Limited liability partnerships — three cheers for private firms

One of the significant proposals of this budget has been tax neutrality on conversion of private limited and unlisted companies into limited liability partnerships or LLPs.

LLP as a form of doing business has been prevalent in the UK, the US and Singapore.

In India, the LLP Bill received the assent of the President on January 7, 2009, thus giving rise to a new form of doing business in India.

Unlike traditional partnership firms, LLP has perpetual succession and the liability of its partners is restricted.

A LLP converges the benefits available to companies and partnership firms in terms of limited liability and flexible internal structure.

It does seem that the government wanted to promote this new form of business. Towards this end, the LLP Act has enabling provisions for conversion of existing partnership firms and eligible companies into LLPs.

In the Union budget of 2009, taxability of LLPs has been brought on a par with general partnership firms.

However, there were no provisions for tax neutrality on conversion of other entities into LLPs akin to those available on conversion of sole proprietary concern or partnership firm into a company.

Hence, entrepreneurs had been wishing that the finance minister will extend tax neutrality to conversion of companies into LLPs. The wish list does not end here. Allowability of carry-forward of loss in the hands of the successor LLP was also awaited. Another request was for treating LLPs at par with companies for foreign investment purposes.

This is because the foreign direct investment regime permitted foreign investment only in companies; whereas, LLPs are considered as partnership firms.

Treating LLPs on a par with companies would open wide the gates of foreign investments into India.

The Union budget 2010 has now paved the way for showering tax neutrality on conversion of eligible companies into LLPs. Thus, it has been proposed that conversion of eligible companies into LLPs will not be subject to capital gains tax provided certain conditions are satisfied.

Apart from this, it has also been proposed that the successor LLP will be entitled to carry forward and set-off the losses and unabsorbed depreciation of the company.

Certain other consequential amendments have also been proposed. It has been proposed that the written down value of the block of assets in the hands of the company as on the date of conversion shall be deemed to be the actual cost of the block of assets in the hands of the LLP.

Further, the cost of acquisition of capital assets in the hands of the successor LLP shall be deemed to be the cost for which the company acquired the said assets.

Another consequential proposal is that if the conditions required to be satisfied for tax neutrality are not complied with, the benefits availed by the company shall be deemed to be the profits and gains of the successor LLP chargeable to tax for the previous year in which the conditions are not complied with.

Accordingly, capital gains exemption claimed by the eligible companies or set-off of business loss or unabsorbed depreciation of the eligible companies claimed by the successor LLPs will be charged to tax in the hands of the successor LLPs in the year in which the conditions have not been complied with. It has also been proposed to clarify that credit for minimum alternate tax paid by the company shall not be allowed to the successor LLP.

However, it’s not a bed of roses all through.

The present budget has not dealt with the issue of permitting foreign investments in LLPs. It can be clarified by issuing appropriate notification under foreign exchange regulations.

Further, one of the conditions required to be satisfied for tax neutrality is that the total sales, turnover or gross receipts in business of the company should not exceed Rs 60 lakh in any of the three preceding previous years.

Reading between the lines, it means that only small private and unlisted companies will be entitled to tax neutrality on conversion into LLPs. Thus, large eligible companies seeking to convert to LLPs will not be able to avail of tax neutrality.

It would be worthwhile to wait and see if this threshold limit is increased in order to grant tax neutrality to large eligible companies.

Only time will tell whether the government decides to relax this condition thereby widening the net for eligible companies to be eligible for tax neutrality on conversion into LLPs.
-Shailesh Monani, Executive Director, PwC & Deepak Bahirwani
Manager, PwC