Companies Act
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This article is written by Aabir Shoaib, pursuing Diploma in General Corporate Practice: Transactions, Governance and Disputes from LawSikho. The article has been edited by Amitabh Ranjan (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).

Introduction

One of the most crucial decisions of the government was amending Section 366 of the Companies Act of 2013. 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 15th August 2018, according to the Ministry of Corporate Affairs (MCA), enforcement notification dated 5 July 2018. Furthermore, on July 5, 2018, the MCA, through notification, issued the Companies (Authorised to Register) Second Amendment Rules, 2018 (‘Amendment Rules’). The aforementioned Amendment Rules will also go into effect on August 15th, 2018. Considering the dynamic evolution of the corporate sector, the intent of the amendment is fundamental, to strike a balance in the ease of doing business to corporate development.

Section 366 primarily deals with the registration of unregistered entities such as partnership firms, limited liability partnerships (LLPs), cooperative societies, and other organisations as defined by the Companies Act of 2013. The amendment allows such organisations with two or more members to register under the Companies Act, 2013 as a company limited by guarantee, a company limited by shares, or an unlimited company.

Unregistered entity under Companies Act, 2013

It is important to note that the term ‘Unregistered Company’ is not defined under the Companies Act, 2013. However the Act, 2013 does give an expression of the term in Section 375. According to Section 375, an unregistered company shall include any partnership, limited liability partnership or a co-operative society, association or company where the number of members is more than seven. Nevertheless, the meaning became clear under the Companies Act of 1956 (“Act of 1956”), as evidenced by Section verbiage as well as several judicial precedents such as those of Valli Pattabhirama Rao v. Sri Ramanuja Ginning & Rice Factory (P) Ltd and Salim Akbarali Nanji v. Union of India, to include partnership firms, societies, or any other entity created under any other statutory provisions being in force, subject to certain special cases and conditions. 

A firm that is not a joint-stock company is not required to register as a company limited by shares under Section 565. The term “Joint Stock Company,” as defined in Section 566 of the Act of 1956, has been abolished, but the principle has been preserved under clause (iii) of sub-Section (2) of the Act of 2013. Furthermore, the procedural features of company registration under Part I of Chapter XXI are not addressed in the act itself but are addressed in the aforesaid Rules, while the same was addressed in Sections 567 to 573 of the Act of 1956.

Provisions under the Amendment and its effects on unregistered entities

With two members, conversion to a corporation under the Act of 2013 is now conceivable

The Companies (Amendment) Act, 2017, changed this Section once, replacing the wording “seven or more members” with “two or more members” in Section 366(2) and inserting “a company less than seven members shall register as a private company” in the provision after clause (VI). These changes improved the clarity of this Section. 

Inclusion of LLPs, partnership firm, co-operative society 

The Amendment now allows registration of unregistered entities such as partnership firms, limited liability partnerships (LLPs), cooperative societies, and other organisations as defined by the Companies Act of 2013. The amendment allows such organisations with two or more members to register under the Companies Act, 2013 as a company limited by guarantee, a company limited by shares, or an unlimited company.

Aspects of the law : not a transfer

The registration of unregistered entities under the Act of 2013, however, is not the same as a transfer because it occurs as a legal operation and is not inter-vivos between the parties. The aforementioned arrangement is merely a conversion, in which an existing corporation is turned into a new registered company under the Act of 2013, rather than a transfer.

Furthermore, a transfer of a capital asset or intangible asset in the form of a business from a firm to a company as a result of the firm’s succession by a company is not recognised as a transfer in any way, according to Section 47 (xiii) of the Income Tax Act, 1961. The requirement is that the existing company should have acquired the assets and liabilities of the firm in the manner prescribed under Section 47(xiii).  In the matter of Vishal Containers P. Ltd. v. Assessee, the Income Tax Appellate Tribunal, the Income Tax Appellate Tribunal Ahmedabad took this approach.

Conversion does not attract stamp duty

On the transfer of property or conveyance, stamp duty is required. Section 3 of the Indian Stamp Act, 1899 (the “Stamp Act”) specifies which instruments are subject to stamp duty. Moreover, 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”. The Stamp Act, 1899,  makes no provision for stamp duty to be paid on the vesting of property. Various courts of law have also taken the aforementioned stance. The following are excerpts from some of the topics:

  1. It was said in the case of Vali Pattabhirama Rao vs. Sri Ramanuja Ginning and Rice Factory (P) Ltd., AIR 1984 AP 176, held that “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”
  2. The High Court of Delhi held in Union of India v. Mahalaxmi Saw Mills P. Limited: “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 a levy of unearned increase;”

A partnership firm, with even two people, can be turned into a company as a result of the aforementioned change. This encourages corporatization, especially in the case of a real estate partnership. The following is stated explicitly in Section 368 of the Act of 2013:

“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.”

After reading the prior Section, it is clear and obvious that the property is transferred into the business without any conveyance, and the company is thus transferable through the transfer of shares. As a result, there is no stamp duty at the moment of conversion because the property has been vested. The Section has the effect of requiring automatic vesting and divesting. The properties are divested from the previous business and transferred to the newly converted company. Because vesting is a legal requirement, no registered instrument of transfer is required.

Conclusion

Section 366 deals with the registration of unregistered entities such as partnership firms, limited liability partnerships, cooperative societies, and other organisations as defined by the Companies Act of 2013. Significant amendments were made and its effect was largely beneficial to unregistered entities. The changes such as conversion to a corporation under the Act of 2013 with two members is now being conceivable; the inclusion of LLPs, partnership firms, co-operative societies and providing them with an option to be registered under the Companies Act, 2013 as a company limited by guarantee, a company limited by shares, or an unlimited company; registration of unregistered entities not tantamounting to transfer of property; conversion not attracting stamp duty, and partnership firms with even two people can now be turned into a company as a result of the aforementioned change. In addition, according to Section 375, an unregistered company shall include any partnership, limited liability partnership or a co-operative society, association or company where the number of members is more than seven.

While, the Amendment Act brought about a number of modifications, in the author’s opinion, the most significant was the inclusion of more entities under Section 366. By decreasing the number of unregistered businesses from seven to two, the Amendment Act encourages them to register as corporations under the Act of 2013, with the same set of owners, without the unnecessary burden of locating and inducting new members. As a result of the transition, there may well be an optimistic rise in corporatization, that encourages commercialization and better governance.

References

  1. https://vinodkothari.com/2018/07/amendment-in-Section-366-of-the-companies-act-2013/
  2. https://indiacorplaw.in/2018/07/corporatisation-prospects-unregistered-entities-amendment-Section-366-companies-act-2013.html
  3. https://advocatespedia.com/366._COMPANIES_CAPABLE_OF_BEING_REGISTERED_.%E2%80%94
  4. Section 75 of Companies Act, 2013 – Damages for Fraud | Corporate Law Reporter
  5. Companies Act, 2013 (mca.gov.in)
  6. Microsoft Word – 3853GI (mca.gov.in)
  7. CompaniesAuthorisedRegister_06072018.pdf (mca.gov.in)
  8. Vali Pattabhirama Rao And Anr. vs Sri Ramanuja Ginning And Rice … on 26 December, 1983 (indiankanoon.org)
  9. Salim Akbarali Nanji And Ors. vs Union Of India (Uoi) And Ors. And … on 1 November, 2002 (indiankanoon.org)
  10. Conversion Of Partnership Into A Company (financialexpress.com)
  11. No transfer as per Section 47(xiii) in case land acquired by assessee company from partnership-firm succeeded by it (taxguru.in)
  12. Vishal Containers Pvt.Ltd.,, … vs Assessee (indiankanoon.org)
  13. Section 3 in The Indian Stamp Act, 1899 (indiankanoon.org)

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