Numerous businesses start in India in different entity structures such as Proprietorship, Partnership Firms, Limited Liability Partnership (LLP), Private or Public Limited Companies, etc.
As the business grows with the desire of the owners of the entity to expand into the vivid horizons; business houses often make changes in the entity structures to align themselves with their business strategies and goals.
In this article, we focus on the conversion of the LLP to a Private Limited Company (hereinafter referred as ‘company’).
We shall shed some light in the following items related to the conversion;
1. Primary needs and benefits to convert from LLP to Company
2. Details about the conversion process
3. Ascertaining the Financial Year if conversion happens during the year
4. Issues related to the Income Tax Act
5. Issues related to the GST Act
6. Compliance with other regulations
7. Conclusion
Page Contents
- 1. Primary needs and benefits to convert from LLP to Company
- 2. Details of Conversion of LLP to Private Limited
- 3. Ascertaining the Financial Year if conversion of LLP to Private Limited happens during the year
- 4. Issues related to the Income Tax Act on conversion of of LLP to Private Limited
- 5. Issues related to the GST Act on conversion of of LLP to Private Limited
- 6. Compliance with other regulations
- 7. Conclusion
1. Primary needs and benefits to convert from LLP to Company
One of the ways to expand the business is infusion of the capital. Due to the separation of management from ownership along with added increment in the supervisory compliances of the companies, investors often feel secure and comfortable to invest in a company rather than investing in a LLP. This is a major reason why various entities including LLP convert themselves into a company. Further they prefer not to incorporate a new company as they might loose the history and branding of the existing entity. Additionally, incorporating a new company and subsequently transferring business and assets from LLP to the new company will result in capital gains tax and may also include stamp duty implications. Hence conversion is opted.
2. Details of Conversion of LLP to Private Limited
Conversion of the LLP to company requires compliance with various laws and regulations. In order to convert the LLP to company, the entity firstly has to file relevant forms with the registrar of companies and seek permission for conversion. Once the conversion permission is granted the LLP ceases to exist and the company comes into existence.
LLP can be converted into a Private Limited Company as per the provisions contained in Section 366 of the Companies Act, 2013 and Company (Authorised to Register) Rules. Conversion Process involves applying for name approval and then filing forms URC 1 along with other relevant forms and documents. The registrar of companies grants registration to the company if all the necessary paperwork and forms are correctly filed; post which the LLP ceases to exist and the converted company comes into the existence.
Post conversion the converted company has to procure new PAN and TAN from the Income Tax Dept. and further register newly with different laws for e.g. State Profession Tax, GST, etc. It is important to remember that the company has to apply for a new PAN as there is a change in the entity structure and the company cannot use the previous PAN of the LLP.
3. Ascertaining the Financial Year if conversion of LLP to Private Limited happens during the year
Once the LLP is converted into a company the LLP ceases to exist. If the conversion is planned to take place at the yearend or at the beginning of the year there is no confusion with the financial year.
The real confusion arises as to what would be the financial year and how the transactions are to be mapped to the LLP and the company; if the conversion happens during the year.
For e.g. if the LLP is converted to company on 1st December of the financial year what would be the financial year for the LLP and for the Company; and how should the transactions be mapped to them respectively? Section 368 of the Companies Act, 2013 comes to the rescue of this issue which states as under;
“Section 368 – Vesting of property on registration — 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.”
The provisions state that on registration of the company, all the properties including assets and liabilities stand vested to the converted company. Thus, in our example the LLP shall report all transactions up to 30th November while all transactions from 1st December onwards are to be mapped and recorded to the newly converted company’s books. The assets and liabilities of LLP shall be the assets and liabilities of the company w.e.f. 1st December.
However, in practice, compliance to this is not easily possible due to various reasons some which are enumerated below:
1. Time lag from application date to the registrar of companies for conversion and actual acceptance date by the registrar of companies is not the same.
2. Even when the company is incorporated, opening up the bank accounts, GST registrations, amending lease agreements, communicating the conversion changes to the various stakeholders, etc. takes considerable time
This time lag exposes the newly converted entity to various complexities as many a times the transactions are still done on behalf of the LLP. Due professional judgment and care should be exercised in mapping the transactions so as to comply with the government provisions as 1st December (refer example above) shall be taken as the beginning date for the company and accordingly all transactions should be reported in the company’s books.
One of the most important questions to be addressed is whether the conversion is taxable to Income Tax or not. If the conversion is taxable then capital gains tax has to be paid. Conversion to be not taxable has to comply with the provisions of Section 47 under the Income Tax Act.
The provisions state that the conversion to be not taxable has to comply with all of the below conditions;
1. all the assets and liabilities of the firm (reference to LLP is drawn over here) relating to the business immediately before the succession (meaning conversion) become the assets and liabilities of the company;
2. all the partners of the firm immediately before the succession become the shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of the succession;
3. the partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company;
4. the aggregate of the shareholding in the company of the partners of the firm is not less than fifty per cent of the total voting power in the company and their shareholding continues to be as such for a period of five years from the date of the succession
If the conversion taken place complies with all the above conditions, there shall be no capital gains tax.
Practical issues in carry forward of losses – Another item of concern is to take and carry forward tax losses and unabsorbed depreciation. Section 72A of the Income Tax Act provides for carry forward of Business losses and unabsorbed depreciation from LLP to the company.
Although there is clear provision for the carry forward of losses, there are practical difficulties due to the limitations in the current ‘Income Tax Forms’ available for filing the return of income by the companies. There are no separate columns in the Income Tax Forms whereby the brought forward losses from the LLP can be declared and hence carrying forward the losses even though being allowed by the Income Tax Act becomes difficult. Even when the company tries to carry forward the losses and then set off them with the profits the same is disallowed due to system limitations. Due professional judgment is required in this case in order to carry forward the losses as the existing Income Tax forms and the Centralized Processing Centre have inherent limitations in their systems which are under improvisation.
Other practical difficulties in claiming the outstanding Income Tax refund – Post conversion the LLP ceases to exist and operating any bank accounts on behalf of the LLP is not legally valid. Since refunds and assessment shall be done in the “Old” LLP PAN, it becomes generally difficult to do so due to inherent system limitations. This issue is not yet catered by the Income Tax website as the release of refund is related to the Pan and Bank Account of the LLP which are required to be surrendered / closed post conversion. Practically we have come across entities keeping their bank accounts open until the refund is issued, but as mentioned; the bank account should ideally be closed on conversion or should be changed to the bank account of the converted company.
Currently there is no facility on the GST portal to update the conversion information with the GST authorities. The only option is to surrender the registration of the LLP and obtain a new GST registration of the company. Nevertheless issues arise if there are any unutilized Input Tax Credit (ITC) and balance in Cash ledger. The real challenge is to transfer the unutilized ITC from the LLP GST registration to the company GST registration. In order to achieve that form GST ITC-02 along with a request for transferring the unutilized ITC has to be filed. For balance in cash ledger the only option is to file for a refund. Ironically this refund is also made to the bank account of the LLP which is supposedly to be closed or updated with the company details.
6. Compliance with other regulations
Either Conversion information has to be updated or new registrations should be obtained with MSME, Profession Tax Act, DGFT regulations, etc. as applicable and as required.
7. Conclusion
Despite various provisions being framed to ensure compliance in conversion process of LLP to a Company, there are various tangible issues and challenges that need consideration and clarification from the government.
Disclaimer – we owe no responsibility for any inadvertent omissions or errors in the content of this article. Please consult a tax professional or expert for specific scenarios.
(Author can be reached at pavangoyal30@gmail.com)
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