting the prescribed financial disclosures and other documents with the Registrar - If the LLP has, for any reason defaulted in filing with the Registrar its Statement of Account and Solvency or Annual Return for five consecutive financial years, then the Tribune is bound to make a winding up order as per the provisions of Section 64 subsection (e).

f) Just and Equitable to wind up - If in the opinion of the Tribunal, it is just and equitable to wind up the LLP; it may order it’s winding up. The Tribunal has wide discretionary powers under this clause and on the basis of judicial decisions; the following circumstances may be made a ground for winding up under Section 64 subsection (f).

i) If there is a complete deadlock in management.

ii) If there is a Bubble LLP i.e. LLP exists only for the name sake without any real business or property.

iii) If there is a loss of substratum i.e. whole of the capital of the LLP has eroded or the main object of the LLP has failed.

iv) If the LLP firm carries business which is illegal.

v) The business of LLP cannot be carried on further except at a loss.

The following points should also be noted and understood along with the conditions laid in section 64. These provisions relate to the details of winding up procedure.

i) The petition or an application for winding up of an LLP could be filed with the tribunal by the LLP itself or by any of its partner(s) or creditor(s) or by the Registrar or by Central Government or by a person authorized by Central Government.

ii) It shall be deemed that winding up of the LLP has commenced from the time of the presentation of its petition to the tribunal.

iii) The tribunal is empowered with the special powers that can be exercised by the Tribunal as per his discretion on presentation of petition. Once the petition for winding up of the LLP, has been received by the Tribunal, it fixes a date for its hearing and issues notice to the LLP to appear and justify its position. The Tribunal shall also give a public notice in order to inform everybody, particularly, the creditors and the partners, about winding up so that their concerns or objections could also be considered. Then, on the specified date, after taking into consideration the concerns of all the parties and circumstances of the case, the Tribunal (within ninety days from the date on which petition was presented), may – dismiss the petition or make an interim order or direct to revive or rehabilitate the LLP or appoint a liquidator as provisional liquidator till the final order or pass an order to windup the LLP.

iv) Once the Tribunal passes and communicates the Winding up order to the firm, the following consequences will follow.

a) The petitioner and the LLP shall ensure that a certified copy of the winding up order has been filed with the ROC so that the Registrar could notify the fact in the Official Gazette.

b) The winding up order serves as a notice of discharge to all the employees and officers of the concerned Limited Liability Partnership.

c) No suit or legal proceedings can be commenced against the LLP without the leave of the court. Even a suit, which is pending against the LLP at the date of winding up order, cannot be preceded unless the permission of Tribunal is obtained. 

Taxability:

Up to the assessment year 1987-88 distribution of assets on dissolution of firm was not subjected to capital gains taxation. As a matter of fact Sec.47(ii) specifically provided that it will not be considered to be a transfer. In Malabar Fisheries Co. vs. CIT (1979) 120-ITR-49(SC), the Supreme Court held that distribution of assets among partners on dissolution does not involve transfer as it is only because of pre-existing rights. This settled position was upset by introduction of Sec. 45(4) and deletion of Sec. 47(ii) with effect from 1-4-1988 i.e., A.Y. 1988-89 onwards. The reasons for the introduction of the new Section and for disturbing the settled position is explained by Circular No. 495, dated 22-9-1987, vide para 24.3. It was felt that the route of dissolution was used in a scheme of tax avoidance, which enabled the participants of the scheme to transfer assets from one hand to another hand without payment of legitimate tax.

The profits or gains are deemed to have arisen in the previous year in which the transfer takes place. The identification of the year of transfer becomes an issue in cases where the year of distribution happens to be different than the year of dissolution. The term ‘distribution’ is a legal and accounting concept which has given rise to a debate as to whether the Section will apply in a case where all the assets are taken away by one of the partners. An issue also has arisen as to whether the sale of capital assets to a partner could be treated as distribution of assets or not. A doubt has arisen about the entity in whose hands the deemed capital gain could be taxable, i.e., whether the gain would be taxed in the hands of the firm or in the hands of the group of partners as the firm has been dissolved and ceases to continue.

Relevant Sections:

Sec. 45(4) of the Income-tax Act provides for taxation of the deemed capital gains arising on distribution of capital assets in the course of dissolution. The essential requirement for attracting this provision is that there is a dissolution, and that in the course of such dissolution, capital assets are distributed.

The said Sec. 45(4) reads as under:         
“The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place, and for the purposes of S. 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as result of the transfer.”

Ordinarily, capital gains arise on transfer of a capital asset. ‘Transfer is considered to be ‘sine qua non’ of capital gains. The term ‘transfer’ is defined by Sec. 2(47) of the Act, which reads as under :

“ ‘transfer’, in relation to a capital asset, includes: the sale, exchange or relinquishment of the asset; or the extinguishments of any rights therein; or the compulsory acquisition thereof under any law; or in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment; or any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in Sec. 53A of the Transfer of Property Act, 1882 (4 of 1882); or any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring or enabling the enjoyment of, any immovable property;

Explanation : For the purposes of sub-clauses (v) and (vi), ‘immovable property’ shall have the same meaning as in clause (Id) of the Sec. 269UA”.

From a bare reading of the above provisions, it is seen that the distribution of capital asset in the course of dissolution is not specifically included in the definition of the term ‘transfer’. Instead, a direct charge is sought to be created by introducing a deeming fiction in the form of Sec. 45(4) for bringing to tax the deemed capital gains on such distribution. It is this act of by passing the provision of Sec. 2(47) by the Legislature that has become the subject matter of an interesting controversy where under a possibility of rendering Sec. 45(4) nugatory is being debated.

One view of the matter is that Sec. 45(4) is a charging Section that brings in an effective charge in the circumstances provided therein, independent of Sec. 2(47). This view is supported by the decisions of the Karnataka and the Goa Bench of the Bombay High Court. The other view of the matter holds that without a specific amendment in Sec. 2(47) amending the definition of ‘transfer’, Sec. 45(4) has no independent application. This view is supported by a decision of the Madhya Pradesh High Court.

Case Studies:-

CIT v. Moped and Machines [ (2005) 281- ITR- 52 (MP)]

The High Court observed that the admitted facts revealed a dissolution of the firm; that the dissolution deed showed that the retiring partner had no objection whatsoever in continuation of business in the same name, either as a sole proprietary or in any other manner as the other partner thought fit; that the other partner in terms of the materials placed on record had taken over the entire assets and liabilities of the partnership firm.

The Court further observed that a reading of Sec. 45(4) showed that the profits or gains arising from the transfer of capital assets by way of distribution of capital assets on the dissolution of a firm was chargeable to tax as the income of the firm, in the light of the fact that a transfer had taken place. The Court also took notice of the assessee’s contention that the term ‘transfer’ had been defined u/s.2(47) of the Act and that if Sec. 2(47) was read with Sec. 45(4), there was no transfer at all, and in any case if there was any transfer, it was not by the assessee, but by the retiring partner.

For considering the issue on hand, the Court was inclined to notice Sec. 47 of the Act. It noted that Sec. 47 was a special provision which would define the transactions not regarded as transfer and a reading of the said Sec. 47 of the Act showed that several transactions were considered as ‘no-transfer’ for the purpose of Sec. 45 of the Act.

It noted Sec. 47(ii), prior to its deletion read as : “any distribution of capital assets on the dissolution of a firm, body of individuals or other association of persons.”; that the said provision was omitted by the Finance Act, 1987 with effect from April 1, 1988; that therefore, any transaction resulting in distribution on dissolution of a firm had to be considered as ‘transfer’ in terms of Sec. 47; that on omission of clause (ii) of Sec. 47, it could not be said that Sec. 45 was inapplicable to the facts in the case on hand.

The Karnataka High Court further distinguished the judgement of the Madhya Pradesh High Court in CIT v. Moped and Machines, 281 ITR 52 relied upon by the assessee by observing that in the said judgement, there was no reference to omission of clause (ii) of Sec. 47 as it stood prior to April 1, 1988; that in the said judgement, what was considered was the provisions of Sec. 45(4) and Sec. 2(47), as it stood then; that therefore, the said judgement would not be applicable to the issue involved in the case on hand; that on the other hand, the decision of the Bombay High Court in the case of CIT v. A.N. Naik Associates, 265 ITR 346 was found to be applicable, as in the said decision, the Bombay High Court had noticed the effect of the omission of the said clause (ii) of Sec. 47 by the Act of 1987.

The Karnataka High Court, in respectful agreement with the judgement of the Bombay High Court, noted that when the Parliament in its wisdom had chosen to remove a provision which provided for the cases of ‘no transfer’, there was no need for any further amendment to Sec. 2(47) of the Act. The Court accordingly held that despite no amendment to Sec. 2(47), in the light of removal of clause (ii) to Sec. 47, the transaction was liable to capital gains tax at the hands of the authorities.

Conclusion :
Normally, in cases of firms consisting of more than two partners, the death or insolvency of a partner would result in dissolution of the firm as per the provisions of the said Act. However, there would be no dissolution in a case where the partners have agreed to continue the partnership and the business even after death or insolvency, on certain terms and conditions. On compliance of such terms, the firm will be said to have continued. In such cases, there is a consensus of opinion that the provisions of Sec. 45(4) will not apply.

Cases which create real difficulty are the cases of partnership consisting of two partners only. It is in such cases that a difficulty arises, where one of the partners dies or is declared insolvent or retires. In such cases, the firm shall stand automatically dissolved on death or insolvency or on retirement by operation of the law. In such cases of severe hardships, the recent decision of the Madras High Court in the case of CIT v. Vijaya Metal Industries, 256 ITR 540, provides a major breakthrough. In that case, the assessee partnership consisted of two partners, which was dissolved on death of one of the partners. The business of the partnership firm was continued by the surviving partner with the assets of the partnership firm. The Income-tax Department applied the provisions of Sec. 45(4) and brought to tax the deemed capital gain by holding that the transfer took place on dissolution of the firm. The Tribunal held that though the dissolution of firm took place by operation of law, it was not followed by transfer of capital assets by way of distribution of such assets. The Madras High Court confirmed the decision of the Tribunal.

The decision in the case of Vijaya Metal Industries provides a much needed relief. With this, one thing is certain that the dissolution by itself will not result in distribution of assets of the firm. The distribution will take place only on taking of a positive action by the parties concerned for distributing the assets. Till such time, the assets may be treated as jointly held by the parties. This by itself is a big relief for the assessees who are caught unaware. It is also certain  that it is possible to defer the year of taxation to the year in which the distribution takes place. This will enable an assessee to comprehend the impact of Sec. 45(4) and plan for the same. In view of the above, a new possibility has emerged where under the surviving partner can successfully join hands with the legal heirs of the deceased partner, in partnership and continue the business with the assets of the erstwhile firm. In such a case, the above-referred decision will help in contending that the assets of the erstwhile firm are not distributed amongst the parties entitled to it and till such time no liability to tax by virtue of Sec. 45(4) will arise.

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