Insight on Conversion of A Company Into LLP

LLPs have gained its importance since the introduction of Companies Act 2013. The LLP is a separate legal entity, liable to the full extent of its assets but the liability of the partners is limited to their agreed contribution in the LLP. A limited liability partnership (LLP) is a partnership in which some or all partners (depending on the jurisdiction) have limited liabilities. It, therefore, consolidates the elements of partnerships as well as corporations. In an LLP, each partner is not responsible or liable for another partner’s misconduct or negligence.  LLP carries the advantage of the Company and versatility of partnership firm. These days the conversion of Company into an LLP has also become a significant tool to close the Company. In simple words, we can say that LLPs are appropriate for medium and small-scale business organizations as well as for professional firms wherein the ownership is limited to certain people. In this write-up, the author intends to discuss the detailed process of Conversion of Company into an LLP, conditions for conversion of Company into LLP, pros and cons of conversion along with tax implication arising out of Conversion of Company into LLP.

1. Conditions/ Eligibility for Conversion of a Company into LLP

i) There should be no security interest created on assets at the time of applying for conversion

ii) The concerned Company must have no pending e-Forms for approval

iii) The concerned Company must have no open charges against it

iv) The concerned company must have filed at least one balance sheet and annual return

2. Process of Conversion of Company into LLP

In the wake of successfully initiating Ease of Doing Business reforms by introducing game-changing, simplified, and integrated procedures viz. SPICe (Simplified Proforma for Incorporating Company electronically), Reserve Unique Name(RUN) for starting a business in India, the Ministry of Corporate Affairs has also launched another major reform by way of process reengineering of incorporation of Limited Liability Partnership(LLP) as well on a big scale. We have tried to elaborate the detailed process of the Conversion of Company into LLP, mentioned hereunder:

1) Convene a Board Meeting to pass the resolution for conversion of the Company into LLP.

2) Reserve the name using RUN-LLP as available on mca.gov.in

3) File Form FiLLiP for New incorporation/ Conversion of the firm into LLP/Conversion of private company/unlisted public company into LLP). Attachments required with such Form are as follows:

• Proof of Registered office (for eg.: utility bill, NOC and proof of ownership)
• Identity proofs and residence proofs of partners and designated partners.
• Consent to act as a designated partner as per the format provided in Rule 7 and Rule 10(8) in LLP Rules, 2009.
• Subscriber Sheet
• Details of Companies/LLPs in which the partners/designated partners are Directors/Partners or Designated Partners.

4) File Form-18. Attachments required along with this Form are as follows:

• Statement of the consent of shareholders
• Statement of Assets and Liabilities of the company duly certified as true and correct by the auditor
• List of all the secured creditors along with their consent
• Approval from any other body/ authority.
• Copy of acknowledgment of the latest income tax return.

5) File Form 3 within thirty days of incorporation of LLP attaching the LLP agreement mentioning therein the terms and conditions of Limited Liability Partnership among the partners.

3. List of Documents/Information required from the client for Conversion of Company into LLP:

The documents/ information required in this regard in enunciated hereunder for ready reference:

• Proof of Address of registered office of LLP (Conveyance Deed, Rent Deed, Lease Deed or such other documents); (Anyone)
• Proof of identity and address of each Designated partners, (Directors) and Subscribers (PAN Card and Aadhar Card). Kindly note that if the duration of stay at the present address is less than one year then address of the previous residence shall be required;
• DPIN, email id, occupation, educational qualification, voter card number of designated partners and subscribers;
• Whether any pending proceedings or conviction, ruling, order, judgment is pending in any Court/ Tribunal in the name of the Company
• Whether any application has been filed earlier for the conversion of the said Company into Limited Liability Partnership, if yes please provide the details;
• Copy of the latest income tax return;
• List of creditors; and (if any)
• List of assets and liabilities of the Company. (certified by Chartered Accountant)

Once the concerned Company is converted into LLP, there are some pros and cons arising out of such conversion, we have tried to highlight the same for quick apprehension of the same, enumerated hereinbelow:

4. Advantages of Conversion of Company into LLP

1. Lesser compliance cost compared to a Company;

2. The audit is necessary only if turnover and contribution exceed Rs. 40 lacs and Rs. 25 lacs respectively;

3. Various stringent provisions that prohibit the Company to take loans from an individual or give loans to the respective Director are not there in case of LLP;

4. There are no restrictions on related party transactions in case of LLP;

5. Non-applicability of MAT;

6. On conversion of Company into LLP, assets of the Company will be converted into LLP. There is no requirement for instrument transfer. Hence, no stamp duty implication would arise on such transfer;

7. After conversion, there would be no restrictions on the number of partners;

8. After conversion into LLP, no requirement on holding a minimum number of meetings and maintaining statutory records is required. Only the Annual Statement of Accounts and Solvency & Annual Return needs to be filed every year.

9. Share of Profit in LLP is exempted from Income Tax in the hands of Partners.

10. Sale of shares of a Company share is subject to valuation under the Income Tax Act and may lead to tax consequences in case the Valuation norms are not met. There is no such valuation requirement in the case of an LLP.

11. Interest can be paid on capital which is generally deductible expenses under the provisions of Income-tax laws.

12. CSR provisions don’t apply for LLP.

5. Limitations of Conversion of Company into LLP

• The Income Tax Rate for LLP is 30% which is at a higher side as compared to Companies.
• There are many deductions like R&D which are available only to Companies.
• There are restrictions on LLP to raise funds through ECB.
• LLP is barred from receiving an unsecured loan from Partners under Banning of Unregulated Deposit Scheme Act 2019. Partners can only make a contribution to the Firm, not as an unsecured loan like Company.
• Partners of LLP would be jointly and severally liable for any tax due under the Income-tax Act 1961. The expression “tax due” includes penalty, interest, or any other sum payable under the Act.
• As per section 40(b) of the Income-tax Act, 1961, Interest & Salary paid to partners by the LLP are allowed to be deducted as an expense only in case all the specified conditions are fulfilled. Further, any Salary or Bonus or Commission or any other Remuneration paid to non-working Partner shall be disallowed.

6. Things to Be Considered While Converting A Company Into An LLP

There are some key points which are required to be dealt with at the time of applying for the Conversion of Company into LLP:

• If there are any existing charges, then the Company has to obtain NOC from Charge Holders.
• After Conversion, PAN, GST Registration needs to be changed accordingly.
• Company shall be deemed to be dissolved & removed from the records of the ROC
• Pending proceedings may be continued, completed enforced by or against LLP
• Conviction ruling, order judgment may be enforced by or against LLP
• Existing contracts, agreements, etc. continues and vest in the LLP
• Out of 2 designated partners, of which 1 shall be a “resident in India “

7. Tax Implication on Conversion of Private Limited Company into LLP

There could be tax implications on the conversion of a Company into LLP (for transfer of business) in the hands of LLP and on its shareholders (for extinguishment of shares held in such Company).

The Income-tax Act, 1961 (IT Act) contains specific provisions governing tax implications in case of conversion of a Private Limited Company or an Unlisted Public Limited Company into an LLP. Section 47(xiii)(b) of the IT Act provides that the conversion will be tax neutral for the company and its shareholders, subject to satisfaction of the following conditions:

1. All the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the LLP;

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

3. The shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the LLP;

4. The aggregate of the profit-sharing ratio of the shareholders of the company in the LLP shall not be less than 50% at any time during the period of five years from the date of conversion;

5. The total sales, turnover or gross receipts in the business of the company in any of the three previous years preceding the financial year in which the conversion takes place does not exceed INR 6 million;

6. The total value of the assets as appearing in the books of account of the company in any of the three previous years preceding the financial year in which the conversion takes place does not exceed INR 50 million; and

7. No amount is paid either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of three years from the date of conversion.

The aforementioned conditions are required to be fulfilled to qualify as a Tax-neutral conversion. The IT Act further provides that if any of the above conditions are not complied in subsequent financial years [mainly conditions (d) and (g)] the exempted capital gains will be subject to tax in the hands of the LLP and its erstwhile shareholders, in the year in which such condition is violated.

Now the question arises whether such extinguishment of shares in lieu of partnership interest will be taxable if the conditions specified under section 47(xiii)(b) of the IT Act are not satisfied?

The conversion of a Company into a Limited Liability Partnership (‘LLP’) would not be treated as tax neutral transfer if the conditions prescribed under section 47(iiib) of the Income Tax Act, 1961 (‘the Act’) would not be met.

The Hon’ble Mumbai Bench of the Income Tax Appellate Tribunal (‘ITAT’) in the case of Celerity Power LLP vs. ACIT in 3637/Mum/2015 has held that conversion of a company into LLP would amount to a Transfer. In order to be exempt from tax, it must satisfy the conditions laid down in section 47(iiib) of the Act.

8. Tax implications in the hands of the Company

If the assets of the Company are transferred to proposed LLP at Written Down Value (for depreciable assets) and at Book Value (for non-depreciable assets), no capital gain would arise. Since there are no Fixed Assets owned by the Company in the nature of Land or Building, the implication of Stamp Duty would not trigger.

9. Tax implications in the hands of the Shareholders

The capital received in LLP would be treated as a consideration in the hands of the shareholders and the cost of the share would be the amount paid by them during the time of purchasing such shares. Hence, if the capital allocated in the LLP to each the shareholder is equal to their cost of shares (including security premium), then no capital gain would arise.

If the capital allocated in the LLP to each shareholder is more than their cost of shares (including security premium), a capital gain may arise. However, we can take a plea that Shareholders are transferring their shares to themselves being the partner in the LLP and hence no capital gain should trigger on the shareholder because one cannot be compelled to make a profit by selling to himself. However, this position may be litigated.

10. Conclusion:

From the reading of the above, it is clear that whether a conversion of the Company into LLP is beneficial or not would depend upon facts and circumstances of each case. Since the advantages of converting a Company into LLP comes with corresponding disadvantages, it is recommended to carefully evaluate the pros and cons before taking any such decision.

Further one should be careful with respect to eligibility and process of conversion in order to avoid any future litigation or rejection of the application.