Hiten Kotak, Leader M&A Tax, PwC India and Rekha Bagry, Partner, M&A Tax, PwC India
The article discusses the need for business to be conducted through LLP, the need to migrate from LLP to Company structure, various ways for migration from LLP to Company structure and issues revolving around it.
One chooses a business entity as a sole proprietor, partnership firm or a Company depending on the needs of the business. Partnership firms are created by way of partnership deed between the partners. The drawback is that firms do not have a separate legal entity status and the liability of the partners is unlimited. Whereas a Company gets incorporated and has a separate legal entity distinct from its shareholders. It has perpetual succession but the compliance procedures are cumbersome. To provide a midway between the two, the Government introduced the Limited Liability Partnership (LLP) concept through the LLP Act, 2008 (LLP Act) with the LLP rules notified in 2009. The LLP is a unique form having partners and legally recognised as a corporate entity. Thus, LLP integrates the features of both Company and partnership firms. Small business and startups are opting for LLP registration as it is easy to start with minimum capital, tax benefits of no minimum alternate tax or dividend distribution tax.
LLP works out to be an ideal form of organization, however, a Company is still more acceptable as an established form of organization. As and when the businesses expand, LLPs may have to be converted into a Company owing to various reasons. For example:
- Foreign Venture Capital Investors (FVCI) cannot invest in LLPs except in startups.[i]
- Foreign Portfolio Investors cannot invest in LLPs.
- Foreign Direct Investment (FDI) in Company is under the automatic route in most sectors whereas FDI in LLP can be under the automatic route only if there are no performance linked conditions in that sector.
- A Company can avail more funds in the form of debt in comparison to a LLP.
- Tax implications in case of business re-organizations between LLPs – No specific exemption is provided under the Income Tax Act, 1961 (ITA) for merger / demerger of LLPs.
- Private equity players may not be very comfortable in investing in LLP.
- Restrictions on LLP in availing External Commercial Borrowings. (may be resolved in due course as RBI in March 2017 removed such restrictions).
Section 366 of the Companies Act, 2013 (Cos Act) provides a one way street for conversion of LLP into a Company. This section provides that “Company” includes any partnership firm, limited liability partnership, cooperative society, society or any other business entity formed under any other law for the time being in force and such entities may apply for registration by following the specified procedure laid down in Companies (Authorised to Register Rules), 2014. A few of the conditions are as follows –
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- Written consent from the majority of members whether present in person or by proxy at a general meeting.
- Consent of Secured creditors for such conversion.
- Minimum seven members shall be required for the registration of a Company.
- An undertaking that the proposed directors shall comply with the requirements of the Indian Stamp Act, 1899 (2 of 1899), as applicable.
- After obtaining availability of name in terms of the provisions of the Cos Act, shall attach the required documents and information for the Registrar along with Form No. URC. 1
- Every Company shall publish an advertisement about its registration under the said Part.
Although it is possible to convert a LLP into a Company, there are still certain areas where clarity may be required as follows:
- As per section 47 (xiii) of the ITA, any capital gains arising on transfer of a capital asset or intangible asset by a firm (which includes LLP) to a Company as a result of succession of the firm by a Company is exempt in the hands of the firm provided certain conditions are satisfied.
- Though Section 47 (xiiib) of the ITA provides capital gains exemption, subject to compliance with certain conditions, in the hands of the shareholders and the Company on conversion of Company into LLP; similar provision is not made under section 47(xiii) of the ITA. Therefore, whether partners of LLP will be eligible to exemption or not remains to be seen.
- As per recent RBI Notification No. 385/2017 dated 3 March, 2017, it is clarified that a Company having foreign investment can be converted into an LLP under the automatic route only if it is engaged in a sector where foreign investment up to 100 percent is permitted under automatic route and there are no FDI linked performance conditions. However there is no clarity whether conversion of LLP into a Company is under approval route or automatic route?
- Applicability of stamp duty on conversion of LLP into a Company?
Recently, the government has taken various steps with respect to ease of doing business in India; however it would be a welcome step if the government clarifies the issues discussed above.
Some other alternatives for migration from an existing LLP structure to a Company structure are as follows –
- Sale of business from LLP to a Company.
- Merger of LLP into a Company.
Given the constant changes in the tax and regulatory laws, one may need to examine the implications arising from such migrations.
[i] [i]As per RBI/2016-17/89 A.P. (DIR Series) Circular No. 7 dated 20 October, 2016, FVCI’s can invest in equity or equity linked instrument or debt instrument issued by an Indian ‘startup’ irrespective of the sector in which the startup is engaged. A startup will mean an entity (private limited company or a registered partnership firm or a limited liability partnership) incorporated or registered in India not prior to five years, with an annual turnover not exceeding INR 25 crores in any preceding financial year.
Views expressed are personal to author. Article includes inputs from Manjit Bhimajiani, Associate Director, PwC India and Pradeep Sethia and Nihal Rajendran