Chapter V of the Direct Taxes Code (DTC) seeks to levy a tax of 20 per cent on the book profits of every company. Profits of the company have to be prepared in the prescribed form in accordance with the provisions of parts II and III of Schedule VI to the Companies Act, 1956. One of the proclaimed objects of the DTC is to reduce the scope for incentives and exemptions.
The Government justly felt annoyed that normal corporate tax of 30 per cent is not paid by most companies taking advantage of deductions by way of incentives and exemptions. The effective tax rate stood at 21.56 per cent for several companies in the private sector and 27.14 per cent for those in the public sector.
Budget papers for 2010 show that as much as Rs 79,554 crore had to be foregone because of incentive deductions. Accelerated depreciation under Section 32 of the I-T Act, 1961 accounted for a revenue loss of Rs 25,180 crore. When a new Code is being drawn up, nothing prevents the Government from abolishing all incentive provisions so that there will be no need for levying the Minimum Alternate Tax (MAT).
Incentives are given on socioeconomic grounds and then complaint is voiced that the effective tax rate is substantially brought down because of incentives. A clear case of pinching the baby and rocking the cradle. And MAT has been on the statute book for a long, long time.
Is there a way of avoiding MAT? Yes, if you read the fine-print of the DTC. MAT is levied only the corporate form of organisation. We have with us now a new entity for taxation called the limited liability partnership (LLP).
The LLP Act, 2009 came into force with effect from April 1, 2009. It provides an alternative to the traditional partnership, with unlimited personal liability on the one hand, and statute based governance structure of the limited liability company on the other, to enable professional expertise and entrepreneurship initiative to combine, organise, and operate in a flexible, innovative and efficient manner.
Section 3 of the Act provides the partners with limited liability protection. They will not be liable for the debts and obligations of the LLP, which is separate from the partners and has perpetual succession. It is a hybrid between a company and the partnership. Finance Act, 2009 sorted out the tax issues of the LLP. They are treated like any other ordinary firm. The share of partners is tax-free. The firm’s profits are taxed. The DTC continues with this arrangement of flow — through taxation of LLPs. The LLP is not liable for levy of MAT because it is not treated as a company. If the book profits of the business organisation are taken as Rs 100, MAT will take away Rs 20 if it is a company. On the other hand, if it is an LLP, there will be no MAT.
This is not all. Companies are liable for a tax of 15 per cent on the amount of dividend distributed by them. The DTC has taken into account criticism of the cascading effect of the DDT levy.
There will be no question of double taxation of the amount of dividend distributed by a company as was the case hitherto between a holding company and its subsidiary. These provisions have been rationalised. The significant part of the DTC is that DDT is not leviable on any part of the profits of the LLP. This can mean substantial savings. If the LLP makes book profits of Rs 100, it does not have to pay a MAT of Rs 20 and the DDT at 15 per cent of the profits.
Unlike the normal partnership, the liability of the partner in an LLP is limited to his contribution towards capital. The non levy of MAT and DDT with regard to the LLP in the DTC is clearly well designed and well thought out. It is not an accidental omission. The Government is doing everything possible to encourage the LLP form of business organisation. The RBI is now seized of the matter of permitting foreign direct investment (FDI) into LLPs.
The Memorandum explaining the provisions of Finance Bill 2009 specifically stated that conversion from a general partnership firm to LLP will have no tax implications if the rights and obligations of the partners remain the same even after conversion and if there is no transfer of any asset or liability after conversion.
The law allows flexibility for an LLP to convert into a company if needed at any time in the future. Such business reorganisations are also covered under the provisions relating to amalgamations in the DTC.
The DTC has given enough time for companies to organise their affairs in such a way that tax considerations are fully taken into account. Companies can consider converting into LLPs to avoid MAT and DDT.