llp in india - updated guidance

Limited Liability Partnership (LLP)in India

Contents

► Overview of LLP law and regulations► Overview of FDI/FEMA regulations► Tax analysis

► LLP in general► Conversion of firm into LLP► Conversion of company into LLP

► Foundation planning structures

Overview of LLP law and regulations

Guidance on LLP in India

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 formed and incorporated under the Limited

Liability Partnership Act, 2008 (LLP Act)► Partners’ liability limited to its contribution ► Perpetual existence independent of its partners► Separate legal entity distinct from its partners: Obligations of LLP is solely of

itself, not its partners; can acquire/ hold/ dispose off property; can sue and be sued; deals with its partners as with creditors/third party

► Dealing with partners at par with external party ► Change in partners does not impact LLP’s existence, rights or its liabilities

► Indicative procedural steps/flow chart to form an LLP (Refer Annexure I)► Broad Contents of Incorporation Document/Statement (Refer Annexure II)



► LLP Agreement governs an LLP► Mutual rights, duties of partners can be agreed in the LLP Agreement► Contents of LLP agreement in public domain (Refer Annexure III)► Unless LLP Agreement specifies, certain default provisions apply (Refer Annexure IV)

► Partner of an LLP► Can be an Individual, Indian/foreign company or Indian/foreign LLP: requires a 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

► 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*

*Requires independent examination of tax implications.



► 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

► For Financial disclosure (refer Annexure V )► Overseas LLP having an India place of business (refer Annexure VI)► For other miscellaneous provisions (refer Annexure VII)

*Refer FDI regulations section for specific requirements of DP in case LLP has FDI

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.


Certain provisions of relevance in the LLP Act

► A partner can retire (cease to be a partner) with 30 days notice. Demise,

lunacy, insolvency can also lead to cessation of partnership interest.

► On cessation of partnership interest, right of erstwhile partner for settlement

at book value unless otherwise provided in the LLP agreement.

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

profits/losses etc. The assignee gets rights of management and access to

LLP information only post suitable modification of the agreement.


Reorganization provisions in the LLP Act

► Special procedure in LLP Act for conversion of: ► A partnership firm into LLP► A private company into LLP► Unlisted public company into LLP

► 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.

*Requires independent examination of tax implications


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. ► 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

► 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.

The above to take effect notwithstanding anything contained in any other law


Conversion of firm into LLP….cont

► Effect of Registration…………..Cont……..► Every agreement to which the firm was a party to have effect as if LLP were a

party: applies irrespective of whether right/liabilities under agreement could be assigned

► Deeds, Contracts, Schemes, Bonds, Agreements, applications, instruments and arrangements subsisting immediately before date of registration continue as if LLP were a party

► Employment terms continue as if LLP were the employer► Appointment of firm in any role/capacity and authority/power conferred on firm

to take effect/operate with substitution of LLP► Approval, permit, license issued under any statute to be conferred on LLP

subject to provision of the relevant statute► All court proceedings, any conviction, Ruling of the Court / authority by or

against the firm to be continued, completed and enforced by or against LLP► LLP to take necessary action of notifying the authority on conversion


Conversion of Firm into LLP …cont

► Partners of LLP jointly and severally liable for

► liabilities and obligations of the firm incurred prior to the conversion (or) which

arose from any contract entered into prior to conversion

► For a year, LLP to mention in every official correspondence

► A statement of conversion

► Name and registration number of the erstwhile firm

► For procedure on conversion please refer Annexure VIII


Conversion of Company into LLP (Chapter X read with Schedule III)

► Provisions largely at par conversion of firm into LLP (please refer earlier slides)

► Some points of substantive differences► 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.

► Company is deemed to be dissolved and removed from the records of ROC► No provision for unlimited liability in respect of pre conversion period / pre-

conversion contracts. ► Procedure of conversion of company into LLP – Annexure IX


Comparative Analysis

PARTICULARS GENERAL PARTNERSHIP LLP PRIVATE COMPANY

Members 2 to 20 Minimum 2 partners 2 to 50 shareholders

Liability Unlimited, Partners jointly and severally liable for

action

Limited except in case of fraud, wrongful act

Limited

Registration Optional Registration with ROC required

Registration with ROC required

Documents to be filed None unless registered File annual accounts and submit annual

statement on solvency

Annual Statement of accounts, articles,

memorandum, etc.

Dissolution By agreement, mutual consent, etc.

By agreement or by order of National

Company Law Tribunal

By court order once the affairs of the company have been wound up

Transfer / Inheritance of shares

Not transferable Transferable, but transferee may not have

management rights

Transferable with the consent of Board of

Directors

Separate Legal Entity No Yes Yes

Duration Not perpetual Perpetual Perpetual

Overview of FDI/FEMA regulations

Acknowledgement and a word of caution

The content in this section is developed based on valuable inputs provided by the regulatory team. The issues identified are indicative and a detailed analysis is beyond the scope of this document. Each case would need to be dealt with based on its specific facts in consultation with the regulatory team.


Regulatory framework

► Foreign direct investment (FDI) policy administered by Government of India and

regulated by Reserve Bank of India (RBI)

► Foreign Exchange Management Act, 1999 (FEMA) and regulations regulate inbound

& outbound investment. Illustratively,

► FEM (Transfer or Issue of Security by a person resident outside India) Regulations, 2000

(Inbound Investment regulations)

► FEM (Transfer or Issue of any foreign security) Regulations, 2004 (Outbound Investment

regulations)

► FEM (Investment in Firm or Proprietary concern in India) Regulations, 2000 (Partnership

investment regulations)

► FDI generally understood to mean investments by way of equity shares, fully

convertible preference shares and convertible debentures


Regulatory framework

► Until recently,

► FDI allowed into “Indian Company”

► “Indian Company” means “Company” incorporated in India

► FDI allowed only in “capital instruments” of Indian Company 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

► Broadly, FDI permitted under 2 routes:

► Automatic route - No prior permission, only requirement to inform RBI within 30

days of inflow / issue of shares

► Approval route - prior approval of the Foreign Investment Promotion Board

(FIPB), Ministry of Finance, Government of India (GOI) required


GOI Press Note No. 1 of 2011

► Calibrated approach for permitting FDI in LLP

► Beginning with “open’ sectors

► FDI upto 100% permitted with prior approval of FIPB

► Only for sectors falling under 100% automatic route

► FDI not permitted in the following sectors

► FDI-linked performance condition is attached (minimum capitalization, lock-in period, etc)

► Prohibited sectors like agricultural/ plantation activity, print media or real estate business

► Sectors having caps, requiring FIPB approval

► FII /FVCI not permitted to invest in LLPs

► LLPs not permitted to avail External Commercial Borrowings (ECBs)

► Conversion of company with FDI into LLP permitted, but prior approval of FIPB

required and under similar conditions



► Downstream investment ► LLPs with FDI not eligible to make any downstream investments

► Indian companies having FDI permitted to make downstream investment in LLPs only if

both the Indian company and the LLP operate in sectors where 100% FDI is permitted

under automatic route and no FDI-linked conditions attached

► Capital contribution by partner only in cash

► Cash to be received by way of inward remittance, through normal banking channels, or by

debit to NRE/FCNR account of the person concerned, maintained with an authorized

dealer/authorized bank



► Designated Partners (DPs) in LLPs with FDI

► For the purposes of appointing a DP, “resident in India" would have the meaning,

as defined for "person resident in India", under FEMA

► Where an LLP wants to have a body corporate as a DP, only a company

registered in India under the Companies Act, 1956 can be a DP

► DP responsible for compliance with the FDI conditions and liable for all penalties

imposed on the LLP for any contravention.


Outbound Investment Regulations

► Outbound investments by an Indian party permitted in an overseas JV /

WOS either under the Automatic route or the Approval route

► Indian party means:

► A company incorporated in India

► A body created under an Act of the Parliament

► A partnership firm registered under the Indian Partnership Act, 1932

► Any other entity in India as may be notified by the RBI

► Outbound investment by an Indian LLP outside India currently not expressly

permitted


Open Issues

► Applicability of valuation norms for foreign investment in LLP ► Clarity on applicability of External Commercial Borrowing

(ECB) restrictions on a partner’s capital contribution to LLP ► Possibility of interest payments?

► Absence of clarity on Overseas Direct Investment by LLP

Tax Analysis – LLP in general


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

► Effective date: Assessment Year (AY) 2010-2011; Financial Year (FY) 2009-2010► FA 2009 amendments to the Income-tax Act, 1961 (IT Act) with reference to the LLP

Act► ‘Firm’ definition amended to include an LLP ► ‘Partner’ definition now includes a partner of a LLP► ‘Partnership’ includes LLP► For an LLP, tax return to be signed by DP (Sec 140 of the IT Act)

► Joint and several liability* of partners for payment of taxes due from LLP (Sec167C of the IT Act) provided ► Liability exists for the year/s of partnership in relation to the partner► Partner needs to prove that non recovery is not attributed to gross neglect, misfeasance or

breach of duty on his part in relation to the affairs of the LLP

► Excerpts from Explanatory Memorandum – Annexure X

*As per Explanatory Memorandum, this is in the contingency of liquidation.


Subsequent amendments

► FA 2010► Conversion of private/ unlisted company into an LLP made tax neutral in hands

of LLP and shareholders, subject to stipulated conditions

► FA 2011► Levy of Alternative Minimum Tax (AMT) [Sec115JC]

► Different computation mechanism when compared with MAT on companies

► Applicable from 1 April 2011; FY 2011-2012, AY 2012-2013► Tax credit can be carried forward for 10 years

► To be set off to the extent of difference between regular tax and AMT

► Every LLP to which section 115JC applies to obtain accountant’s report


Advantages of being assessed as a ‘firm’

► Tax rate of 30.9%, against Indian company tax rate of 32.445% (for foreign companies, the tax rate is 42.024%)► no scope for higher rate even if LLP comprised only of corporate entities

► No tax on cash distribution during the life of or on winding up of LLP ► Indian company pays 16.2225% tax on its profit distributions as dividend

distribution tax (DDT)

► Internal change in the partnership composition does not impact carry forward of loss, right in respect of share in loss proportional to that of a retired partner is however lost

► No MAT/AMT in respect of investment linked deduction or in respect of income exempt under Chapter III (other than S 10AA) including exempt long term capital gain


Advantages of being assessed as a ‘firm’

► Loan to a partner or to the concerns in which a LLP partner holds beneficial interest do not trigger deemed dividend – Sec 2(22)(e) of IT Act implications

► Deemed income provisions of Sec 2(24)(iv) of IT Act does not apply in respect of transaction with partners

► Artifice of Sec 73 of It Act does not apply to convert delivery based share trading loss to be speculation

► Partnership firm is not a taxable entity under the Wealth Tax Act. Comparable amendments relating to the fiction of LLP being equated to a “firm” not carried out in the Wealth tax Act


Disadvantages of being assessed as a ‘firm’

► May not qualify for tax holiday/incentive provisions when restricted to

company.

► Certain presumptive tax provisions can be invoked only by a foreign

company and do not apply to an LLP (E.g. Sec 44BBB of IT Act)

► Certain deductions in computing business profits are available only to a

“company” taxpayer – e.g.

► Section 35(2AB) of IT Act - Weighted deduction for scientific research

► Section 35D of IT Act- Deduction for preliminary / pre-operative expenses.

► Tax neutrality for merger /demerger apply only when companies are parties

to the reorganization


Other Consequences of being assessed as ‘firm’

► LLP taxed as a “general partnership” (firm)► Entity level taxation of LLP ; partners not taxed again irrespective of residential

status and tax treaty residence.► Possibility of deduction for remuneration paid to “individual” working partner if

authorised by document of partnership, presumably the LLP Agreement► Simple interest permitted @ 12% p.a. on capital contribution by firm if authorised

by document of partnership, presumably the LLP Agreement

► Residential status of LLP determined based on “control and management” test: LLP resident in India even if C&M of its affairs is partly in India

► Disallowance of interest/remuneration in tax assessment of LLP if there is failure resulting in best judgment assessment. Such amount also not assessable in the hands of the partner.


Levy of AMT (as applicable from FY 2011-12)

► Unlike companies, minimum tax for LLP is not with respect to ‘book profit’

► Brief mechanism of calculation of AMT

Total income (TI) as per normal provisions (A) 300

Add:►Income linked deductions, if any, under Chapter VIA (Part C); and►Deduction, if any, claimed u/s 10AA

100

100

Adjusted Total Income (ATI) (B) 500

Tax on TI at (A) @ 30%* - say 90

Tax on ATI at (B) @ 18.5%* - say 93

Tax liability of LLP Higher of A 93Or B

*Rates need to be increased by cess


Levy of AMT

► AMT is a concern for LLP which enjoys specified income linked deductions more than 40% of its specified deductions

► AMT not payable on:► Exempt income (say, dividends, STT based LTCG, share of firm, etc.)► Relief on account of investment linked tax holiday

► LLP is still a firm for all tax purposes:► No DDT► Interest / salary expenses allowed as per law


Comparison: AMT (LLP) and MAT (Company)

AMT MAT

► Linked to total income as adjusted for

deductions u/s 10AA and under Ch.

VI-A

► Investment linked tax holiday cases

protected

► Incomes exempt u/s 10 beyond

purview of AMT

► Quantum of carried forward losses

does not impact AMT

► Linked to ‘Book Profit’ as modified for

specified downward / upward

adjustments

► Investment linked tax holiday cases

subject to MAT

► STT paid LTCG subject to MAT

► Restrictive set off of book losses of

earlier years


Certain ambiguities of LLP

► Issues could possibly arise in cross-border taxation of an LLP. Some of these issues could be:► Entity Classification Issues

► Would an LLP be recognized as a “body corporate” of “pass through” by other countries?

► How would the rules for determining residency of an LLP be applied?► Who would be eligible for treaty benefits – the entity or its members?► How would the nature of income derived by the entity/ members be classified?

► Risk of double taxation on account of conflicts in classification between countries► Possible tax arbitrage opportunities could also exist

A detailed analysis of the above issues is beyond the scope of this document and each case would need to be dealt with based on its specific facts


Procedural compliance to ensure assessment as a Firm

► A Firm is assessed as a Firm if:

► evidenced by an instrument.*

► individual shares of the partners are specified in the instrument

► certified copy of the instrument of partnership is filed along with the first ROI.

► Certification of the instrument of partnership required by all partners except minors.

► Next stage submission of instrument of partnership with ROI if :

► change in constitution.

► change in partnership interest.

► Change in constitution does not affect entity level assessment. [Contrast case of

dissolution/succession where split assessment done for part of the year].

* LLP Agreement can contextually be considered as an instrument.


Remuneration to a working partner

► Remuneration to a working partner allowable,► if the working partner is an individual (may or may not be a designated partner)

► is authorized and in accordance with the partnership deed

► does not pertain to any period earlier than the date of partnership deed

► The aggregate remuneration to all partners does not exceed the limits specified in Sec 40(b) of IT Act which is based on

the book profits of the Firm i.e.

► 60% of book profit beyond 3 Lakhs ( higher of 1.5 Lakhs or 90% of book profit upto 3 Lakhs)

► “Book profit” for remuneration deductibility means:

► Net profit as shown in Profit & Loss Account for the previous year;

► Computed in the manner laid down in Chapter IV-D of the IT Act

► Increased by the aggregate remuneration paid or payable to all the partners, if such remuneration has been deducted in

arriving at the net profit.

► “Book profit” is calculated before (a) set off of losses under Chapter VI /(b) Chapter VI-A tax break

► Payments made to a partner under independent contract “may not “ be deductible as expense if equated

with remuneration to a partner. Sec 40(b) of IT Act does not permit deduction of remuneration by whatever

name called beyond permissible limits. Scope of meaning of “remuneration” may be litigative.


Interest to a partner

► Interest paid to partners (including corporate partners) admissible, provided capital contribution is used for business purpose

► Conditions for interest deductibility► Should be authorised and in accordance with the terms of the partnership deed ► Rate of interest not to exceed 12% (simple interest) per annum► Should not relate to any period earlier to the date of the deed.

► Once admissible, adequacy of profit not a hurdle► Interest paid to partners is treated at par with interest under Section 36(1)

(iii) of IT Act and may require capitalisation in terms of proviso to Section36(1)(iii)► Refer Munjal Sales Corporation v CIT (298 ITR 298) (SC)

► No withholding tax on interest paid to resident partners [Sec194A(3)(iv) of IT Act]► For non-resident partners, one may need to evaluate relevant tax treaty

provisions, where applicable and in particular, characterization issues


Assessment of LLP partners

► Exemption in respect of share of profit [Section 10(2A) of IT Act]; calculation based on proportion of “total income” as assessed in the hands of LLP

► Interest / remuneration taxed as business income, where admitted as deduction for the LLP

► MAT provisions not applicable to a corporate partner’s share of profit ► Issues on deductibility of expense in view of Sec 14A of IT Act read with

Rule 8D in respect of contribution► Partner liable for recovery of taxes of LLP only in the limited circumstances

of Sec 167C of IT Act; general provisions of unlimited liability of Sec 188A of IT Act arguably do not apply to LLP (Confirmed by Explanatory memorandum)

► Partner may not be liable to pay wealth tax in respect of LLP’s chargeable wealth


Impact of other sections

► Contribution to LLP may trigger capital gains in the hands of contributing partner with respect to value at which transfer is recorded. But, discretion of partners and the LLP in this behalf is subject to requirement of Rule 23(2) of LLP Rules, 2009 to obtain valuation report [Sec 45(3) of IT Act]► Based on a senior counsel’s opinion, arguable that the transfer could be done at

a negotiated value ► Implications on receipt of shares of a closely held company with reference to

scheduled value of shares [Sec 56(2)(viia)] may need to be factored in► View of AAR in Canoro Resource case- TP provisions override Sec 45(3).

► Arguably, Sec 45 (3) overrides Sec 50C fiction of IT Act.► Distribution by LLP of property at the time of its cessation may trigger Sec 45(4)

provision of IT Act► Assignment of interest by a partner likely to trigger capital gains tax► Possibility of arguing that ‘cessation’ of interest is akin to retirement of a partner not

triggering tax implications if settlement of balance by cash payout


Miscellaneous provisions

► TP provisions – Associated Enterprise relationship trigger for a person holding 10% interest and /or on account of participation in capital, control and management

► Time limit of assessment, reassessment, rectification, etc gets extended for the member on consequential impact arising from tax assessment of the firm [Sec153(3) /155(1) /155(IA) of IT Act].

► Accelerated assessment should there be discontinuance of LLP business [Sec 176(5) of IT Act]

► Possibility of Tax Authority invoking of “agency” provisions in relation to non-resident partners - Sec 163 of IT Act


Situations where LLP is not recommended/ feasible

► LLP will not be able to get itself listed without further reorganization

► Unlike in case of a company, cross border merger of a foreign entity with an

Indian LLP is not possible

► Charity organizations which need to fall back on Sec 25 of the Companies

Act.

Tax Analysis – Conversion of firm into LLP

► Tax implications of conversion► Applicability of Part IX ratio to LLP conversion

Tax implications on conversion of firm / company into LLP

Tax implications of conversion

► Explanatory Memorandum to Finance Bill 2009 reads as under :

“ 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”.


Tax implications of conversion

► CBDT Circular 5/2010 dated 3 June 2010 explaining provisions introduced by Finance (No.2) Act, 2009

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 IT Act for conversion of firm into LLP1

► Process of conversion and statutory vesting akin to conversion of firm to company under Part IX of Companies Act

1 Section 47(xiiib) deals with conversion of company into LLP. This is captured in ensuing slides


Summary of Judicial views on conversion of firm under Part IX of the Companies Act

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

No “transfer” in absence of two important ingredients (i) existence of a party and

a counter-party and, (ii) No consideration received by the transferor

Absence of consideration flowing to the transferor - "full value of the

consideration" does not mean the market value of the asset transferred, but it

shall mean the price bargained for by the parties to the transaction”

Allotment of shares to partners is in lieu of their capital contribution; allotment of

shares has no correlation with vesting of properties in the company

Extracts from relevant case laws – Annexure XI


Applicability of Part IX ratio to LLP conversion

► LLP conversion under LLP Act, in substance, at par with Part IX conversion

under Companies Act.

► Part IX provisions provide for properties of firm to “pass to and vest” in the

company. LLP Schedule provides for “transfer to and vesting” of properties

in LLP and define conversion to interalia include transfer.

► The legal dictionary confirm that the word “pass” synonym with “transfer”. [Refer

Black’s Law Dictionary].

“In the language of conveyancing, the term means to move from one person

to another; i.e. to be transferred or conveyed from one owner to another.”

► Advanced Law Lexicon:

“to go by transfer of conveyance or to come by inheritance [S. Sale of Goods Act (3 of

1930)].


Applicability of Part IX ratio to LLP conversion

► Similarities of features with Part IX conversion. ► Involves vesting;► It is transformation of an entity in a different form. ► No two parties exist at a single point of time to permit bilateral transfer.► There is no flow of consideration to the firm; the firm is dissolved.

► According to Explanatory Memorandum, it is as if; there is mere change in designation of tax status of same entity !.

► LLP conversion arguably:► Does not trigger tax implications for the firm► Does not trigger fiction of Sec 45(4) of IT Act► Does not trigger tax implications for the partner/s who do, as such. Receive

income through the passage of the firm

Issues to be addressed : Indirect tax, stamp duty implications

Tax Analysis – Conversion of company into LLP

► Section 47(xiiib) compliant conversion (w.e.f 1.4.2011)

► Possible tax implications in case of Section 47(xiiib) non compliant conversion

► Treatment of various expenses and claims


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.”


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.”


Conversion of Private / unlisted Company into LLP

► Conditions for tax neutral conversions of companies into LLP► 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

► On fulfillment of above conditions, company as also shareholders are exempt from capital gains tax liability


Conversion to LLP : certain aspects

► No lock in period for the period upto which erstwhile shareholder continues to be a

partner, so long as condition of aggregate of 50% of profit sharing ratio fulfilled

► Conditions not violated if LLP makes payment to partners for services or contracts

unrelated to the rights of partner on conversion;

► No provision for cost step up for LLP and the shareholder if capital gains exemption forfeited requiring LLP to pay tax

► No specific amendments to permit continuing tax holiday in the name of LLP;► DTC requires eligibility as of the date of transition in the hands of the same

taxpayer as a precondition of gradfathering


Conversion to LLP : Issues

► 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

► Unresolved questions : No guidance in LLP Act

► Security premium in books of company can be considered to be at par with share capital,

requiring credit to capital contribution in the books of LLP

► Bonus share capital can be considered as part of share capital requiring credit to capital

contribution in the books of LLP

► Reserves on the books of company are, in certain noted cases, conventionally credited as

reserves in the books of LLP for compliance with 3 year lock in condition of restricted

withdrawal

► Lock in on withdrawal of funds, arguably , applicable to initially converted capital contribution


Other tax implications of conversion*

► Unlikely DDT implications u/s.2(22)(a) in absence of distribution by company to shareholders; incorrect to suggest that LLP interest held by partners collected by company and distributed to shareholders

► Unlikely DDT implications u/s.2(22)(c) in absence of distribution;► Winding up or liquidation generally means realization of assets, discharge of

liabilities and distribution of residuary surplus to shareholders. Conversion into LLP does not involve the above.

► CBDT Circular - 5P dated 9 October 1967 on amalgamation also supports► Unlikely S.2(24)(iv) implications for shareholders in absence of any benefit

passed on by the company► At best, corresponding sacrifice by shareholders

* Equally applicable to 47(xiiib) non-compliant conversion


Tax neutral section 47 (xiiib) protected conversion : Back-up provisions

Section Brief Particulars

5th proviso to Section 32

In the year of conversion, aggregate of depreciation to LLP and company not to exceed depreciation as would have been allowable to the company without such conversion

Explanation 2C to section 43(6)

WDV of block of assets of company to be WDV of LLP

Section 35DDA(4)

Amortisation in respect of residual VRS payment by company available to LLP

Explanation 13 to Section 43(1)

Actual cost of capital asset for which investment linked deduction is granted u/s. 35AD to the company to be NIL in the hands of LLP

Section 49(1)(iii)(e)

Actual cost of capital asset of company to be the actual cost to LLP

Section 49(2AAA)

Cost of shares in company would represent cost of LLP interest for partner


Tax neutral section 47 (xiiib) protected conversion : Back-up provisions

Section Brief Particulars

Section 72A(6A)

LLP can carry forward unabsorbed business losses / unabsorbed depreciation [Arguably, fresh lease of time period available]

Section 115JAA(7)

No carry forward of MAT credit to LLP

Section 47A(4) and Section 72A(6A)]

Also, S. 47(xiiib) breach leads to LLP paying tax in the year of

violation on:

►Capital Gains exempted in the hands of company and the shareholder

►Forfeiture of loss claimed by LLP [Proviso to section 72A(6A)]


Possible tax implications in case of section 47(xiiib) 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► On principles, akin to case of amalgamating company transferring assets to

amalgamated company► Capital gains or business income liability unlikely in absence of

consideration


S.47(xiiib) non compliant conversion: Implications for shareholders► Judicial thinking in context of conversion of firm to company under Companies

Act favours the taxpayers ► Distinguishing features in case of partners

► Firm and partners received income through common passage; partner has no separate source of income

► No accrual of income to firm and NIL tax liability of firm release the partners ► No separate income stream to partners independent of the firm ► No independent liability on dissolution; consequences u/s.45(4) of ITA on the firm

► Distinguishing features in case of shareholders (tax department contentions ) ► Shareholder enjoys independent source of income ► There is extinguishment of shares at the end of conversion [Refer Grace Collis (248

ITR 323)(SC)]► There is receipt of consideration in the form of LLP interest by the erstwhile

shareholders ► Legislative / CBDT thinking supports taxation in absence of compliance with

exemption conditions.


S.47(xiiib) non compliant conversion: Shareholder’s possible defences

► Introduction of exemption provision is not, in itself, indicator of an effective charge if conditions of exemption remain unfulfilled

► Charge to tax needs to be established independently with the support of a proper charging provision

► CBDT Circular or Explanatory Memorandum, which deviates from correct interpretation, has no legal force

► In terms of S.58(4) of LLP Act, the sequence of steps is : registration of LLP; vesting of assets; dissolution of company. This is suggestive of extinguishment being after the stage of registration and vesting; no consideration becomes due as a result of extinguishment

► Partner interest in LLP is not capable of being ascertained [refer SC in Sunil Siddhartbhai (156 ITR 509)]. The value of consideration is not ascertainable and the charge should therefore fail

► Cases of vesting do not envisage any enrichment, any real income capable of attracting charge to tax


Treatment of various expenses and claims

Nature of claim / section

K&S preferred views

43B / 40(a)(ia) [for expense incurred and debited to P&L a/c by company]

►Section 58(4) of LLP Act requires transitioning of “rights” in favour of LLP. Possible to urge that right to avail deduction on payment of outstanding expense, which is otherwise allowable should travel to LLP

►In respect of actual payment beyond the due date of return, company will suffer disallowance but, the deduction can be enjoyed by the LLP.

►In respect of payments made by LLP post the date of conversion, but, prior to the due date of return as applicable to the company, the deduction will relate back to the company.

Bad debt u/s.36(1)(vii)

►In addition to contentions captured herein, having regard to the judgement of Supreme Court in the case of Veerbhadra Rao (155 ITR 152) it should be possible for LLP to claim deduction in the year of write off.




K&S preferred views

MAT credit ►In view of the fact that LLP is not liable to MAT upto AY 2011-12 and considering the specific provisions of 115JAA(7), it may not be possible to transfer MAT credit to LLP

Depreciation [section 32]

►In year of year of conversion, Fifth proviso to Section 32 grants proportionate deduction of depreciation to the predecessor and successor.

►Since this is a case of succession covered by section 170 of the Act, read with Explanation 1 of section 43(6), the tax WDV of the company should be the tax WDV of LLP.

Cost of acquisition for capital gain (Section 49)

Since this is a case of “succession” read with section 49(1)(iii)(a), cost to the company should be cost of acquisition of asset to the LLP.




K&S preferred views

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►Company and LLP to file income tax return respectively; ►Company to file return of income upto the date of conversion and LLP for the period from date of conversion till year end.

Permanent Account Number (PAN)

LLP is a different entity and hence, preferred view is that a separate Permanent Account Number would be advisable.


Right to carry forward losses available with LLP?

► Two Possible views► View 1: Right to carry forward not available

► Right to carry forward loss is available only to an assessee who incurred it. Section 72A and 78 are exception to the principle

► In absence of specific provision in law, in following cases, court / ITAT did not permit right to carry forward to the successor

► Hindustan Aeronautics (149 ITR 795)(Karn) - in the context of amalgamation prior to insertion of section 72A of IT Act

► Amin Machinery Pvt Ltd (299 ITR 140(AT)(AHD) - in the context of Part IX conversion

► S.78(2) does not cover any other mode except by way of inheritance


Right to carry forward losses available with LLP?

► View 2 : Right to carry forward is available► Section 58(4) of LLP Act requires transitioning of “rights” in favour of

LLP. Possible to urge that right to avail carry forward of loss which is otherwise allowable should travel to LLP

► SC in Shah Sadiq and Sons [166 ITR 102] held that right to carry forward is accrued and vested right

► Vesting of right on the basis of section 58(4) will be for the residual period which remained unavailed in the assessment of the company.

► Without impairing such general right, the LLP which fulfills certain specific conditions of section 47(xiiib) may be able to enlarge its benefit in terms of section 72A (6A) of the Act

► While View 2 is arguable, View 1 is the K&S preferred view

India LLP – Possible planning opportunities

Tax Q&RM Guidance:

It may be noted that the planning opportunities outlined in the subsequent slides are conceptual in nature and provide a prima facie view of the likely tax consequences. A more detailed analysis and an assessment of the facts would be necessary before considering feasibility for a particular situation. Further, It is important that ambiguities in the FDI policy and uncertainty in the tax treatment, where applicable, is highlighted to clients while discussing planning opportunities.


Repat / DDT Planning

► Description:

► Indian operations set up as LLP

► Hold Co is partner in LLP

► LLP distributes profits to partners

► Benefits:

► No DDT

► Greater flexibility on claiming credit by Hold Co for India taxes. DDT does not apply

► If Hold Co jurisdiction treats LLP as transparent, direct credit possible

► If Hold Co treats LLP as non-transparent, UTC possible

► Can also be combined with “conversion planning”, where feasible

► Possibility of conversion of cash rich India Co into LLP prior to profit distribution*

► Issues

► FDI restrictions need to be considered

► Taxation of India LLP at entity level on global basis should fairly mitigate additional taxation in the hands of Holdco even assuming LLP is alleged to trigger PE for Holdco

► Comprehensive analysis on tax implications in Hold Co’s jurisdiction may be required

India LLP

Parent

Profit Distribution

Hold Co

* Event of conversion as also event of withdrawal of past profit have independent tax implications.


Exit Planning

► Description:► Indian operations held by way of LLP which is a separate legal person

► HoldCo is partner in LLP

► HoldCo proposes to exit Indian operations

► LLP interest transferred to third-party at FMV

► Benefits:► Possibility of avoiding capital gains tax under many tax treaties

► Interest in LLP could be capital asset in India

► Exclusive taxation right to residence country under “residuary rule” in most tax treaties. Hence, gains arising from transfer of Interest in LLP by Hold Co taxable in residence country of Hold Co only

► Issues► FDI restrictions need to be considered

► May not viable under treaties such as US/ UK as taxation would be as per domestic tax law

► There could be uncertainty if gain is held connected to immoveable property or connected with PE

INDIA LLP

PARENT

HoldCo(Treaty Country)

Transfer of LLP interest


MAT Planning, new business

► Description► India Co invests in an India LLP► India LLP sets up an eligible undertaking

eligible for deduction under Sec 35AD

► Benefits► Profits earned by LLP eligible for investment

linked deduction► AMT not applicable to LLP in respect of tax

benefit arising due to investment linked incentive

► Distribution by LLP tax exempt and not subject to MAT for India Co

► Benefit also available for exempt income of LLP under Section 10(38)► Workable for LLP set up as an operating

entity

India Co

India LLP

WOS of India Co

95 percent holding 5 percent holding

Undertaking eligible for investment linked

deduction u/s 35AD


AOP Mitigation

► Description:

► Onshore component of EPC contract among consortium

members executed through a LLP

► Benefits:

► Issues of emergence of AOP and related tax

consequences mitigated

► Issues:

► Applicability of TP provisions for transactions between Foreign Co

and India LLP

India Co.

INDIA LLP

Foriegn Co.

EPC Contract eg: Power contract


Deemed Dividend Mitigation

► Description► Holding company with multiple Indian

operating entities

► Indian operating entities set up as LLPs

► Excess cash in one operating entity and need

for cash in another

► Inter-LLP loan

► Benefits► Inter-LLP not considered as deemed dividend

► Tax efficient movement of cash within

operating entities

► Issues► FDI restrictions need to be considered

Hold Co

India LLP1 India LLP2 India LLP 3

Loan


Deemed Dividend Mitigation - Variation

► Description

► Parent with cash rich subsidiary (Hold Co) in high tax

jurisdiction

► Indian operating entity for Parent set up as India

LLP2

► Excess cash sitting in Hold Co and need for cash in

India LLP2

► IndaiLLP1 formed with Hold Co as a partner

► Cash divested in India LLP1 as capital contribution

► Inter-LLP loan

► Benefits

► Inter-LLP loan not considered as deemed dividend

► Tax efficient movement of cash

► Issues

► FDI restrictions need to be considered

► India LLP 1 should not pursue NBFC covered activity and should not be a conduit

Parent

India LLP1 India LLP2

Loan

Hold Co

Cash

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