Before I get into the intricacies of “Business Restructuring through conversion into LLP”, let me give you a brief context that led to the evolution of LLP as a flexible route for business ventures.
Need and Evolution:
The traditional business structures for small and medium scale enterprises (SMEs) most often seen in India are proprietorships, partnerships and incorporated companies. Of these, the former two are most vulnerable due to restricted members’ strength, resulting into lack of adequate capital as well as the fragile feature of both the forms due to unlimited liability of members and non separate legal entity adds more business risks. Likewise, the incorporated companies inevitably come with the array of statutory compliances which impose restrictions on them to be an enticing corporate venture.
In order to mitigate the aforesaid hardships, there has been an urgent need for a new corporate structure that would provide an alternate to traditional partnership, with unlimited liability, on the one hand and statute based governance structure of limited liability on the other. The resultant structure carrying eminent features of both the structures is the Limited Liability Partnership [LLP] through enactment of the Limited Liability Partnership Act, 2008 in India which received the assent of the President on 7th January, 2009.
Now the professionals and the small and medium entrepreneurs prominently fit into the framework of the LLP to reorganize their business in a most efficient manner, as it would allow an entrepreneur to get into the business without exposing his full assets to it.
Attribute to Manufacturing and Service Sector:
LLP provides a bridge between the two risks where an entrepreneur would be able to foray into a business venture without any fear of being held liable for the partners’ misconduct. Therefore, LLP is viewed as an alternative business vehicle in both manufacturing as well as service sector.
“In the professional world, doctors, dentists and lawyers get together to form limited liability partnerships where partners own the company and split profits according to ownership percentages.” -Kristy
As such the Limited Liability Partnership form has opened the door for Manufacturing Sector to enjoy the dual advantage of less compliance with higher access to credits in the market. Another advantage for SMEs that in the new LLP form alike Companies, only the Limited Liability Partnership having turnover/contribution of more than Rs. 40/25 Lacs have to get their accounts audited as per the requirement of law providing a step ahead in the flexibility.
LLP has come like boon for the Service Sector and especially for professionals like chartered accountants, company secretaries & lawyers. Now, LLP will give the professions the much needed impetus of global presence and level playing field against their foreign counterparts. From the perspective of customers, Limited Liability Professional Partnership concerns will provide a single-window shop to all people wanting to avail professional services. From the perspective of professionals, the regime of limited liability partnership will provide a platform to conduct profession efficiently that would in turn increase the capability to compete with global firms apart from making the presence felt in international market for professional services.
Reorganization of Existing Business Entities:
Since LLP is a unique blend of General Partnership and Limited Company, so to make available the benefits of the LLP structure to the existing partnership firms, private limited companies and unlisted public limited companies, the LLP Act, 2008 contains enabling provisions pursuant to which a firm (set up under the Indian Partnership Act, 1932) and private company or unlisted public company (incorporated under the Companies Act, 1956) would be able to convert themselves into LLPs.
While taking the decision to convert into an LLP, firms are faced with weighing up the risk management benefits versus the costs of conversion. The level of costs will depend on whether the firm undertakes the legal work in-house, or enlists the help of an external specialist who has experience of other conversions.
Conversion of sole proprietorship into an LLP is not possible due to only presence of sole entrepreneur in the proprietorship firm.
Any conversion of a company with FDI into an LLP will be allowed only if the company is engaged in sectors/activities where 100% FDI is allowed, through the automatic route and there are no FDI-linked performance related conditions and prior approval of FIPB/Government is obtained.
Just like a company, it is also possible to compromise or arrange merger and amalgamation of two or more LLPs as well as merger between LLP and a private company. Provisions of section 60 to 62 of the LLP Act provide for the manner in which compromises or arrangements including mergers and amalgamations involving LLPs shall be allowed. These provisions are akin to the Sections 230-232 of the Companies Bill, 2011 or Sections 391-394 of the Companies Act, 1956 with respect to Amalgamation/Mergers or reconstruction of Companies.
Conversion of Partnership Firm into LLP:
LLP is a business structure which offers almost all the advantages of a partnership and at the same time mitigates the disadvantages of the traditional partnership to a large extent. These exclusive advantages of LLP over partnership coupled with the flexibility of a partnership structure serves as the foundation stone for a LLP.
Major advantages of conversion
- Unlimited number of partners in LLP.
- Limited liability of partners.
- No limit for minimum capital contribution.
- No exposure to personal assets of the partners
- Partners are not agents of other partners.
- LLPs enjoy higher creditworthiness compared to Partnerships.
- Recognized as body corporate.
- Separate legal entity, hence, feature of perpetual succession unlike partnership.
- Exclusively, multidisciplinary LLPs are allowed.
- Partners can transfer their right to share profits to anyone else.
- Foreign Investment (FDI) is also allowed to access to foreign expertise.
- Complete flexibility in managing the business.
- Partner can enter Joint Ventures with other parties in the name of LLP, which is otherwise not feasible in case of partnerships
- Being regulated form of business, LLP will attract investment from PE Firms and other investors.
Pre-requisites for conversion
A partnership firm may convert itself into a limited liability partnership (LLP) as per Section 55 and second schedule of the LLP Act, 2008, subject to following per-conditions –
- The partnership firm to be registered under the Indian Partnership Act, 1932.
- All the partners of the firm should become the partners of LLP on its conversion.
- The designated partners should receive their DIN (Director’s Identification Number) on conversion.
- Digital Signature Certificate for one of the Designated Partners.
- Minimum of 2 designated partners should be appointed and one of them to be resident of India.
- Name of proposed LLP (Limited Liability Partnership).
- LLP (Limited Liability Partnership). Agreement.
- Registered office for the existing partnership firm.
Conversion of CA firms
In terms of Council decision dated 14th July, 2011, guidelines for Conversion of CA firms into LLPs and constitution of separate LLPs by the practicing chartered accountants have been finalized. Therefore now existing CA firms may convert themselves into LLPs and the other members in practice can form new LLPs. This new amendment will pave the way for a consolidation of so many small CA firms, help them to grow exponentially and expand in scale and operations and have savings in cost by way of infrastructure.
Tax implication on conversion
LLP and traditional partnership is being treated as equivalent (except for recovery purpose) in the Act, the conversion from a partnership firm to an LLP will have no tax implication, if the rights and obligation of the partners remain the same after conversion and if there is no transfer of any asset or liability after conversion. If there is a violation of these conditions, the provision of capital gain will apply.
Conversion of Private/Unlisted Public Company into LLP:
LLP is an extremely beneficial form of business structure, having certain inherent advantages over the private company structure, i.e. operational benefits, financial flexibility, tax efficiency, etc. All these advantages pave the way for the conversion of private/unlisted public companies into LLP.
Major advantages of conversion
- Flexibility in operations
- Less Statutory Compliances, i.e. No mandatory requirement to hold any meeting, maintain minutes, statutory records or statutory registers
- Minimum regulatory compliances
- Unlimited number of partners unlike private limited company
- Minimum Government Intervention
- Easy to dissolve or wind up
- Partners can increase the capital anytime without paying additional fees
- Withdrawal of capital possible
- Minimal cost of conversion
- Withdrawal of profits anytime and in any ratio by different partners
- No mandatory audit requirement where the annual turnover is less than or equal to Rs. 40 lacs and the contribution of the partners is less than or equal to Rs. 25 lacs
- No Surcharge or Dividend Distribution Tax for LLP
- Interest on capital and accumulated profits deductable while arriving at taxable profits of LLP
- Restricted applicability of minimum alternative tax (MAT) as alternate minimum tax (AMT).
Pre-requisites for conversion
A private company may convert itself into an LLP as per section 56 and third schedule of the act and an unlisted Public company may be converted into an LLP as per section 57 and the fourth schedule of the act, subject to following pre-conditions –
- Company to be registered under the Companies Act, 1956.
- Partners of LLP should comprise all the shareholders of the company and no one else.
- At least 2 designated partners, of whom 1 to be a resident in India.
- Designated partners to obtain DIN if they don’t have one.
- Digital signature certificate for at least one of the designated partners.
- LLP (Limited Liability Partnership) name.
- LLP (Limited Liability Partnership) agreement.
- No security interest in its asset shall subsist or in force at the time of application.
Tax implication on conversion
Conversion of private/unlisted public company into LLP is exempt from tax in terms of clause (xiiib) in section 47 of the Income Tax Act 1961 introduced by way of The Finance Act 2010. Therefore, Capital Gain on conversion of Company into LLP will be exempt from tax, if prescribed conditions are complied with. Further, the successor LLP will not be allowed to take the credit of MAT paid by the predecessor company.
Carry Forward and Set off Losses and Unabsorbed Depreciation
The accumulated loss and unabsorbed depreciation of Company is deemed to be loss/ depreciation of the successor LLP for the previous year in which conversion was effected and such loss can be carried for further eight years in the hands of the LLP.
Status on conversion of firm or company into LLP
It is essential to note that on conversion, all the members of the firm or the company shall become the partners of the LLP. Upon such conversion, on and from the date of certificate of registration issued by the Registrar in this regard, the effects of the conversion shall be such as are specified in the act. On and from the date of registration specified in the certificate of registration, all tangible (movable or immovable) and intangible property vested in the firm or the company, all assets, interests, rights, privileges, liabilities, obligations relating to the firm or the company, and the whole of the undertaking of the firm or the company, shall be transferred to and shall vest in the LLP without further assurance, act or deed and the firm or the company, shall be deemed to be dissolved and removed from the records of the Registrar of Firms or Registrar of Companies, as the case may be.
Steps for conversion of firm or company into LLP
Although Limited Liability Partnership is a new concept for Indian business community, it is expected that a number of firms, private and unlisted public companies will get the benefit of limited liability and the flexibility it offers for internal management of business through Redefinition of Business Affairs into LLP.
The LLP form would enable entrepreneurs, professionals and enterprises providing services of any kind or engaged in scientific and technical disciplines, to form commercially efficient vehicles suited to their requirements, especially to Chartered Accountants who have begun transforming into limited liability partnerships and multidisciplinary combinations, inviting global opportunities. Owing to flexibility in its structure and operation, the LLP would also be a suitable vehicle for small enterprises and for investment by venture capital.