CONVERSION OF PARTNERSHIP FIRM AND PRIVATE LIMITED COMPANY INTO LLP

Transcription

1 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Seminar on 05 th March 2011 LIMITED LIABILITY PARTNERSHIP CONVERSION OF PARTNERSHIP FIRM AND PRIVATE LIMITED COMPANY INTO LLP - CA S. V. SHANBHAG svshanbhag.co@gmail.com I. OVERVIEW OF LLP: A limited liability partnership [LLP] is a cross breed offspring of a partnership and a limited company. A partnership is not a distinct legal entity in law and has no separate existence apart from the partners that constitute it. A partnership cannot own property in its name and what is loosely called the estate of the partnership is in fact the bundle of all the assets and liabilities owned by the partners together in joint. On the other hand, a limited company is a separate entity distinct from its own shareholders and is legally competent to own properties in its own name as well as transact in its own name. Whereas in a partnership, a partner is personally liable for the firm s debts, the liability of the shareholder of a limited company to such debts of the company is limited to his shareholdings. Yet, with all these defects, a partnership firm is operationally easier in functioning, whereas a limited company is burdened with too many hassles in legal compliances. In this scenario, emerged this entity of LLP as a compromise trade off between a partnership and a limited company. LLP is a partnership which has a distinct legal identity in law just like a limited company. The liability of the partner in a LLP is limited to the capital contributed by him. Limited liability partnerships existed all over the world. But, in India, LLP is a new concept and is governed by the Limited Liability Partnership Act

2 II.PROVISIONS OF LLP ACT IN RESPECT OF CONVERSION A FIRM / PRIVATE LIMITED COMPANY / UNLISTED COMPANY TO LLP: In view of the distinct privileges enjoyed by LLP, the LLP Act contains provisions paving way for an existing Partnership Firm or a Private Company or an Unlisted Public Company to convert itself into LLP. The provision for conversion are contained in Section 55, 56 & 57 (of Chapter X) read with schedule II/III and IV of the LLP Act, Registration of Conversion: The Registrar, on satisfying that a Firm, Private Company or an Unlisted Public Company, as the case may be, has compiled with the provisions of Second schedule, third schedule or the forth schedule, as the case may be, shall, subject to the provisions of this act the rule made there under, Register the documents submitted under such schedule and issue a Certificate of Registration. Application for conversion shall be made in Form 17 (Firm to LLP) and in Form 18 (Private Company / Unlisted Public Company to LLP) along with the prescribed documents: The Registrar shall register the documents submitted by the Firm, Private Limited Company or Unlisted Public Limited Company provided they have followed the provisions of chapter X and Second schedule, Third schedule, Forth schedule respectively. The Registrar has to issue Certificate of Registration. It will be effective from the date specified in the Certificate. The LLP has to inform the Registrar of Firm or Registrar of Companies within 15 of the Registration about the conversion and the particulars of the LLP. (Sub Section-1) in Form No. 14 On conversion the Partners of Firm or the shareholders of the Private Company or Unlisted Company shall be bound by the provisions of Second schedule, Third schedule or Forth schedule. (Sub Section 2) Effect of Conversion: From the date of conversion (i) There shall be a LLP name specified in the certificate of Registration

3 (ii) All the tangible i.e. Immovable or Movable and Intangible property of the Firm or Private Limited Company or Unlisted Company shall be transferred to the LLP and this property will become property of the LLP. Like wise all liabilities of these converted entities shall be the liability of the LLP. (iii) The Firm or the Company shall be deemed to be dissolved and removed from the records of the Registrar of the Firms or Registrar of the Companies. (Sub Section 4) III. COVERSION OF FIRM TO LLP: i) Advantages of LLP over a Partnership Firm FIRM Unlimited Personal Liability for Investment in Firm. Joint & Several Liability Partner is a agent of firm & that of other partners Not a separate entity No Perpetual successions Dissolution by death of partner ( unless agreement to contrary ) Max Partners ( 10 or 20 Nos) Partner cannot be employee firm Bar on Admission of a minor [ Sec 30(1) ] LLP No Personal Liability except in case of fraud Not Liable for independent & unauthorized acts of other Partners. Only Agent of firm ( not of other Partners ) Separate entity distinct from partners Perpetual succession Death of Partner does not dissolve the firm. No max Limit Can be Employee of firm since firm is a dish net entity No express bar ii) Income Tax implications on conversion of a Partnership Firm into LLP There is no provision under Income Tax Act to specifically provide that conversion of a Partnership Firm to LLP dose not amount to transfer. However such a provision is inserted in Sec.-47 (xiiib) by Finance Act 2010 in the case of conversion of a Private / Unlisted Public Limited Company into an LLP

4 It is however to be noted that the Explanatory Memorandum to Finance Bill 2009 provides that conversation of a General partnership to LLP will not have any tax implication if a. Rights and liabilities of partners remain same after conversion and b. There is no transfer of assets or liabilities after conversion The concept of transfer is given in Sec.-2(47) which is an inclusive definition. It has two categories of transfer Actual Transfer and Deemed Transfer. Sale, Exchange, Relinquishment or Extinguishment of assets, compulsory acquisition of assets are examples of Actual Transfers. Deemed Transfer is a transfer by fiction. E.g. Conversion by an assessee of his Capital Assets into stock in trade is treated as a transfer U/s 2 (47) even though there are no two parties to this Act of conversion. In short, unless there is a specific provision in the IT Act treating a non transfer as a transfer what can be taxed as Capital gains are only transaction involving actual transfers. Under the circumstances it is possible to argue that conversion of a Firm into LLP dose not resulting a transfer with in the meaning of Sec.-2(47) nor there is any specific provision U/s 45 to treat such a conversion as transfer. Reliance may be placed the decision of Bombay High Court in the case of CIT vs Texspin Engineering and Manufacturing Works (2003) 263 ITR 345 [Bom] iii) Cautions before converting FIRM TO LLP a) Firm intending to avail benefit U/s 44AD (New) w.e.f. AY and subsequent years will loose benefit of Presumptive Taxation since an LLP is not entitle to the benefit under Sec.44AD. b) There is a controversy as to whether a Firm having unabsorbed losses can Carry forwarded or Setoff in view of provisions of Sec.-78(2). The judgment of ITAT Ahmedabad in the case of Amin Machinery (P) Ltd vs Dy CIT (2008) 114 ITD 413 is against the Assessee. However few other case law decisions seem to suggest that the carry forward is not a problem. No express provisions is brought in the IT Act, like Sec.-47(xiii) & (xiv) which deal with succession of a Firm to Company and Proprietorship to Company respectively. c) Firm s having unabsorbed Depreciation

5 - Similar to carry forward loss stated above, there is controversy regarding allowability of unobserved depreciation of the Firm after conversion to LLP. d) Admission of minor No express provision in LLP Act IV. CONVERSION OF PRIVATE / UNLISTED PUBLIC LIMITED COMPANY TO LLP: a. Exemption from Capital Gains Tax [New clause (xiiib) of Section 47] The Finance Act, 2010 has inserted a new clause (xiiib) in Section 47 and a new sub section (4) in Section 47A of the Act with effect from Assessment year The said new clause (xiiib) provides that the transfer of a Capital Asset or Intangible asset to LLP or any transfer of share or shares held in the company by a shareholder on conversion of a private company or unlisted company into an LLP in accordance with sections 56 & 57 of the limited liability partnership act, 2008 shall not be regarded as a transfer for the purpose of the capital gains tax, subject to the following conditions: i. The total sales, turnover or gross receipts in business of the company do not exceed Sixty Lakhs rupees in any of the three previous years preceding the previous year in which conversion takes place; ii. All the shareholders of the company immediately before the conversion become partners of the LLP. Their capital contribution and profit sharing ratio should be in the same proportion as their shareholding in the company as on the date of the conversion; iii. The shareholders of the company do not receive any consideration or benefit other than share in profit and capital contribution in the LLP; iv. The aggregate of the profit-sharing ratio of the erstwhile shareholders of the company in the LLP shall not be less than

6 percent of the profits of LLP at any time during the period of 5 years from the date of conversion; v. All assets and liabilities of the company immediately before the conversion become the assets and liabilities of the LLP; and vi. No amount is paid, either directly or indirectly, to any partner out of the accumulated profit standing in the account of the company as on the date of conversion for a period of 3 years from the date of conversion. If all the above conditions(i) to (vi) are complied with, the conversion shall not attract capital gains tax either for the company or the successor LLP or for the shareholders of the company (who become partners in the successor LLP and get share of profits and capital in the LLP in lieu of their shares in the company). New sub-section (4) of section 47A provides that where any of the conditions laid down in section 47(xiiib) [i.e. conditions (i) to (vi) above] are not complied with, the amount of capital gains arising from the transfer of such capital asset or intangible asset or share or shares not charged under section 45 by virtue of the said conditions shall be deemed to be taxable capital gains of the successor LLP or the shareholders of the predecessor company in the previous year in which such non-compliance takes place. Advantages of conversion of Private companies to LLP: a) Dividend Distribution Tax(DDT): DDT is payable by resident companies on distribution of profits to its shareholders. As an LLP is not a company, DDT would not be applicable on distribution of profits by an LLP. b) Deemed Dividend: Transaction involving distribution by a company of accumulated profits entailing release of all/any part of assets to its shareholders/distribution to the shareholders at the time of reduction of capital/payments of advance /loan to shareholder, etc are normally categorized as deemed dividends as per the provisions of the income tax Act, Again, as this provision is applicable only to companies, LLP would not be affected

7 c) Carry forward/set-off of losses: Unabsorbed accumulated loss/depreciation of company carry forward and set off to successor LLP The Finance Act, 2010 has amended section 72A of the Act by inserting new sub-section (6A). The new sub-section (6A) provides that the accumulated business loss and unabsorbed depreciation of the predecessor company shall be allowed to be carried forward and set-off of by the successor LLP if all the above conditions [conditions (i) to (vi) above] in clause (xiiib) of section 47 are satisfied. The accumulated business loss and unabsorbed depreciation of the predecessor company shall be deemed to be the accumulated business loss and unabsorbed depreciation of the successor LLP for the purpose of the previous year in which the business reorganization by way of conversion of company into LLP is effected and the provisions of the Act shall accordingly apply. If the conditions stipulated above are not complied with, the benefit availed by the company shall be deemed to be the profits and gains of the successor LLP chargeable to tax for the previous year in which the requirements are not complied with. d) Interest on Capital Contribution: A Partner is entitled to receive interest on his capital contributions (irrespective of whether LLP makes a profit or loss) if LLP agreement so provides. The interest is deductible in the hands of the LLP under section 40(b) subject to certain conditions. A shareholder of a private company is entitled to dividend only if the company makes a profit. Further, dividend is not a deductible item of expenditure in computing taxable income of the private company. On top of it 18% has to be paid by the company on dividend declared by it. This makes share capital a very costly component of finance for private company compared to capital contributions from partners in case of a LLP. e) LLP can maintain its accounts on cash basis: LLP is allowed to maintain its books of accounts on either accrual basis or cash basis. Companies are required by the Companies Act, 1956 to maintain books of account only on accrual basis. f) Remuneration paid to partners: Payment of salary, bonus, commission or remuneration to working partner of an LLP would be required to be authorised by LLP agreement

8 However, it should also be born in mind that the over all Ceiling of monitory limit would be as under: Book Profits On the first Rs.3,00,000/- or in case of loss On the balance of book profits 60% thereof Limit on Remuneration Rs. 1,50,000/- or 90% of book profit, whichever is more g) No Wealth-Tax on LLPs: Wealth Tax is applicable to Individual, HUF & Companies. Accordingly LLPs are not required to pay Wealth Tax. h) Benefit of amortization of VRS payments made by predecessor company In section 35DDA, a new sub-section (4A) has been inserted by the Finance Act, 2010 to provide that where there has been reorganization of business, whereby a private company or unlisted public company is succeeded by a limited liability partnership fulfilling the conditions laid down in clause (xiiib) of section 47, benefit of amortization of Voluntary Retirement Scheme payments shall, as far as may be, apply to the successor limited liability partnership, as they would have applied to the said company, if reorganization of business had not taken place. However, no amendment has been made to section 10(10C) to provide tax exemption to employees of an LLP in respect of VRS payments received by them from employer LLP. Thus, it makes sense for the company to first implement the VRS scheme before converting to LLP so that employees can avail the benefits under section 10(10C) of the Act. i) No compulsory audit for small LLPs: A Private company irrespective of its size and volume of activity (turnover) has to get its accounts audited annually. A LLP is required to get its accounts audited only if turnover exceeds Rs.40 Lakhs or its capital contribution exceeds Rs.25 Lakhs. Disadvantage of conversion of Private Limited companies into LLPs: The disadvantages of such conversion are: a) LLP are made liable to pay MAT from Assessment Year by Finance Act

9 b) No MAT to successor LLP: If a private company which has MAT credit under section 115JAA converts to LLP, it shall lose the MAT credit. The Finance Act, 2010 has proposed to insert a new sub-section (7) in section 115JAA to provide that MAT credit of the predecessor company shall not be available to the successor company. Thus, it may make sense for the company to first avail the MAT credit before converting to LLP. The above provisions of section 115JAA(7) shall apply regardless of whether the conversion complies with section 47(xiiib) or not. c) Certain deductions such as 80IA (4) (i), 80IB (6), 80IB (7) under the Act are available only to companies. d) No Exemption u/s 10(10c) available to employees of a LLP in respect of VRI payments received from an employer LLP. V. Conclusion: The new hybrid entity structure could be of immense utility for emerging entrepreneurs and professional alike from taxation point of view also. However regulatory bodies like ICAI, ICSI & ICWAI need to amend the existing regulations to accommodate their members to set up an LLP structure. ******* - 9 -