The Union Budget 2009 presented by the Hon’ble Finance Minister, Mr. Pranav Mukherjee today, inter alia also provided the much awaited tax treatment for the new corporate business vehicle viz., Limited Liability Partnerships (“LLP”). With this proposal, the unclear picture surrounding the tax aspects of LLPs seems to have been cleared.
As expected, the announced taxation regime for LLPs is similar to that presently applicable to partnership firms registered under the Indian Partnership Act, 1932. This is a clear demarcation from the general global practice, where LLPs are exempt from tax (or in other words are treated as pass through) and the partners are directly taxed. Similar recommendations were made by the Naresh Chandra Committee Report. Under the proposed regime in India the LLPs would be taxed at entity level and the share of profits to be received by the partners would be exempt from tax. Nonetheless, owning to the structural and operational flexibility coupled with clarity on tax aspects, LLPs could be a suitable vehicle for investment by venture capitalists and private equity players, which presently operate through a domestic trust – could be registered or unregistered.
This article provides an overview of key tax & regulatory aspects relating to migration to LLP structure.
SEBI (Venture Capital Funds) Regulations
SEBI (Venture Capital Funds) Regulations, 1996 permits a body corporate to be registered as DVCF, if such body corporate is set-up or established under the laws of the Central or State Legislature. There is no clarity on how one has to read the terms “under the laws of the Central or State Legislature” and whether LLP set-up under the LLP Act 2008 could be covered.
Since LLP would be treated as a non-transparent entity for tax purposes, the foreign investors may not able to enjoy the tax treaty benefits (if any) of investing in India through such LLPs. Thus the unified model which arguably may have worked for a trust would not be available for LLPs.
Incorporation of LLP
As per section 11 of the LLP Act, 2008, for a LLP to be incorporated, two or more persons associated for carrying on a lawful business with a view to profit shall subscribe their names to an incorporation document. The language suggests that LLP necessarily needs to be incorporated with a view to profit – the term is very wide and it may also include profit on account of capital nature. Typically, funds are structured to make long term investments and characterise the gains / losses on such investments as capital gains / losses. One therefore needs to consider on whether such characterisation would be available to LLPs.
Procedure for conversion
The LLP Act, 2008 provides a procedure for conversion of a firm, a private company and unlisted public company into a LLP. However, it does not provide the procedure for conversion of trusts into LLP.
Further, the proposals by Union Budget in its provisions relating to direct taxes (i.e., memorandum explaining provisions of the Finance Bill) states that the conversion from a general partnership to a 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 after conversion. In case of violation of these conditions, the provisions of section 45 of the Income Tax Act, 1961 (“the Act”) shall apply. However, there is no corresponding mention about such amendment in the Bill. Further there seems to be a prohibition on transfer of assets after conversion – there needs to be a time limit for such prohibition and there cannot be a blanket prohibition. These provisions may not be applicable to conversion of trusts and hence tax aspects of such conversion should be addressed.
Section 10(23FB) of the Act provides exemption in respect of the income of a venture capital company or venture capital fund. A “venture capital company” has been defined as a company which has been granted a certificate of registration under SEBI regulations. A “venture capital fund” is defined as a trust. LLP being neither a company nor a trust, such exemption under section 10(23FB) of the Act may not be applicable to them.
Considering the above practical difficulties, there is a need to make representations both to SEBI and the tax department to clear the ambiguity surrounding the LLP pertaining to some of the issues pointed above.
By Vikram Bohra, Senior Manager, Jignesh Desai, Assistant Manager and Namrata Doshi, Associate, PricewaterhouseCoopers, India
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