Presentation Slides - Pinakin Desai

Tax Issues in Reorganisation
through Limited Liability

Partnership (LLP)
- Pinakin Desai
Contents
Overview of LLP law and regulations
Tax analysis
LLP in general
Conversion of firm into LLP
Conversion of company into LLPs
June 2011
Page 2
Tax Issues in Reorganisation through LLP
Overview of LLP law and regulations
Indian LLP : A Snapshot
Two or more persons associating for carrying on lawful business with

a view to profit can incorporate LLP [Sec11(1)(a) of LLP Act]
Key attributes of an Indian LLP
Incorporated entity: Body corporate
Partners liability limited to contribution
Perpetual existence independent of its partners
June 2011
Page 4
LLP Agreement governs an LLP
Mutual rights, duties of partners can be agreed in the LLP Agreement
Contents of LLP agreement in public domain
Partner of an LLP
Can be an Individual, Indian/foreign company or LLP: minimum of 2

partners
is an agent of LLP for the purpose of business of LLP, but not of other
partners
Not liable for LLP obligation unless it relates to his own wrongful act or
omission
June 2011
Page 5
Contribution by partner
Can be tangible movable or immovable or intangible property or other

benefit to the LLP
Can be contracts for services performed or to be performed
to be valued by a CA /cost accountant / a valuer on the panel
Partner can assign, wholly or in part, his interest/ right to share of

profits/losses etc. The assignee gets rights post suitable modification
of LLP agreement.
June 2011
Page 6
Designated partner (DP)
Requires a minimum of 2 individual DP, one of whom has to be an

Indian Resident
Where LLP consists of only body corporate partners, can nominate a

DP
A DP is responsible for
compliance obligations, penalties, receive notices, verify statement of

account/annual solvency status, etc
matters specified in the LLP Agreement
DP remains responsible for his liability even after LLP name is struck off
The LLP Act creates various obligations on DP while not conferring any special power. DP has
right of management only to the extent conferred by the LLP Agreement.
June 2011
Page 7
Reorganization provisions in the LLP Act
LLP Act has provisions dealing with the following*.
Hiving off or separation (demerger) of undertaking, property or liabilities

of LLP.
Compromise, arrangement or reconstruction between LLP and creditors.
Compromise, arrangement or reconstruction between LLP and its

partners.
Amalgamation of two LLPs.
Voluntary, involuntary winding up of LLP.
* There are no specific provisions in ITL to deal with these
June 2011
Page 8
Regulatory framework
Until recently,
FDI allowed into Indian Company
FDI allowed only in capital instruments i.e. Equity Shares, Compulsory

Convertible Preference Shares (CCPS) and Compulsory Convertible
Debentures (CCDs).
Partnership interest in LLP not equated with such shares / CCPS /

CCDs
FDI up to 100% permitted with prior approval of FIPB
Only for sectors falling under 100% automatic route
LLPs not permitted to avail External Commercial Borrowings (ECBs)
June 2011
Page 9
Tax Analysis LLP in general
LLP provisions - Finance (No.2) Act, 2009 (FA

2009)
FA 2009 amendments to the Income-tax Act, 1961 (IT Act) with reference to
the LLP Act. Definition of firm, partner and partnership amended to
accommodate LLP.
A limited liability partnership and a general partnership will be accorded

the same tax treatment. *
As an LLP and a general partnership is being treated as equivalent (except

for recovery purposes) in the Act, the conversion from a general partnership
firm to an LLP will have no tax implications if the rights and obligations of
the partners remain the same after conversion and if there is no transfer of
any asset or liability after conversion. If there is a violation of these
conditions, the provisions of section 45 shall apply. *
* Excerpts from Explanatory Memorandum to Finance Bill No.2 of 2009. Reiterated also in CBDT Circular 5/2010 dated 3 June 2010
June 2011
Page 11
Advantages of being assessed as a firm
Tax rate of 30.9%, against Indian company tax rate of 32.445% ;
No further tax (including MAT) on partners
No tax on distribution during the life of or on winding up of LLP
Internal change in the partnership composition, except retirement,

does not impact carry forward of loss
Non applicability of section 2(22)(e), section 2(24)(iv) and section 73
Deduction of interest, remuneration if authorised by LLP Agreement:
Section 56(2)(viia) applicable only in respect of shares of CHC
June 2011
Page 12
Alternative Minimum Tax (AMT) [S.115JC]

(W.e.f. 1.4.2012)
Unlike companies, minimum tax for LLP is not w.r.t. book profit
AMT payable by LLP on Adjusted on total income i.e on total

income as increased by
Income linked deduction under Chapter VIA
Exempt income of SEZ u/s 10AA
AMT not payable on:
Exempt income (say, dividends, STT based LTCG, share of firm, etc.)
Relief on account of investment linked tax holiday
*Rates need to be increased by cess

June 2011
Page 13
Alternative Minimum Tax (AMT) [S.115JC]

(W.e.f. 1.4.2012)
Brief mechanism of calculation of AMT
Total income as per normal provisions (TI)]
NIL
Add:
Income linked deductions under Chapter VIA
Exempt income of SEZ u/s 10AA
250
250
Net Total Income (TI)
500
Tax on ATI at @ 18.5%* - say
90
Tax on TI at @ 30%* - say
NIL
Tax liability of LLP
Higher of X
Or Y
*Rates need to be increased by cess
June 2011
Page 14
90
Tax Analysis Conversion of firm into LLP
Conversion of firm into LLP

Partners of Firm
Partners of LLP
Partnership
interest
Company
Assets & liabilities vested on conversion
LLP
Effect of Registration:
In terms of section 58(4) of LLP Act:
LLP comes into being from date of registration
There is transfer of assets, etc
Firm shall be deemed to be dissolved and removed from the records of the
ROF
To take effect notwithstanding anything contained in any other law
June 2011
Page 16
Tax implications of conversion
CBDT Circular 5/2010 dated 3 June 2010:

5.6 As an LLP and a general partnership is being treated as
equivalent (except for recovery purposes) in the Act, the conversion
from a general partnership firm to an LLP will have no tax implications
if the rights and obligations of the partners remain the same after
conversion and if there is no transfer of any asset or liability after
conversion. If there is a violation of these conditions, the provisions of
section 45 shall apply.
No specific amendment in Sec 47 of ITA for conversion of firm.
Process of statutory vesting akin to conversion of firm to company

under Part IX of Companies Act
*Section 47(xiiib) deals with conversion of company into LLP. This is captured in ensuing slides
June 2011
Page 17
Conversion of Firm into LLP (Chapter X Read with

Schedule II)
Pre-conditions of conversion
Firm as defined in Indian Partnership Act may convert.
Partners of LLP into which the firm is to be converted should comprise of

all the partners of the firm and no one else.
June 2011
Page 18
Conversion of firm into LLP.cont
Transfer and vesting in LLP without further assurance, act or deed

as vesting in the firm as on the date of registration :
All tangible (moveable and immoveable) property; all intangible property.
All assets, interests, rights, privileges relating to the firm.
All liabilities and obligations relating to the firm.
Whole of the undertaking of the firm.
All deeds, scheme, approval, licenses, Court proceedings etc etc
June 2011
Page 19
Judicial views on conversion of firm to company

under Part IX*
No transfer by firm in absence of simultaneous existence of two

parties
No consideration received by the firm or partners as a result of

transfer
Principle continues to govern conversion to LLP; recognized in

CBDT circular
Sec. 45(4) of IT Act not applicable to conversion; vesting of property

different from "transfer by way of distribution" in s. 45(4) of the IT Act
*Refer CIT v Texspin Engg & Mfg works (263 ITR 345)(Bom)
June 2011
Page 20
Tax Analysis Conversion of company into LLP
Conversion of company into LLP
Shareholders
Company
June 2011
Page 22
Partners of LLP
Partnership
Interest
Assets & liabilities vested on conversion
LLP
Conversion of company into LLP
Section 58(4) of LLP Act: Notwithstanding anything contained in any

other law:
a)
there shall be a LLP by name specified in certificate of registration
b)
all property (tangible and intangible) vested in firm/company shall be

transferred to and vest in LLP
c)
firm or company shall be dissolved and removed from record of

registrar of firm/company
June 2011
Page 23
Section 47(xiiib) compliant conversion (w.e.f 1.4.2011)

- Conversion of Private / unlisted Company into LLP
Excerpts from Explanatory Memorandum to Finance Bill, 2010

reads as under:
The Finance (No.2) Act, 2009 provided for the taxation of LLPs in the
Income-tax Act on the same lines as applicable to partnership firms.
Section 56 and section 57 of the Limited Liability Partnership Act,
2008 allow conversion of a private company or an unlisted public
company (hereafter referred as company) into an LLP. Under the
existing provisions of Income-tax Act, conversion of a company into
an LLP has definite tax implications. Transfer of assets on conversion
attracts levy of capital gains tax. Similarly, carry forward of losses and
of unabsorbed depreciation is not available to the successor LLP.
June 2011
Page 24
Conversion of Private / unlisted Company into

LLP
CBDT Circular 1/2011 dated 6 April 2011 explaining provisions

introduced by Finance Act, 2010
12.1 The Finance (No. 2) Act, 2009 provided for the taxation of LLPs
in the Income-tax Act on the same lines as applicable to partnership
firms. Section 56 and section 57 of the Limited Liability Partnership
Act, 2008 allow conversion of a private company or an unlisted public
company (hereafter referred as company) into an LLP. Under the
existing provisions of Income-tax Act, conversion of a company into
an LLP had definite tax implications. Transfer of assets or shares
held in the company by a shareholder on conversion attracted levy of
capital gains tax. Similarly, carry forward of losses, unabsorbed
depreciation, etc. was not available to the successor LLP.
June 2011
Page 25
LLP taxation-Conversion of unlisted company to

LLP [47(xiiib) (w.e.f 1.4.2011)
Conditions for tax neutral conversions of companies into LLP1
June 2011
Conversion is in accordance with section 56 / 57 of LLP Act

All assets and liabilities of company to become that of LLP
All shareholders to become partners in LLP with capital contribution and
profit sharing ratio in the proportion of shareholding
Shareholders not to receive any consideration or benefit,
directly/indirectly, in any form except by way of share in profit and capital
contribution in LLP
Aggregate of profit sharing ratio of the shareholders of company in LLP
50% for a period of 5 years
Sales, turnover or gross receipts in business of company in any of 3
years < INR 6 million
No direct / indirect payment to any partner out of accumulated profits of
company for a period of 3 years post conversion date
Page 26
Conversion of Company into LLP (Chapter X

read with Schedule III)
Provisions largely at par with conversion of firm into LLP
Conversion is in accordance with section 56 / 57 of LLP Act
Cannot be inter vivos transfer by way of sale
Company can apply for conversion only if:
There is no security interest* in its assets subsisting or in force at the

time of application; and
The partners of LLP to which it converts comprise all the

shareholders of the company and no one else
Condition relevant to the date of conversion
RBI does not grant approval for conversion of NBFC to LLP
*Undefined term, ROC considers it as charge on the assets secured by the creditors as per Companies Act provisions
June 2011
Page 27
Conversion of unlisted Company into LLP

All assets and liabilities of company to become that of LLP
Effective date of conversion :
June 2011
Date of application v/s date of registration
Wholesale conversion; akin to amalgamation
Unlike demerger or unlike transfer under section 47(xiii)
Accompanied by dissolution of company
Page 28

All shareholders to become partners in LLP with capital contribution and
profit sharing ratio in the proportion of shareholding
Position of minor shareholders
No clarity on treatment of preference shareholders
No clarity on share in losses
June 2011
Page 29

Shareholders not to receive any consideration or benefit,
directly/indirectly, in any form except by way of share in profit and
capital contribution in LLP
Split of capital to loan account of shareholder
Payment of remuneration unrelated to conversion;
Avoid differential asset sharing ratio
June 2011
Page 30

Aggregate of profit sharing ratio of the shareholders of company in LLP
50% for a period of 5 years
No lock in period upto which erstwhile shareholder continues to be a

partner, so long as condition of aggregate of 50% of profit sharing ratio
fulfilled;
Involuntary transfers beyond the control of the assessee (such as death etc)
arguably not covered
Admission up to 50% is permissible
Withdrawal by a retiring partner any violation?
June 2011
Page 31

Sales, turnover or gross receipts in business of company in any of
3 years < INR 6 million
Scope of sales, turnover or gross receipts in business:
Advances received by the builder
SEZ developer offering rental under HP chapter
Investment company collecting dividend income
Entity not in existence for 3 preceding previous years
Receipts from non business activities not to be reckoned
June 2011
Page 32

No direct / indirect payment to any partner out of accumulated profits of
company for a period of 3 years post conversion date
Unresolved questions : No guidance in LLP Act
Security premium in books of company
Bonus share capital
Reserves on the books of company
Lock in on withdrawal of funds, arguably , applicable to initially converted

capital contribution
June 2011
Retirement within 3 years; avoid withdrawal?
Page 33
Other tax implications of conversion*
Unlikely DDT implications u/s.2(22)(a) in absence of distribution by

company to shareholders
Unlikely DDT implications u/s.2(22)(c) in absence of distribution;
Unlikely S.2(24)(iv) implications for shareholders in absence of any

benefit passed on by the company
corresponding sacrifice by shareholders
No specific amendments to permit continuing tax holiday in the name

of LLP;
June 2011
Page 34
Tax neutrality of conversion : Back-up

provisions
Actual cost (WDV) of capital asset of company to be the actual cost

(WDV) to LLP [Section 49(1)(iii)(e)]
LLP can carry forward unabsorbed business losses / unabsorbed

depreciation [Section 72A(6A)]. Arguably, fresh lease available.
However, no carry forward of MAT credit to LLP [section 115JAA(7)]
Cost of shares in company would represent cost of LLP interest for

partner [Section 49(2AA)]
June 2011
Page 35
Forfeiture of exemptions : Back-up provisions
Also, S. 47(xiiib) violation leads to
LLP paying tax in the year of violation on:
Forfeiture of loss claimed by LLP [Proviso to section 72A(6A)]
Capital Gains exempted in the hands of company [section 47A(4)]
Shareholder paying tax in the year of violation on capital gains

exempted
June 2011
Commercial risk for newly admitted partners of LLP
Partner who retired earlier also liable
No provision for cost step up for LLP and the shareholder if capital
gains exemption forfeited requiring LLP to pay tax.
Page 36
Tax Analysis Non compliant conversion
Non compliant conversion: Implications for

company
Not correct to suggest that, absent S.47(xiiib) exemption, charge is,

per se, attracted
No consideration accruing to the company; company is statutorily

dissolved
No consideration payable by LLP to the company
Capital gains or business income liability unlikely in absence of

consideration
On principles, akin to case of amalgamating company transferring

assets
June 2011
Page 38
S.47(xiiib) non compliant conversion:

Implications for shareholders
Distinguishing features as compared to case of partners
Firm and partners received income through common passage
Consequences u/s.45(4) of ITA on the firm
Shareholder: extinguishment of shares against receipt of consideration in

the form of LLP interest
Legislative / CBDT thinking supports taxation in absence of compliance

with exemption conditions
June 2011
Page 39
Other tax implications of conversion
Return of Income : As held by Ahmadabad ITAT in Amin Machinery

(P) Ltd [114 ITD 413] in the context of Part IX conversion
predecessor and successor are separate persons
Permanent Account Number (PAN):LLP is a different entity
June 2011
Page 40
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Tax Issues in Reorganisation

through Limited Liability

Overview of LLP law and regulations

Conversion of firm into LLP

Conversion of company into LLPs

Tax Issues in Reorganisation through LLP

Overview of LLP law and regulations

Indian LLP : A Snapshot

Two or more persons associating for carrying on lawful business with

Key attributes of an Indian LLP

Incorporated entity: Body corporate

Partners liability limited to contribution

Perpetual existence independent of its partners

Tax Issues in Reorganisation through LLP

Indian LLP : A Snapshot

LLP Agreement governs an LLP

Mutual rights, duties of partners can be agreed in the LLP Agreement

Contents of LLP agreement in public domain

Can be an Individual, Indian/foreign company or LLP: minimum of 2

Tax Issues in Reorganisation through LLP

Indian LLP : A Snapshot

Can be tangible movable or immovable or intangible property or other

Can be contracts for services performed or to be performed

to be valued by a CA /cost accountant / a valuer on the panel

Partner can assign, wholly or in part, his interest/ right to share of

Tax Issues in Reorganisation through LLP

Indian LLP : A Snapshot

Designated partner (DP)

Requires a minimum of 2 individual DP, one of whom has to be an

Where LLP consists of only body corporate partners, can nominate a

compliance obligations, penalties, receive notices, verify statement of

matters specified in the LLP Agreement

Tax Issues in Reorganisation through LLP

Reorganization provisions in the LLP Act

LLP Act has provisions dealing with the following*.

Hiving off or separation (demerger) of undertaking, property or liabilities

Compromise, arrangement or reconstruction between LLP and creditors.

Compromise, arrangement or reconstruction between LLP and its

Amalgamation of two LLPs.

Voluntary, involuntary winding up of LLP.

* There are no specific provisions in ITL to deal with these

Tax Issues in Reorganisation through LLP

FDI allowed into Indian Company

FDI allowed only in capital instruments i.e. Equity Shares, Compulsory

Partnership interest in LLP not equated with such shares / CCPS /

FDI up to 100% permitted with prior approval of FIPB

Only for sectors falling under 100% automatic route

LLPs not permitted to avail External Commercial Borrowings (ECBs)

Tax Issues in Reorganisation through LLP

Tax Analysis LLP in general

LLP provisions - Finance (No.2) Act, 2009 (FA

A limited liability partnership and a general partnership will be accorded

As an LLP and a general partnership is being treated as equivalent (except

Tax Issues in Reorganisation through LLP

Advantages of being assessed as a firm

Tax rate of 30.9%, against Indian company tax rate of 32.445% ;

No further tax (including MAT) on partners

No tax on distribution during the life of or on winding up of LLP

Internal change in the partnership composition, except retirement,

Non applicability of section 2(22)(e), section 2(24)(iv) and section 73

Deduction of interest, remuneration if authorised by LLP Agreement:

Section 56(2)(viia) applicable only in respect of shares of CHC

Tax Issues in Reorganisation through LLP

Alternative Minimum Tax (AMT) [S.115JC]