tax issues in reorganisation through limited liability ... slides - pinakin... · fa 2009...

Tax Issues in Reorganisation Tax Issues in Reorganisation through Limited Liability Partnership (LLP)

- Pinakin Desai

Contents

► Overview of LLP law and regulations

► Tax analysis

► LLP in general

► Conversion of firm into LLP

► Conversion of company into LLPs

June 2011 Tax Issues in Reorganisation through LLP

► Conversion of company into LLPs

Overview of LLP law and regulations

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

► Partners’ liability limited to contribution


Partners’ liability limited to contribution

► Perpetual existence independent of its partners


► LLP Agreement governs an LLP

► Mutual rights, duties of partners can be agreed in the LLP Agreement

► Contents of LLP agreement in public domain

► Partner of an LLP

► Can be an Individual, Indian/foreign company or LLP: minimum of 2

partners


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

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


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

profits/losses etc. The assignee gets rights post suitable modification

of LLP agreement.


► 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


► 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

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.

Reorganization provisions in the LLP Act

► 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.

* There are no specific provisions in ITL to deal with these

Regulatory framework

► Until recently,

► FDI allowed into “Indian Company”

► FDI allowed only in “capital instruments” 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

► FDI up to 100% permitted with prior approval of FIPB

► Only for sectors falling under 100% automatic route

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

Tax Analysis – LLP in general

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

► FA 2009 amendments to the Income-tax Act, 1961 (IT Act) with reference to

the LLP Act. Definition of ‘firm’, ‘partner’ and ‘partnership’ amended to

accommodate LLP.

► “A “limited liability partnership” and a general partnership will be accorded

the same tax treatment”. *

► “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


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”. *

* Excerpts from Explanatory Memorandum to Finance Bill No.2 of 2009. Reiterated also in CBDT Circular 5/2010 dated 3 June 2010

Advantages of being assessed as a ‘firm’

► Tax rate of 30.9%, against Indian company tax rate of 32.445% ;

► No further tax (including MAT) on partners

► No tax on distribution during the life of or on winding up of LLP

► Internal change in the partnership composition, except retirement,

does not impact carry forward of loss


does not impact carry forward of loss

► Non applicability of section 2(22)(e), section 2(24)(iv) and section 73

► Deduction of interest, remuneration if authorised by LLP Agreement:

► Section 56(2)(viia) applicable only in respect of shares of CHC

Alternative Minimum Tax (AMT) [S.115JC] (W.e.f. 1.4.2012)

► Unlike companies, minimum tax for LLP is not w.r.t. ‘book profit

► AMT payable by LLP on Adjusted on total income i.e on total

income as increased by

► Income linked deduction under Chapter VIA

► Exempt income of SEZ u/s 10AA


► AMT not payable on:

► Exempt income (say, dividends, STT based LTCG, share of firm, etc.)

► Relief on account of investment linked tax holiday

*Rates need to be increased by cess

Alternative Minimum Tax (AMT) [S.115JC] (W.e.f. 1.4.2012)

► Brief mechanism of calculation of AMT

Total income as per normal provisions (TI)] NIL

Add:

► Income linked deductions under Chapter VIA

► Exempt income of SEZ u/s 10AA

250

250

Net Total Income (TI) 500


Net Total Income (TI) 500

Tax on ATI at @ 18.5%* - say X 90

Tax on TI at @ 30%* - say Y NIL

Tax liability of LLP Higher of X 90

Or Y

*Rates need to be increased by cess

Tax Analysis – Conversion of firm into LLP

Conversion of firm into LLP

Partners of Firm Partners of LLP

Company

A B C D

LLPAssets & liabilities vested on conversion

Partnership

interest


► 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

► To take effect notwithstanding anything contained in any other law

Tax implications of conversion

► CBDT Circular 5/2010 dated 3 June 2010:

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


conversion. If there is a violation of these conditions, the provisions of

section 45 shall apply.

► No specific amendment in Sec 47 of ITA for conversion of firm.

► Process of statutory vesting akin to conversion of firm to company

under Part IX of Companies Act

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

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.


Conversion of firm into LLP….cont

► 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.

► All deeds, scheme, approval, licenses, Court proceedings etc etc

Judicial views on conversion of firm to company under Part IX*

� No “transfer” by firm in absence of simultaneous existence of two

parties

� No consideration received by the firm or partners as a result of

transfer

� Principle continues to govern conversion to LLP; recognized in

CBDT circular


CBDT circular

� 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

*Refer CIT v Texspin Engg & Mfg works (263 ITR 345)(Bom)

Tax Analysis – Conversion of company into LLP

Conversion of company into LLP

Shareholders Partners of LLP

A B C D

Partnership

Interest


Company LLPAssets & liabilities vested on conversion

Conversion of company into LLP

► Section 58(4) of LLP Act: Notwithstanding anything contained in any

other law:

a) there shall be a LLP by name specified in certificate of registration

b) all property (tangible and intangible) vested in firm/company shall be

transferred to and vest in LLP

c) firm or company shall be dissolved and removed from record of


c) firm or company shall be dissolved and removed from record of

registrar of firm/company

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


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


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.”

LLP taxation-Conversion of unlisted company to LLP [47(xiiib) (w.e.f 1.4.2011)

► Conditions for tax neutral conversions of companies into LLP1

► 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


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

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

► Provisions largely at par with conversion of firm into LLP

► Conversion is in accordance with section 56 / 57 of LLP Act

► Cannot be inter vivos transfer by way of sale

► 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

► Condition relevant to the date of conversion

► RBI does not grant approval for conversion of NBFC to LLP

*Undefined term, ROC considers it as charge on the assets secured by the creditors as per Companies Act provisions

Conversion of unlisted Company into LLP

All assets and liabilities of company to become that of LLP

► Effective date of conversion :

► Date of application v/s date of registration

► Wholesale conversion; akin to amalgamation

► Unlike demerger or unlike transfer under section 47(xiii)


► Accompanied by dissolution of company


All shareholders to become partners in LLP with capital contribution and

profit sharing ratio in the proportion of shareholding

► Position of ‘minor’ shareholders

► No clarity on treatment of preference shareholders

► No clarity on share in losses



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

► Split of capital to loan account of shareholder

► Payment of remuneration unrelated to conversion;


► Avoid differential asset sharing ratio


Aggregate of profit sharing ratio of the shareholders of company in LLP

≥ 50% for a period of 5 years

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

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

fulfilled;

► Involuntary transfers beyond the control of the assessee (such as death etc)


► Involuntary transfers beyond the control of the assessee (such as death etc)

arguably not covered

► Admission up to 50% is permissible

► Withdrawal by a retiring partner – any violation?


Sales, turnover or gross receipts in business of company in any of

3 years < INR 6 million

► 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

► Entity not in existence for 3 preceding previous years

► Receipts from non business activities not to be reckoned


No direct / indirect payment to any partner out of accumulated profits of

company for a period of 3 years post conversion date

► Unresolved questions : No guidance in LLP Act

► Security premium in books of company

► Bonus share capital


► Reserves on the books of company

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

capital contribution

► Retirement within 3 years; avoid withdrawal?

Other tax implications of conversion*

► Unlikely DDT implications u/s.2(22)(a) in absence of distribution by

company to shareholders

► Unlikely DDT implications u/s.2(22)(c) in absence of distribution;

► Unlikely S.2(24)(iv) implications for shareholders in absence of any

benefit passed on by the company

► corresponding sacrifice by shareholders


► corresponding sacrifice by shareholders

► No specific amendments to permit continuing tax holiday in the name

of LLP;

Tax neutrality of conversion : Back-up provisions

► Actual cost (WDV) of capital asset of company to be the actual cost

(WDV) to LLP [Section 49(1)(iii)(e)]

► LLP can carry forward unabsorbed business losses / unabsorbed

depreciation [Section 72A(6A)]. Arguably, fresh lease available.

► However, no carry forward of MAT credit to LLP [section 115JAA(7)]

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


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

partner [Section 49(2AA)]

Forfeiture of exemptions : Back-up provisions

► Also, S. 47(xiiib) violation leads to

► LLP paying tax in the year of violation on:

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

► Capital Gains exempted in the hands of company [section 47A(4)]

► Commercial risk for newly admitted partners of LLP


► Shareholder paying tax in the year of violation on capital gains

exempted

► Partner who retired earlier also liable

► No provision for cost step up for LLP and the shareholder if capital

gains exemption forfeited requiring LLP to pay tax.

Tax Analysis – Non compliant conversion

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


► Capital gains or business income liability unlikely in absence of

consideration

► On principles, akin to case of amalgamating company transferring

assets

S.47(xiiib) non compliant conversion: Implications for shareholders

► Distinguishing features as compared to case of partners

► Firm and partners received income through common passage

► Consequences u/s.45(4) of ITA on the firm

► Shareholder: extinguishment of shares against receipt of consideration in

the form of LLP interest


► Legislative / CBDT thinking supports taxation in absence of compliance

with exemption conditions

Other tax implications of conversion

► 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

► Permanent Account Number (PAN):LLP is a different entity


Thank you

tax issues in reorganisation through limited liability ... slides - pinakin... · fa 2009...

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