Limited Liability Partnership (‘LLP’) is a form of business structure which combines best elements of the partnership and corporate structures of carrying out business and provides considerable flexibility in management and for conducting businesses, especially to small and medium firms. The LLP were recently introduced in India vide the Limited Liability Partnership Act, 2008 (‘LLP Act’). However, the need for a clear cut tax regime in respect of the income of the LLP was essential to give certainty in all respects of conducting business via this mode of business.
LLP to be treated at par with general partnership
The Union Budget 2009 announced on July 6, 2009 has laid down the roadmap for the taxation of the LLPs in India. The new provisions introduced in relation to the taxation of LLP do not treat the LLP as a transparent entity but treat the same at par with the general partnerships under the Indian Partnership Act, 1932. Accordingly, the profits and losses of the LLP would not pass through in the hands of the partners but would be assessable in the hands of the LLP. The definition of “firm”, “partner” and “partnership” under section 2(23) of the Income Tax Act, 1961 (‘IT Act’) have also been extended to include LLP, a partner in a LLP and LLP respectively within their scope. Accordingly, all the provisions relating to the firm incorporated apply mutatis mutandis to LLP.
Conversion of general partnerships / companies into LLP
The LLP Act provides for the conversion of general partnerships and private limited companies or unlisted public companies into LLP. However, no amendments have been proposed to the IT Act per se clarifying the tax implications arising on the conversion of a general partnership into a LLP. The memorandum to the budget states that no tax liability would arise in case of a conversion of a general partnership into LLP, so long as there is no change in the rights and obligations of the partners and no transfer of assets or liabilities post the conversion. However, the conversion of a general partnership into LLP would inevitably involve the limitation of personal liability of the partners, thereby resulting in a change in the obligations of the partners. Therefore, the issue would arise whether such a conversion would lead to a transfer liable to tax under section 45 of the IT Act. Further, there is no indication on the tax implications of the conversion of a private limited company or public unlisted company into an LLP, neither in the Act nor in the memorandum.
Although the LLP have been treated at par with the general partnership, they have been specifically excluded from the provisions of section of 44AD of the Act, which provide for an option of the income of the general partnerships to be taxed at a presumptive rate of 8%. There seems to be no clarity on such an approach of excluding LLP from the provisions of presumptive taxation.
A new section 167C has been introduced in the IT Act, which makes every partner of a LLP jointly and severally liable for the taxes to be paid by the LLP for the period during which he was a partner, unless the non-recovery of taxes cannot be attributed to gross neglect, misfeasance or breach of duty on his part. The aforesaid is irrespective of any contrary provision in the LLP Act. Although this section appears to be in conflict with the scheme of the LLP Act, which does not make the partners personally liable for the liabilities of the firm, it seems to be in line with existing provisions of section 179 of the IT Act, which cast a similar liability on the Directors of a private company in liquidation.
Since the LLPs have been treated at par with the general partnership, they would not be liable to Dividend Distribution Tax and Minimum Alternate Tax. Further, the Budget has also scrapped the surcharge on tax for firms. Also, if the LLP is a non-resident under the IT Act (its control management is wholly situated outside India), it would continue to be taxed at 30% plus applicable cess. All the aforesaid factors make LLP an attractive mode of business so far as the tax cost is concerned. However, LLP, which is a hybrid structure between a company and a firm, could have been more attractive mode of investment if a pass through status was accorded to it for tax purposes.
The practice of taxing the income of the LLP in the hands of the firm is a divergence from the practice of treating the LLP as a tax transparent entity in certain other countries like UK and USA, which tax the income of the LLP in the hands of the partners. Thus, in case of the income of the LLP is also taxed in other jurisdiction where the income is taxed in the hands of the partners, the availability of tax credit to LLP in India might lead to certain difficulties.
The introduction of a tax regime will provide a road of certainty in relation to the tax costs associated with carrying the business via the LLP mode. However, further clarification and suitable amendments to the Act are desired to remove the cloud of uncertainty in relation to conversion of general partnerships and companies into LLP.
– By Pranay Bhatia, Partner, Economic Laws Practice and Kumar Sampat, Associate, Economic Laws Practice