1. Introduction :- A new type of entity namely limited liability partnership (hereinafter referred to LLP) has come into existence by LLP Act, 2008. LLP is an alternate corporate business that offers the twin benefits of limited liability companies and the flexibility of partnership firms. Introduction of LLPs in India is a path breaking reform which is in consonance with the changing environs of the business world. With the introduction of the LLP Act, 2008 a taxing framework was an essential next step. This type of entity is already in existence in various countries. In countries like the USA & UK LLP are treated as a tax transparent entity i.e. partners are liable to tax for income of LLP. However, the Finance Bill, proposes to tax the LLP at entity level along the line of general partnership i.e., LLP shall be liable to tax at the entity level and the share of profits received by the partners shall be exempt.
2. Amendments :- The Finance Bill proposes following new provisions and amendments to the existing provisions in relation to LLP:
• By virtue of clause 3(c) of the Finance Bill, section 2(23)(i) defining “firm” is extended to include LLP as defined under LLP Act 2008. The term “partner” shall include a partner of a LLP & the term “partnership” is extended to include LLP.
• By virtue of clause 53 of the Finance Bill, new clause (cd) under section 140 is introduced – This section provides that the Return of Income of the LLP shall be signed and verified by the designated partner.
• In case there is no designated partner or a designated partner cannot sign the Return of Income, the same shall be signed by any other partner.
• By Clause 58 of the Finance Bill, section 167C is introduced. This section makes every partner of a LLP jointly and severally liable for the taxes to be paid by the LLP for the period during which he was a partner, unless the non-recovery of taxes cannot be attributed to gross neglect, misfeasance or breach of duty on his part.
• LLPs have been excluded from the provisions of presumptive taxation contained in section 44AD of the Act
3. Definition :- The term firm is amended to include LLP as defined under the LLP Act. S. 2(n) of the LLP Act defines LLP as a partnership formed and registered under this Act. Sec. 2(d) of the LLP Act defines a ‘body Corporate” and includes LLP incorporated outside India. S. 2(m) defines a foreign LLP to mean a LLP incorporated and registered outside India and which establishes a place of business in India. Under Chapter XI of the LLP Act, S. 59 provides that Central Government may make rules for provisions in relation to establishment of place of business by Foreign LLP within India. A co-joint reading of the amendment in the definition of ‘firm’ under the Income-tax Act and S. 2(n) read with sections 2(d) & 2(m) it appears that foreign LLP operating in India shall not be covered by the definition of firm under the I.T. Act. Hence, there is no provision under the Income Tax dealing with taxability of foreign LLPs operating in India.
4. Conversion :- According to the Memorandum to Budget, conversion of firm into LLP will have no tax implications if following two conditions are satisfied:
1. Rights and obligations of the partners remain the same after conversion, and
2. There is no transfer of any asset or liability after conversion.
However, there is no corresponding provision in the Finance Bill to this effect. The proposal in the Memorandum to the Budget appears to be absurd. As per sections 27(3) and 28(1) of the LLP Act, 2008 partner of LLP is not liable for obligations of LLP arising in a contract or otherwise and it shall be solely the obligation of the LLP. Contrary to this, S. 26 of the Indian Partnership Act, 1932 provides that every partner is liable jointly with all other partners and also severally for all acts of the firm. Hence, it is statutorily impossible that the obligations of the partners would remain same after conversion from firm to LLP. In fact, one of the prime reasons for conversion of firm to LLP is the limitation of joint and several liability.
Hence, if above proposal is enacted in the I.T. Act, it would act as a barrier for firms to convert into LLP. Also, with respect to the condition that there should be no transfer of any asset or liability after conversion, no time limit for the same is suggested.
In any event, if the above two conditions are met, still there is a road block as under clause 7(c) of Second Schedule to the LLP Act, on conversion of firm to LLP the firm shall be deemed to be dissolved. Whether such deemed dissolution would be covered by section 45(4) of the Income-tax Act or whether the conversion of firm into LLP shall not be considered as a transfer on the lines of conversion of firm into a company under Chapter IX of the Companies Act, 1956 is still unclear. The Bombay High Court in CIT vs. Texspin Engg. & Mfg. Works (2003) 263 ITR 345 has held that in case of conversion of a firm into a company under Part IX of the Companies Act, 1956 there is no distribution of capital assets and neither S. 45(4) nor 45(1) is applicable. Applying the ratio of the Bombay High Court, it may be fairly concluded that conversion of firm into LLP would not fall within the ambit of S. 45.
However, a suitable amendment in S. 47 is suggested.
Also there is no discussion about taxability in case of conversion of company into LLP.
5. Amalgamation :- Chapter XII of the LLP Act, 2008 provides for compromise, Arrangement or Reconstruction of LLP. Under the said chapter, S. 62 of the Act provides for Amalgamation of one LLP with another LLP on terms and conditions as contained in the said section. The conditions are similar to those contained under the Indian Companies Act, 1956 with respect to amalgamation of companies. Under S. 47 of the I.T. Act, transfer of capital asset of a company in a scheme of amalgamation is exempt from capital gains. However, the bill has not introduced any amendment in S. 47 so as to cover scheme of amalgamation of LLP and hence transfer of capital assets in a scheme of amalgamation of LLP may be regarded as a taxable transfer.
6. Tax Credit :-The practice of taxing the income of the LLP in the hands of the firm is a divergence from the practice of treating the LLP as a tax transparent entity in certain other countries like UK and USA, which tax the income of the LLP in the hands of the partners. Thus, in case of the income of the LLP is also taxed in other jurisdiction where the income is taxed in the hands of the partners, the availability of tax credit to LLP in India might lead to certain difficulties.
7. Stamp Duty :- On conversion of firm, private cos and unlisted cos into LLP, all the properties of the transferor entity shall be transferred and shall vest in the LLP without further assurance, act or deed. It may be noted that registration of a firm as a company under the Companies Act does not require a separate ‘conveyance’ for vesting of the property. Hence stamp duty may also be not payable in case of conversion to LLP. However, it is expected that clarity may be provided regarding stamp duty so that conversions become an easy process.
8. Miscellaneous :- The effective rate of tax for LLPs would be 30.9 per cent which is lower than the rate applicable to companies; i.e., 33.99 per cent. Further Dividend Distribution tax and MAT applicable to companies do not apply to LLPs.
9. Conclusion :- Section 47 of the Act should be suitably amended to exempt conversions & amalgamations so that Capital gains tax is not attracted. LLP is at nascent stage and proper support in the form of simplified procedures, incentives and a user friendly tax regime will make it more attractive.
Remuneration to Partners – Clause 15 – S. 40
According to existing provisions, payment of remuneration to working partner is allowed as deduction; professional firm and other firms are treated separately. Clause 15 of the Finance Bill proposes to make upward revision of existing limits of remuneration on uniform bases as under for both types of firms:
|(i)||On First 3 lakh of Book profit or loss.||Rs.1,50,000 or 90% 90 whichever is more|
|(ii)||On Balance||At 60%|
The Amendment will take effect from 1-4-2010 (A.Y. 2010-11) onwards.
The above amended provision will also be applicable to limited liability partnership.
Author: Rahul Hakani, Advocate