Conversion Process from Private Limited Company to LLP

In this article, I will explore the provisions pertaining to the conversion of Private Limited companies into Limited Liability Partnership. Drawing from my recent experience of successfully converting a Private Company into a Limited Liability Partnership, this write-up will provide both theoretical insights and practical guidance on this conversion process.

The transition of a Private Limited Company into a Limited Liability Partnership (LLP) is regulated by the Limited Liability Partnership Act of 2008. Specifically, Section 56, Section 58, and Schedule III of this Act lay out the rules and steps for executing the transition from a Private Limited Company to an LLP.

As per Section 56 in combination with Schedule III and applicable regulations, only private companies are eligible for conversion into an LLP, as per Schedule III Para I Company, which specifically refers to private limited companies. Moreover, it’s important to understand that conversion in this context doesn’t simply involve changing the name of the organization, but also transferring all of its assets, liabilities, property, rights, privileges, obligations, and interests from the private company to the LLP as per the given schedule.

ELIGIBILITY FOR CONVERSION OF PRIVATE COMPANIES INTO LIMITED LIABILITY PARTNERSHIP

The discussion now turns to which companies are eligible for conversion and the manner in which they can transform into an LLP.

ELIGIBLE COMPANIES

For a company to be eligible for conversion, it must meet the following criteria:

1. At the time of making the application, there should be no active security interest on the company’s assets. It may have existed prior to making the application for conversion, but it must not be active when making the application.

The term “security interest” is not specifically defined under either Schedule III or the LLP Act, 2008. Nor is it defined in the Companies Act, 2013. However, the term “Charge” is defined under Section 2 clause 16 of the Companies Act, 2013 as “an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage.” The concepts of charge and security interest are not synonymous as the concept of security interest is broader than charge.

The security interest is defined under Section 2(1)(zf) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 as “the right, title, and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31.” Section 31 details conditions under which the SARFAESI Act, 2002 does not apply.

2. Only the shareholders of the converting company should become partners in the LLP.

While the LLP Act of 2008 doesn’t explicitly cover the proposed partnership structure, the capital contribution by those partners, and the distribution of profits among those partners, the Income Tax Act does lay out certain constraints, which we will examine in this discussion.

PROCESS OF CONVERSION

A company transitions into an LLP by following the procedures described in the Third Schedule of the LLP Act, 2008, as outlined in Paragraph 2 of the Third Schedule, in addition to Rule 32 and 39 of the LLP Rules, 2009.

The Third Schedule of the LLP Act, 2008’s third paragraph highlights the general procedural facets and is largely directive. It specifies two documents that are necessary for a company to convert into an LLP:

a. A statement by shareholders in the prescribed format and manner, along with the applicable fees. This statement should include the following details:

• The Company’s Name and Registration Number.
• The Company’s Date of Incorporation.

b. Documents of incorporation and a statement referred to in section 11, such as a subscriber sheet, etc.

The majority of the conversion procedure from a Private Limited Company to an LLP is covered under Rule 39.

STEPS TO CONVERT THE COMPANY INTO THE LLP

A company transitions into an LLP by following the procedures described in the Third Schedule of the LLP Act, 2008, as outlined in Paragraph 2 of the Third Schedule, in addition to Rule 32 and 39 of the LLP Rules, 2009.

The Third Schedule of the LLP Act, 2008’s third paragraph highlights the general procedural facets and is largely directive. It specifies two documents that are necessary for a company to convert into an LLP:

a. A statement by shareholders in the prescribed format and manner, along with the applicable fees. This statement should include the following details:

The Company’s Name and Registration Number. The Company’s Date of Incorporation.

b. Documents of incorporation and a statement referred to in section 11, such as a subscriber sheet, etc.

The majority of the conversion procedure from a Private Limited Company to an LLP is covered under Rule 39.

STEPS TO CONVERT THE COMPANY INTO THE LLP

The conversion process from a company to an LLP starts with the board passing a resolution to reserve the name. Prior to initiating the conversion process, the company must ensure that:

a. There are no pending eForms for payment or processing.

b. At least one Financials (AOC-4) and Annual Return MGT-7/7A have been filed by the company.

c. The Company is not a Section 8 Company.

d. The company must have share capital.

The initial step is to reserve the name. The form RUN LLP must be filed to reserve the name. The board resolution approving the reservation of the LLP name for the conversion of the company into the LLP must be attached with Form RUN LLP.

After the reservation of the name, the company is to file a conversion form (eForm 18), along with an incorporation form (FiLLiP) and the consent of the Designated Partners in eForm 9.

In MCA Version 3, we begin filling out the FiLLiP form after selecting the radio button for conversion of Private Company into LLP. The FiLLiP form is filled out in the same way as for incorporating an LLP. The following documents must be attached with the FiLLiP form:

• Proof of ID and Address for the Partners.
• Proof of Registered Office along with NOC Subscribers sheet

Form 9 is filed under Section 7, Rule 7, and other applicable provisions of the LLP Act, 2008. In MCA Version 3, Form 9 is pre-filled and does not require any input.

Form 18 is completed after FiLLiP and Form 9. Form 18 requires providing various details such as if any case is pending, total assets, total financial assets, and total revenue, etc.

The required attachments in Form 18 include:

• Financials drawn as per schedule III and signed by the Directors and Auditor of the Company, not older than 15 days.
• List of Secured Creditors and their consent. If the company does not have any secured creditors, it is recommended to furnish an affidavit of the same effect.
• In case the company is regulated by any specific body or authority, then approval from such authority or body is required.
• The company needs to file the latest income tax return filed by them.
• Auditor Certificate
• Additional documents as requested by the approving authority, such as: a Certificate from the Auditor certifying that the company is not an NBFC (Non-Banking Financial Company), the most recent Annual Return of the Company, ADT-1 form for the appointment of the Statutory Auditor of the Company, and an Ordinary Resolution or Board Resolution for the appointment of the Auditor.

POST CONVERSION COMPLIANCE AND INCOME TAX PROVISIONS

Once the Company is converted into an LLP. The Registrar of Companies shall issue the Certificate of Conversion in Form 19 under Rule 32(1) of the LLP Rules 2009 to be read with the Schedule III and LLP Act, 2008.

The LLP Shall file an initial LLP Agreement in Form 3 within 30 days of the conversion. Though, as per Rule 21, the LLP Agreement needs to be filed within 30 days of incorporation, incorporation means registration under the LLP Act, 2008 and includes conversion.

After Conversion, LLP and its Partners need to comply with the provisions of the LLP Act 2008 along with Schedule III and Rules made thereunder.

GLIMPSES OF INCOME TAX PROVISIONS 

We have to analyze income tax implications for conversion of a company to an LLP to achieve tax efficient conversion.

Section 45 of the Income Tax Act (‘IT Act’) provides that any profits or gains arising from the transfer of a capital asset shall be chargeable to tax under the head ‘Capital gains’.

Section 2(14) of the IT Act defines the term ‘capital asset’ to include property of any kind held by an assessee, whether or not connected with his business or profession. Therefore, in context of a company, following would qualify as capital assets:

Assets of the company which are being transitioned to the LLP

Shares held in the company by its shareholders.

Further, Section 2(47) of the IT Act defines ‘transfer’ in an inclusive manner, so as to include sale, exchange, relinquishment of the asset or extinguishment of any rights therein. Given the wide definition of ‘transfer’, a view is taken that conversion of company should be covered within the ambit of ‘transfer’ and accordingly, any profits or gains arising on conversion of a company to an LLP should be chargeable to tax as capital gains on two accounts:

Transfer of capital assets from company to LLP upon conversion; and

Transfer of a shares held in the company by a shareholder as a result of conversion of the company into an LLP

Furthermore, Section 48 of the IT Act provides the mode of computation of capital gains, wherein full value of consideration received/accrued pursuant to transfer is reduced by the cost of acquisition of the transferred asset to arrive at capital gains.

Accordingly, the gains derived on conversion of a company to an LLP may be subject to tax as per Section 45, computed in terms of Section 48 as follows:

EXEMPTION PROVIDED UNDER SECTION 47 FROM LEVY OF CAPITAL GAINS TAX

Section 47 (xiiib) of the IT Act provides an exemption from levy of capital gains tax on the abovementioned transfers pursuant to conversion of a company to LLP subject to fulfilment of below specified conditions:

a.) Transfer of all assets and liabilities: All the assets and liabilities of the company immediately before conversion become the assets and liabilities of LLP.

b.) All shareholders to become partners in LLP: All the shareholders of the company immediately before conversion become the partners of LLP and their capital contribution and profit-sharing ratio in the LLP are in the same proportion as their shareholding in the company as on the date of conversion.

c.) Consideration to shareholders: The shareholders of the company does not receive any consideration or benefit, other than by way of share in profit and capital contribution in LLP.

d.) Profit sharing ratio of shareholders in LLP: The aggregate of the profit-sharing ratio of the shareholders of the company in LLP should not be less than 50% at any time during a period of 5 years from the date of conversion

This point is important to be read with LLP Act, 2008 Schedule III, LLP Act, 2008 does not prohibit the change in partnership structure. However, to enjoy the benefit of taxation one much notice that profit sharing ratio of the shareholder turned partner shall not be less than 50%.

e.) Total sales, turnover or gross receipts in the business of the company: Must not exceed INR 60 lakhs in any of the 3 previous years preceding the previous year in which the conversion takes

f.) Total value of the assets as appearing in the books of account of the company: Must not exceed INR 5 crores in any of the three previous years preceding the previous year in which the conversion takes

g.) No amount to be paid to any partner out of accumulated profits of the company as appearing on conversion date for a period of 3 years from the date of

Moreover, Section 47A of the IT Act provides that if any of the conditions mentioned above are not complied with, then the amount of gains arising from the transfer pursuant to conversion to LLP which have not been charged to tax by virtue of fulfilment of above mentioned conditions, shall be deemed to be the gains chargeable to tax in the hands of the successor LLP or the shareholder of the predecessor company, as the case may be, for the previous year in which any of such condition is breached.

Conclusion: The process of converting a Private Limited Company into a Limited Liability Partnership is multifaceted, involving various stages like ensuring eligibility, proceeding with the conversion process, and following post-conversion compliance norms. It is also vital to consider the income tax implications of such a conversion to avoid legal and financial complications. Successful conversion can bring benefits such as more flexibility in business operations and less stringent compliance requirements.

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CS Nishant Mishra | Practicing Company Secretary | Mobile:9899864768 | E-Mail: [email protected]