Conversion Of Existing Firms-limited Liability Partnerships - Various Aspects

Parmod K. Bansal

Parmod K. Bansal

The entire world is gradually drifting towards one global market without any trade barriers between the countries. A small organization led by few partners cannot think of growth on large scale without corporatising itself. Limited Liability Partnership (LLP) is an alternative corporate business form that gives the benefits of limited liability of a company and the flexibility of a partnership. The LLP Act provides the legal framework for conversion of existing partnership firms, a private company or an unlisted company into LLPs. This write-up deals with the various aspects relating to conversion of existing firms or companies into Limited Liability Partnership. According to the author, the tax aspects on conversion of partnership firms and companies into LLPs are full of confusion in the absence of any clarity from the Legislature. He opines that the omission of certain critical provisions would inhibit any conversions in a big way as stakeholders may not wish to take undue risk by taking any steps in the dark and, thus, it is of almost importance that clear provisions are laid down by the Legislature, setting the tone and tenor of its intent in the Income-tax Act, 1961 itself. He has also given some suggestions to the Finance Ministry in the context of conversion of LLPs.

1 - The entire world is gradually drifting towards one global market without any trade barriers between the countries. A small organisation led by few partners cannot think of growth on large scale without corporatising itself. Limited Liability Partnership (LLP) is an alternative corporate business form that gives the benefits of limited liability of a company and the flexibility of a partnership.

As against the company form of structure, LLPs provide flexibility without imposing detailed legal and procedural requirements. The internal governance structure of a company is regulated by the statute (i.e., the Companies Act, 1956) whereas for an LLP, it is by way of a contractual agreement between the partners. The management-ownership divide inherent in a company is not there in an LLP. Further, LLPs have more flexibility and less compliance requirements as compared to a company.

Even though the legal framework for LLPs had become effective April 1, 2009, yet the Tax Code for new regime was eagerly awaited. The Finance Act, 2009 has now cleared the air of uncertainty over tax treatment of LLPs which are now proposed to be taxed like general partnership firms. They will have to pay an effective tax of 30.9 per cent - which includes a basic tax of 30 per cent, plus the education cess. LLPs are spared of the 10 per cent surcharge, and, thus, their tax liability will be lower than that of companies, which also have to pay dividend distribution tax besides minimum alternate tax.

In view of various benefits accorded to LLPs, any person setting up a new venture may opt for the LLP structure in consonance of its needs and other commercial considerations. Further, for existing entities, the Act further provides the legislative sanction on conversions to LLP form of structure.

2 - The LLP Act provides the legal framework for conversion of existing partnership firms, private company or an unlisted public company into LLPs. Chapter X of LLP Act, read with relevant schedules, provides that the entity proposing to convert itself into LLP is required to follow the procedure laid down in relevant schedules of the LLP Act. Further, after compliance of the conditions, the Registrar of LLPs shall issue a certificate of registration and the entity, in turn, would be required to inform the Registrar of Firms or companies (as the case may be) within 15 days of receiving the registration.

The entity would assume the status of LLP post conversion and, thus, the liability of partners would become limited. Nevertheless, the Act provides that in case of conversion of a firm, partners shall continue to be personally liable for liabilities and obligations of the firm which were incurred prior to the conversion date.

The Act further provides that all assets, liabilities, obligations, rights, etc., transfer and vest with LLP on conversion, from the date of registration and the firm or company would cease its existence.

However, even if we have legal framework for such conversions, the existing entities can convert themselves into LLPs only after due consideration of the tax cost. Thus, any decision therefore would depend on the fact, whether the benefit offered by the new regime really outweighs the cost involved.

3 - The Finance Act, 2009, has considered "LLPs" as "firm" for tax purposes. However, the tax aspects of conversion into LLPs have not been specifically covered by the Act, leaving it as a subject-matter of interpretation. There are numerous issues which may arise on such conversions into LLP.

4 - The tax aspects on conversion of partnership firms and companies into LLPs are full of confusion in the absence of any clarity from the Legislature. Reliance on precedents on similar issues may still not prevent the revenue from litigating, who may wish to tax various aspects of the transaction. Now this is of considerable surprise, given the fact that Ministry of Corporate Affairs (MCA), being another arm of the Government has targeted conversion of a substantial number of existing companies into LLPs and the confusion may prevent the dream of MCA to even take-off.

The omission of such critical provisions would inhibit any conversions in a big way as stakeholders may not wish to take undue risk by taking any steps in the dark. Thus, it is of utmost importance that clear provisions are laid down by the Legislature, setting the tone and tenor of its intent in the Act itself. The suggestions to the Finance Ministry in the context of conversion of LLPs, include as follows :

A - Such conversions to LLPs be considered outside the purview of capital gains tax, both for the entities and the concerned shareholders/partners.

B - Carry-forward of losses and continuity in availability of tax holiday benefits be allowed specifically post-conversion.

C -Mergers of LLPs be made tax-neutral.

D - Provisions be incorporated on similar lines as section 47(xiv) and (xv) of the Act, wherein succession is considered as exempt subject to compliance of certain conditions.

E - Stamp duty exemption to be provided on such conversions.

However, as an interim measure, the CBDT may issue a circular clearly laying down the above aspects (to the extent possible) which, in turn, would help the businessmen in instilling some confidence on the tax regime and would also, in turn, act as a deterrent for tax department to tax such transactions. Thus, the above concerns deserve immediate attention of the Legislature in order to make the regime a preferred vehicle for conducting business in the present century.

by: Taxmann

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