AIFTP JOURNAL June, 2011

IN PURSUIT OF KNOWLEDGE Limited Liability Partnership CA. Pankaj Jain

DIRECT TAXES BACKGROUND

Limited Liability Partnership is a body corporate formed and incorporated under Limited Liability Partnership Act, 2008 and is a separate legal entity from that of its partners. In other words it can be said that LLP is a mixture of incorporated Company and partnership. It is an ‘Alternative Business Vehicle’ or a ‘Hybrid’ that provides flexibility of limited liability with partnership structure that is a resultant outcome of quality extracts from Indian Partnership Act & Companies Act.

MAIN FEATURES OF LLP

The main features of a Limited Liability Partnership are as follows: Changes in partners not to affect the existence, rights or liabilities of partnership Provisions of Indian Partnership Act, 1932 shall not apply unless otherwise provided. The mutual rights and duties of Partners within a LLP are governed by an agreement between partners or between the partners and the LLP as the case may be. Any obligation of LLP whether arising out of a contract or otherwise, shall be soiéiy the obligation of LLP, the partners are not personally liable directly or indirectly At least 2 designated partners where one being resident. Any individual or a body corporate may be a partner in the LLP Partners of LLP are agents of lIP, but not agents of the firm i.e., no partner shall be an agent of other partners and responsible

INCORPORATION OF LLP The steps involved in incorporation of LLPs are as mentioned below:

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IN PURSUIT OF KNOWLEDGE – Limited Liability Partnership

{NOTE:* Where the proposed name includes word like ‘Chartered Accountant’, ‘Company Secretary’ or ‘Advocates’ or any similar word indicative of Profession, then approval from Governing Council of the profession is required and proof of which is required to be attached withe-form}

LLP AGREEMENT The concept of LLP is based on the Agreement and therefore the agreement between partners is of utmost importance. While drafting the agreement, the following points shall be kept in mind:– a)

Rights and Duties of Partners

b)

Remuneration if payable

c)

Capital Contribution

d)

Profit Sharing Ratios

e)

Management of business of LLP

f)

Death/Voluntary retirement /resignation of partners

g)

Termination/Dissolution, etc. In the absence of express agreement the LLP shall be governed by First schedule of LLP Act.

TAXABILITY OF LLPs The Approach towards taxation of LLPs is as under: LLPs are taxed along the same lines of that of a partnership firm as definition of ’Firm’ covers LLP also. The share of Partners in the total income of are tax free in their hands under section 10(2A) of Finance (No. 2) Act, 2009 Interest paid to partners of LLP is allowable as deduction subject to compliance of certain conditions. Conversion of General partnership firms to LLPs under the Second Schedule to the LLP Act, 2008 shall not give rise to capital gains. LLPs cannot avail the presumptive taxation scheme under section 44AD w.e.f. Assessment Year 2011-12. LLPs are not liable to wealth tax.

TAXABILITY OF LLP AS A PARTNERSHIP FIRM Taxability shall be similar to partnership firm provided conditions given in section 184 of IT Act are complied with by a LLP. The two main conditions are as follows: •

Existence of written LLP Agreement or a written instrument certified in writing by all partners

•

Clear specification of individual partner shares in agreement.

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AIFTP JOURNAL June, 2011

Certified copy of LLP Agreement is submitted along with first return of Income of LLP. The LLP shall be assessed as a firm till such time there is no change in:– •

Constitution of the LLP and/or

•

Shares of profits of partners

The LLP as per section 6(2) of the Act, is considered a resident in India in any previous year except when during the particular year control and management is situated wholly outside India. The decided cases in this regard are:•

Asstt. CIT vs. Kakkar Cold Storage [2004] 1 SOT 156 (Asr-Trib), it was held that a partnership may be evidenced by one or more documents. Where there was not a regular partnership deed, documents relating to formal transfer or letters of correspondence between partners may constitute ‘Instrument of Partnership’

DEDUCTION OF REMUNERATION & INTEREST PAID TO PARTNERS •

There is major contradiction between section 23(4) of the LLP Act regarding the payment of remuneration to the partners by aLLP

•

As per section 23(4) ‘in absence of agreement on any matter, the provisions relating to matter in First schedule shall apply’

•

But para I of the First Schedule states that ‘in the absence of any agreement on any matter, entire First Schedule shall apply’ and also Para 6 of the schedule states that ‘No partner shall be entitled to any remuneration for acting in the business/management of a LLP’ –

In the decided case of Aphali Pharmaceuticals Ltd. vs. State of Maharshtra, the Supreme Court held that expressions used in the section shall prevail against express enactment in the Schedule in case of any inconsistency. Therefore in view of this judgement section 23(4) can overcome the bar on remuneration as provided in the schedule if provisions of. remuneration are made in LLP Agreement.

•

The claim for deduction of remuneration paid to partners is discretionary and not a mandatory y provision as held in the decided case of Tulsa Ram Kanhaiyalal & Sons. vs. ITO [2008] 25 sot 402 (Jodh., Trib) (SMC)

•

The remuneration/commission paid to non-working partners are not allowable as

•

The deduction of any interest paid to partners under section 40(b) shall be allowed if all conditions are satisfied:-

•

–

Payment of interest is authorisedby LLP Agreement

–

Payments will be allowed as deduction only for a period beginning from date agreement and not for earlier period.

–

Payment of interest should not exceed amount calculated @ 12% p.a simple interest

–

The requirements of section 36(1) (iii) of the Act are satisfied

The decided case of Munjal Sales Corporation vs. CIT [2008] Supreme Court laid down following principles:–

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AIFTP JOURNAL June, 2011

IN PURSUIT OF KNOWLEDGE – Limited Liability Partnership

–

Section 40 is not a stand alone section and its object is to provide limitation on amount of deduction which assessee is entitled to under sections 30 to 38.

–

The firm claiming deduction of interest paid shall establish the right to claim deduction under section 36(iii) and is not disentitled to claim deduction by reason of applicability under sec. 40(b)(iv)

SET OFF/CARRY FORWARD OF LOSSES OF LLP •

A LLP is allowed to set off losses and carry forward the losses as in case of firm.

•

However under section 78(1) of the Act, where there is a change in constitution of the firm, it shall not be entitled to have carry forward and set off of losses.

•

As pointed before under section 2(23) the expressions ‘firm’, ‘partner’ and ‘partnership’ have the same meaning but an LLP have features of perpetual succession as Body corporates therefore concept of change in constitution’ has no relevance to LLP.

•

This has been reinstigated in the decided case of Sant Lal Arvind Kumar (supra) that the term ‘firm’ under section 78(1) refers to only general partnerships and not to LLPs.

ACCOUNTS AND AUDIT •

Every LLP shall maintain proper books of account on cash or accrual basis according to double entry system and the same shall be preserved for eight years.

•

Within six months from the end of each financial year, LLP shall prepare a statement of account and sovency in Form-8 of LLP Rules, 2009 and to be filed with ROC within 30 days of the said six months

•

As per section 34(4) of LLP Act, 2008 the accounts of LLP shall be audited in accordance with rule 24(8) which prescribes that a LLP whose turnover does not exceed ` 40,00.000 in any financial year or contribution does not exceed ` 25,00,000 shall not be required to get its accounts audited.

•

The designated partners may appoint/reappoint auditors who shall hold office as per terms of his/her appointment

TAXATION OF PARTNERS OF LLP •

A minor can be inducted as a partner in LLP for the benefits of partnership within the meaning of section 2(23) for income tax purposes also

•

A person who has become a partner in accordance with the LLP Agreement but has .not filed his consent in Form No. 4 will not cease to be a partner

•

Under section l0(2A) the share of total income of the LLP is exempt from taxation in the hands of partners. This benefit is also extended to companies who is a partner in LLP.

•

The salary/remuneration due to or received by a partner from LLP shall be taxed in partner’s hands as ‘Profits and Gains from business or profession’ after deduction of any expense incurred for earning the same.

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AIFTP JOURNAL June, 2011

•

The rights of a partner to a share of the profits/losses are transferable either wholly or in part. However, the tax implications on the same have not yet been clarified.



The interesting decided case law in this regard reads as under:



ITO vs. Smt. Paru D. Dave [2008] 110 lTD 410 (Mum. —Tri.) it was held that introduction of new partners to partnership firm does not entail to relinquishment of their rights in the partnership property and therefore no capital gain arises therefrom. The same holds good for LLP as well.

•

The contribution is made in the form of asset or services to LLP by its partner are taxable in their hands.

CONVERSION OF GENERAL PARTNERSHIP FIRMS TO LLPs – TAX IMPLICATIONS •

The conversion of general partnership firm into LLP is done in accordance with Second Schedule to the LLP Act,2008

•

The second schedule states that such partnership shall be converted if and only if the partners of the LLP into which the firm is to be converted, comprise all the partners of the firm and no one else.

•

There is no provisions exempting conversion of general partnerships to LLPs from capital gains tax nor there is a provision applying any tax.

•

The Explanatory Memorandum of Finance (No. 2) Bill, 2009 clarifies that if the rights and obligations of partners remain the same, there shall be no transfer of asset/liability and therefore no capital gains

•

In the decided case of CIT vs. Texspin Engg. & Mfg. Works [2003] 129 Taxman 1 (Bom.) it was held that conversion of firm into a company under Part IX of Companies Act, 1956, –

there is no transfer by way of distribution of asset. Therefore section 45(4) is not attracted

–

Asstt. CIT vs. Unity Care and Health Services [2006) 103 lTD 53 (Bang.) ITAT held that section 47 (xiii) applies only to case of transfer of a firm to a company by a sale and not under Part IX of the Companies Act, which is similar to Second Schedule of LLP Act. Therefore based on this it is construed that conversion of firm into LLP is not conversion and the losses can be carried forward and set off

CONVERSION OF PVT. CO./UNLISTED CO. INTO LLP As per section 56 of LLP Act, a private company may convert into LLP in accordance with Third Schedule only if:– •

There is no security interest in its assets subsisting ar the time of making application

•

Partners of the LLP to which it converts comprise of all the shareholders of the company and no one else

•

Section 47(xiiib) inserted by Fjnance Act, 2010 w.e.f. 1-4-2011 provides for exemption to capital gains upon conversion of a Co. to LLP subject to fulfillment of all conditions as mentioned below:– AIFTPJ – 243

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AIFTP JOURNAL June, 2011

IN PURSUIT OF KNOWLEDGE – Limited Liability Partnership

a)

All the Assets & Liabilities get vested in LLP



All the Shareholders shall be the partners of LLP and no one else and their Capital Contribution in the LLP shall be in same ratio as their shareholding in the Co.

b)

No receipt of consideration other than share in profit and capital contribution by partners.

c)

Aggregate profit share of shareholders is not less than 50% at any time during 5 years from conversion.

d)

Total sales/turnover in any 3 previous preceding years from conversion does not exceed ` 60 Jakhs

e)

No payment made to any partner out of balance of accumulated profit in books of accountfor 3 years from conversion

COMPROMISE AND ARRANGEMENT IN LLPs •

Under setion 60(1) of LLP Act provides that where a compromise or arrangement is proposed between a LLP and its creditors or LLP and is partners, the Tribunal on application of LLP order a meeting of its creditors/partners to be held in such manner prescribed.

•

The compromise/arrangement will be sanctioned by NCLT if the majority i.e. three-fourths in value of the creditors, or partners agree to the Compromise/Arrangement.

Where the assessee is allowed deduction or allowance in the assessment of any earlier previous year in respect of loss, expenditure or trading liability and the assessee or •

The successor derived some benefit in respect of such trading liability by way of remission/cessation thereof, such benefit shall be liable to be taxed in the hands of assessee.

•

No compromise or arrangement proposed in connection with scheme of amalgamation of a LLP, shall be sanctioned by NCLT unless it has received report from Registrar

INCOME TAX RETURN •

U/s 140 of the IT Act, the responsibility to file income tax return of a LLP vests with designated partner, however, if not possible for a designated partner to sign, then by any partner

•

As per sec. 167C, every partner is jointly & severally liable for payment of tax dues unless it is proven that such non recovery cannot be attributed to gross neglect, misfeasance or breach of duty [Inserted by Fin. Act, 2009 w.e.f 1.4.20101]

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AIFTP JOURNAL June, 2011

POINTS OF COMPARISON BETWEEN LLP, COMPANY AND PARTNERSHIP FIRM Sr. Conditions LLP Company No. 1. Registration To be registered with To be registered Registrar of LLP under with Registrar of LLP Act, 2008 Companies under Companies Act, 1956. 2 Name Name should contain Name should contain ‘Limited Liability ‘Limited’ / ‘Private Partnership’ or ’LLP’ as Limited’ as last words last, words 3. Legal entity LLP is a separate legal Company is a separate entity registered under legal entity registered LLP Act under Companies Act, 1956 4. Formation Cost The cost of Formation The cost of Formation is lesser that of is higher than that of formation of Company. formation of LLP 5 Formation by Foreign Nationals alone Foreign Nationals alone Foreign Nationals cannot form a LLP. can form a Company 6. Minimum Number Minimum 2 partners Minimum 2 in case of of Members Private Company 7 in case of Public Company 7 Management Minimum 2 Designated Minimum 2/3 Directors Team partners 8. Administration Designated Partners Directors are are responsible for day- responsible for day-to- to-day operations and day operations and statutory compliances statutory compliances 9. Remuneration to Remuneration to Remuneration to Managerial partners will be Directors of Public Com- Personnel determined on LLP panies are governed Agreement by Companies Act 10. Liability of Limited to the extent Limited to the amount Partners/ of contribution of share capital agreed Members towards LLP to be contributed on each share AIFTPJ – 245

Partnership Registration is optional

Any name as per choice

Not a separate legal entity

The cost of Formation is negligible Foreign Nationals cannot form Partnership Firm in India 2

No requirements Partners are responsible for day to-day operations and statutory compliances The firm can pay remuneration to its partners Partners have unlimited liability

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AIFTP JOURNAL June, 2011

IN PURSUIT OF KNOWLEDGE – Limited Liability Partnership

11. Capital Determined by partners Contribution as per the LLP agreement

Limited to the unpaid Unlimited may amount of share capital extend to their agreed to be personal assets contributed

12. Transfer of Ownership transfer is Ownership Rights governed by the LLP Agreement

Ownership is easily Not transferable transferable by transfer of shares

13. Statutory There is no requirement Meetings to hold any meeting

Board Meetings and General Meetings are required to be conducted as per Companies Act

There is no provision in regard to holding of any meeting

14.

Required to maintain books of account, statutory registers, minutes, etc.

Required to maintain books of account as Tax laws

Maintenance of Required to maintain Statutory books of account. Records /Minutes Book

15. Annual Filing

Annual Statement of accounts and Solvency & Annual Return needs to be filed every year.

Annual Accounts and No return except Annual Return needs to Tax returns be filed with the Registrar of Companies

16. Agreements / Partners are free to There are restrictions Partners are free Contracts with enter into any contract for contracts in which to enter into any Partners/Director with LLP directors are interested. contract partnership 17. Reputation LLP enjoys higher reputation compared to Partnership as it is registered and regula- ted by LLP Act

Due to Stringent Creditworthiness Compliances & of firm depends disclosures under upon goodwill and various laws, Companies creditworthiness of enjoy high degree of its partners creditworthiness

18. Dissolution Voluntary or by order Voluntary or by order of National Company of National Company Law Tribunal Law Tribunal

22

By agreement, mutual consent, insolvency, certain contingencies, and by court order

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COMPARATIVE CHART OF TAXATION OF FIRM, LLP AND COMPANY Points of Firm LLP Comparison

Pvt. Co./Unlisted Co.

Rate of Tax 30% + educ. cess @ 30% + educ. cess 2% & H.E.C @ 1% 2% & H.E.C @ 1%

30% for A.Y 2o12-13 and surcharge @ 5% if net income exceeds ` 1 crore + educ.cess @ 2% & H.E.C @ 1%

Minimum Alternate No Tax

Instead of MAT, Alternate Minimum Tax shall be payable by LLPs @ 18.5% on adjusted total income

Yes, @ 20.0077% for A.Y. 2012-13

Dividend Distribution Tax

No

DDT @

No

Tax Treatment of Share of total Share of total income Dividends tax free profits shire/dividends income of firm of LLP exempt in in the hands of in the hands of exempt in partners partners hand u/s 1o(2A) shareholders partners/members hand u/s 1o(2A) provided DDT paid on dividends Basis of Accounting Can opt to use cash Can opt to use cash asis of accounting basis of accounting it is allowed by LLP Act, 2008

Only mercantile basis allowed as Co.s Act does not allow cash basis accounting

Admission of minor as a partner/member

Minor cannot be appointed as a partner but can be admitted only for benefits

Interest on capital paid to partners/members

Partners can be paid Partners can be paid Shareholders can interest on capital which interest on capital which be paid interest on is deductible u/s 36(1) is deductible u/s 36(1) capital except in (iii) read with (iii) read with account with sec. sec. 40(b)(v) sec. 40(b)(v) 208 of Cos. Act

Deemed dividend under section 2(22)(e)

Loan to firm to a partner not taxable as deemed dividend in his hands

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No express bar on No express bar minor being from minor appointed as a Partner becoming a or admitted for benefits shareholder

Loan to LLP to a partner Loan /advance by not taxable as deemed Co. to shareholder dividend in his hands is deemed dividend u/s 2(22)(e) 23

AIFTP JOURNAL June, 2011

IN PURSUIT OF KNOWLEDGE – Limited Liability Partnership

Changes in partners/ members – affect on carry forward of loss

Change in constitution Cessation of partnership of firm due to death/ is not succession retirement then loss therefore carry forward cannot be carry fwd/set possible off as sec. 78(1) will be applicable

Change in shareholding may affect carry fwd/set off of losses as per section 79 of IT Act

Wealth Tax

No wealth-tax

No wealth-tax

Applicable

Presumptive tax scheme

Firms can avail presumptive tax schemes u/s. 44AD, 44AE and 44AF

LLPs can avail presumptive tax schemes u/s. 44AD, 44AE and 44AF

Companies can avail presumptive taxation new see 44AD

Taxability of VRS No tax exemption to No tax exemption to received employees of firm for employees of firm for VRS payments received VRS payments received from firm

VRS payments received by employees of a Company is exempt from tax under section 10(10C)

CHECKLIST FOR CONVERSION OF COMPANY INTO LLP Sr. Considerations Effect on conversion No.

Possible Solution

1.

Defer conversion till MAT credit is recouped

Does the Cos. have MAT credit accumulated will be accumulated MAT credit lost. Neither refund nor set-off u/s 115 JAA which it is hope- against LLPs tax liability ful of tax liability setting off in next few years?

2. Does the Company intend to implement VRS scheme to downsize/restructure?

Tax exemption up to ` 5 lakhs under section io(ioC) in respect of VRS payments is available to employee if received from employer being a company. This is not applicable to employee if employer is LLP

Implement VRS and then convert

3.

Availment of LLP after conversion not free from doubt.

Defer Conversion

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Does the Company have unavailed installments of deductions u/s 35D?

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4. Does Company have huge After conversion, it cannot be accumulated profits? either distributed to partners or credited to capital accounts after conversion for 3 years 5. Are the same shareholding Violation of sec. 47(xiiib) entails of the Company not sure consequences under section (4) of remaining partners of for LLP the successor LLP for at least 5 years after conversion?

Consider using up the accumulated profits issuing bonus shares, before conversion Consider buy back of shares of such shareholders before conversion

CHECKLIST FOR CONVERSION OF FIRM INTO LLP Sr. Considerations Effect on conversion No.

Possible Solution

1.

Does the firm intend to avail of presumptive taxation scheme under sec. 44AD?

Newiy inserted Sec. 44AD ­— cannot be availed by LLPs

2.

Does firm has unabsorbed Controversial issue as there has Defer conversion until losses to be carried been no amendments by Finance losses set off forward or set off? Act (2002) to clarify the issue

3. Does the rfirm have No amendments by Finance Act unabsorbed depreciation? (2002) to clarify the issue

Defer Conversion until unabsorbed depreciation is recouped

4.

Do partners intend to No enabling provision in the admit minors to the LLP Act, 2008 for this benefit of partnership after conversion to LLP?

Admit them to the benefits of partnership before conversion

5.

Has the firm already admitted minors to the benefit of partnership before conversion?

Admit them to the benefits of partnership before conversion

6.

Do the partners intend to There is no express bar to admit minors to the induct minor as partner benefit of partnership after conversion of firm to LLP?

LLP has to honour the commitments of the firm after conversion so there is no problem

Ensure full capital contribution & execution of LLP Agreement in his name by his natural guardian

[Source : Paper presented at National Tax Conference held on 23-4-2011 at Jodhpur] uu AIFTPJ – 249

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