Corporatisation Prospects for Unregistered Entities: Amendment to Section 366 of the Companies Act, 2013

[Pammy Jaiswal is a Partner at Vinod Kothari and Company]

Background

By virtue of the enforcement notification of the Ministry of Corporate Affairs (‘MCA’) dated 5 July 2018, the proposed change under section 75 of the Companies (Amendment) Act, 2017 (‘Amendment Act’) relating to section 366 of the Companies Act, 2013 (‘Act, 2013’) has been notified with effect from 15 August 2018. Further, by way of its notification dated 5 July 2018, the MCA has also issued the Companies (Authorised to Register) Second Amendment Rules, 2018 (‘Amendment Rules’). The said Amendment Rules shall also come into force from 15 August 2018.

The section deals with registration of unregistered entities like partnership firms, limited liability partnerships (‘LLPs’), cooperative societies and such other entities as a company under the Act, 2013. The amendment paves way for such entities having two or more members to get themselves registered under the Act, 2013 either as a company limited by guarantee, company limited by shares or unlimited companies.

This post endeavours to briefly discuss the impact of the amendment to the section and also Amendment Rules.

Legal Aspects – Not a Transfer

Registration of unregistered entities under the Act, 2013 does not tantamount to transfer at all as the same take place as operation by law and is not inter-vivos between the parties. The said arrangement is not a transfer but a mere conversion wherein old entity is transformed into a new registered company under the Act, 2013.

Further, as per section 47 (xiii) of the Income Tax Act, 1961, the transfer of a capital asset or intangible asset in the form of a business by a firm to a company as a result of succession of the firm by a company shall not be treated as transfer at all. This is so long as certain prescribed conditions are complied with. This approach was followed by the Income Tax Appellate Tribunal, Ahmedabad in the case of Vishal Containers P. Ltd. v. Assessee.

No Stamp Duty Implication on Conversion

Stamp duty is payable on transfer of property or conveyance. Section 3 of the Indian Stamp Act, 1899 (‘Stamp Act’) spells out the applicability of the instruments chargeable with stamp duty. Further, section 2(14) of the Stamp Act defines an instrument as “every document by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded:”

Nowhere under the Stamp Act does it provides for payment of stamp duty on vesting of property. Various courts of law have also firmly taken the aforesaid view. Extracts of some of the cases are set below:

(i) In Vali Pattabhirama Rao v. Sri Ramanuja Ginning and Rice Factory (P) Ltd. AIR 1984 AP 176, the Court stated:

“The Division Bench of Andhra Pradesh High Court relying on Section 575 of the Companies Act, 1956 has held that if a partnership firm registered as a company, there was a statutory vesting including of all immovable property and no separate conveyance was required for the same;”

(ii) In Union of India v. Mahalaxmi Saw Mills P. Limited, the High Court of Delhi held:

“If no conveyance deed is required for vesting of a property from a partnership firm to a company, it could not be said that any transfer of the property takes place which would require levy of unearned increase;”

As a result of the aforesaid amendment, a partnership firm with even two persons can be converted into a company. This promotes corporatisation, particularly in case of a property-owning partnership. Section 368 of the Act, 2013 clearly states the following:

All property, movable and immovable (including actionable claims), belonging to or vested in a company at the date of its registration in pursuance of this Part, shall, on such registration, pass to and vest in the company as incorporated under this Act for all the estate and interest of the company therein.”

[Emphasis supplied]

On reading of the aforesaid section it becomes clear and evident that the property comes into the company without any conveyance, and the company thereby becomes transferable by transfer of shares. Accordingly, there is no stamp duty at the time of conversion as there is vesting of property. The effect of the section is that there is an automatic vesting and divesting. The old entity is divested of the properties and the newly converted company is vested with the properties. The vesting being statutory, no registered instrument of transfer is necessary. Accordingly, one can expect increase in the corporatisation since the amendment shall give impetus to property owning partnership forms, LLPs, and other unregistered entities to embark upon incorporating companies under the Act, 2013.

The position would be different where the company incorporated had come into existence even while the firm existed and a separate agreement of transfer was entered into between the directors of the company and partners of the firm. Stewart & Co. Ltd. v. C. Machertech; AIR 1963 Cal 198 (DB).

Conclusion

While various changes have been brought by way of the Amendment Act, one of the important changes relates to section 366. By reducing the number from seven to two, the Amendment Act encourages the unregistered entities to register themselves as companies under the Act, 2013 with the same set of owners without the undue harassment of identifying and inducting new members in such unregistered entity. As a result of the change, one may find an increase in corporatisation which in turn promotes commercialisation and improved governance.

Pammy Jaiswal

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