The Hindu Business Line : Make LLPs a viable format

To make LLPs a viable alternative to companies, it may be important to recognise them as a pass-through entity, which would avoid the cascading effect of taxation.

Girish Vanvari
Alok Mundra

Until now, three forms of organisation have predominantly dominated the Indian business scene — companies, partnerships firms and sole proprietorships. The inherent restrictive characteristics of the existing forms created a definite need to evolve a different and flexible structure which would be a blend of these forms.

Taking the cue from the developed nations, the Ministry of Company Affairs (MCA) came up with the concept of limited liability partnerships (LLPs). Basically, the idea of introducing the LLPs was to combine the characteristics of corporate and non-corporate entities and provide the Indian corporate sector with a new format of doing business.

The Government enacted the LLP Act, 2008 (LLP Act) which became effective from January 9, 2009, and subsequently LLP Rules, 2009 have been introduced and most of the rules became effective on April 1.

Key features

The significant features of LLP are:

LLP is a body corporate with a status distinct from its partners and has perpetual succession similar to that of companies, thus change in partners will not affect its existence;

Procedures have been defined for registration of LLP, responsibility and obligations of partners, conversion of existing partnership firm and companies into LLP, transfer of rights by partners, winding up of LLP, etc.

An LLP partner is not personally liable for an obligation of an LLP. However, partner will be personally liable for any liability arising out of his omission or wrongful act;

LLP will require at least two partners to accept the role of designated partners. One of such partners should necessarily be an Indian resident;

If at any time, the number of partners of an LLP falls below two and the business is carried on with only one partner for more than six months, that only partner will be liable for the obligations of LLP during that period.

However, why is there still no rush to incorporate these entities?

The primary reason could be host of changes which needs to be made or lack of clarity in many other laws and regulations to recognise the stature of LLP to make it an attractive vehicle or alternate choice for corporates to carry out their businesses. One of the key areas where clarity needs to be provided is in the taxation of LLP and its partners.

Taxing as company or firm

LLP is largely governed by the similar platform as applicable to the companies in terms of their formation, compliances etc. Therefore, the Income-Tax Act, 1961 may provide for similar tax treatment as applicable to Indian companies under the current provisions of I-T Act. In such a scenario, LLP might also attract minimum alternate tax, dividend distribution tax, etc., as applicable to companies.

Alternatively, LLP can be treated as a pass-through entity for taxation purpose which is largely followed in most of the developed nations where LLPs are recognised.

To make LLPs a viable alternative to companies, it may be important to recognise them as a pass-through entity, which would avoid cascading effect of taxation which is currently faced by companies in the form of corporate and dividend distribution taxation. Unless and until it is differentiated from companies for taxation purpose, it might not serve its purpose and may not be used on a large scale due to its untested format as against companies which are well-recognised over many decades.

Further, considering that LLP is not a taxable entity and its income is taxable only in the hands of its partners, there can be challenges if there is any foreign income earned by such LLP on getting tax credits, etc., in the absence of clarity in the tax treaties. Thus, the Indian Government may have to look back into the treaties and incorporate the necessary amendments in this regard.

Conversion of existing companies

Once the taxation aspects of LLP and its partners are clarified, we may see significant amount of conversion of existing companies or partnership firms into LLPs. In the beginning, this number may outpace the newly formed LLPs and keeping these aspects in mind, the LLP Act provides for the procedures and regulations for conversion of unlisted/private limited companies and partnership firms into LLP.

However, conversion of existing companies and partnership firms would result in transfer of assets and liabilities by companies and partnership and obviously it would result in capital gains tax implications on transferor entity.

To facilitate conversion, it would be imperative to provide exemption on similar lines as currently provided in Section 47(xiii) of the I-T Act which should result in tax neutral conversion of companies/partnership firms into LLPs subject to satisfaction of certain conditions.

The LLP Act, on a similar lines as of the Companies Act, 1956 , has recognised the concept of compromise, arrangement and amalgamation between two or more LLPs. However, the LLP Act has explicitly not recognised a concept of amalgamations between existing partnership firms or companies with LLPs or LLPs amalgamations into companies.

It would be interesting to note that under the Companies Act, amalgamation of unregistered companies which can be wound up under the Act (it includes any partnership firm having seven or more members) are allowed to be amalgamated with the companies which are registered under the Companies Act.

In a scenario where LLP is having more than seven members, it should be eligible to amalgamate with the companies registered under the Companies Act, though the LLP Act is silent about this issue. However, one has to wait and watch till these issues crop up at the time of corporate reorganisations between partnership firms, companies and LLPs and suitable amendments are incorporated to facilitate them.

Irrespective of the above, the I-T Act, recognises amalgamation between companies and demerger of a company under Section 391-394 of the Companies Act and, therefore, all consequential provisions are on the similar lines such as deduction of expenses on amalgamation, treatment of share transfers in the hands of shareholders, transfer of assets in the hands of transferor companies, depreciation on assets acquired by transferee company in the process of amalgamation etc. Thus, it would be critical that similar provisions are incorporated to facilitate amalgamation, arrangements which are recognised by the LLP Act and it should not be less favourable to this format than applicable companies in current tax regime. This would provide appropriate exits to the partners of LLP and facilitate inorganic growth of business through LLPs in tax optimal manner.

In the nutshell, as we have seen in the past that government has came out with instruments such as Foreign Exchange Convertible Bonds (FCEB), Indian Depository Receipts (IDRs), however corporates have not shown any interest due to lack of clarity in the tax treatment of these instruments and such concepts are limited to the books. In the backdrop of this, in order to avoid similar fate being faced by LLPs, appropriate amendment shall be brought in the forthcoming Budget to address as many tax issues as possible with respect to LLPs to make them a viable option for industry to consider it favourably.

(The authors are with KPMG.)

More Stories on : Budget | Business Models | Taxation

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Power plans

Make LLPs a viable format

Slowdown effects on transfer pricing

Perils of renewed dialogue with Pakistan

Anchor investor

MFs and investors

AI support