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Accounting and Tax Implication on conversion of Co to LLP

smit shah 
on 09 May 2014

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Before starting with anything we shall have the Overview of LLP its Enactment, features, Constitution etc.

Background of LLP:

LLP as a structure is not new in the International Scenario .Most western economies have provisions for hybrid business entities like the LLPs.

LLP is governed by Limited Liability Partnership Act which came in to force on 1st day of April 2008. This is Act was introduced with idea of promoting MSME Sector with the advantage of Self governance and less compliance. Here are some major notified dates in relation to LLP Act.

• Rajya Sabha - 24th October, 2008

• Lok Sabha - 13th December, 2008 

• President of India - 7th January, 2009 

• Official Gazette - 9th January, 2009 

• LLP Act – Effective date 1st April, 2009 

• LLP Rules – Effective date 1st April, 2009 

• Various amendments made from time to time 

It is an alternate corporate body which combines the benefit of both Company and Partnership. It contains the benefit of Limited liability to partner and Flexibility of Partnership. LLP is a corporate body and granted the legal status same as that of company. Unlike the partnership in LLP the liability of the partner is limited up to the contribution made by them.

Why Conversion needed?

A registered limited company in India (Private or Public) has a lot of complex formalities and incurs additional overheads for managing affairs including mandatory board meeting, maintenance of statutory records, etc. Absence of such mandates for LLP combined with advantages such as non-applicability of dividend distribution tax on profit repatriation, transfer of profit rules and deemed dividend profit issues, MAT provisions; underline the attractiveness of the LLP form of business.

Conversion of Company in to LLP procedure:

It is provided in section 56 and 57 of the LLP Act, 2008 that Companies can get themselves converted into LLP; however the Tax implications upon the conversion were not clear leaving doubts as to Applicability and impact of Capital Gains Tax and Deemed Dividend Tax. Further there was no clarity over the status of carry forward losses and unabsorbed depreciation, MAT credit, Written down Value of block of Assets in the hands of the LLP including other related Tax Provisions.

But The Finance Bill, 2010 Finance ministry addressed the above issues and opened the doors of conversion of Company to LLP.

Relevant Provisions:

• Chapter X – Section 56 and 57 of The LLP Act, 2008

• Third and Fourth Schedule of The LLP Act, 2008

• Rule 39 and 40 of LLP Rules, 2009

• Section 47(xiiib) of The Income Tax Act

Requirements

Section 56 of the Limited Liability Partnership Act provides the rules and regulations for the conversion of Company in LLP subject to condition that

1. There is no Security interest in the Company’s Assets subsisting or in Force at the time of Application for Conversion it means that if any assets of the company is mortgaged or hypothecated against any secured loan at the time of conversion then such company cannot be converted in to LLP.

- However afterwards MCA has eased some rules and regulations and now even the company has taken loan against Assets can be converted in to LLP.

- And in case of unsecured loan no need to take written permission of the creditors.

2. If the company has taken loan must have to comply all the formalities as per companies Act, 195

Taxability on Conversion:

It is now provided that transfer of assets on conversion of company to LLP in accordance with the section 56 and section 57 of the LLP Act, 2008 shall not be considered as transfer for the purpose of Capital Gain under section 45 of Income Tax Act. Clause (xiiib) has been inserted in section 47 of The Income Tax Act. However, following condition must be satisfied in order to gain this benefit.

I. The Partners of LLP to which it converts, Comprises all Shareholders of the Company and no one else and their contribution and profit sharing ratio remains same as the ratio of their share holding pattern.

II. All assets and Liabilities of the company before the conversion shall become the Assets and Liabilities of the LLP after conversion n.

III. The Aggregate of the Profit Sharing Ratio of the Shareholders of the Company in the LLP shall not be less than Fifty Percent at any time during the Period of Five Years from the Date of Conversion.

IV. The share holder of the company shall not receive any consideration directly or indirectly except profit sharing in LLP.

V. The total sales, Total Turnover or Gross Receipt shall not exceed Rs. 60 Lacs in any of 3 Preceding previous year in which conversion takes place.

VI. No Amount shall be paid to the partners out of accumulated profit standing in Balance sheet at the least for the period of 3 years from the conversion date.

If all the above conditions are satisfied then LLP would be exempt from the Capital Gain under Income Tax Act

Here are some important rules and amendments regarding LLP which are important to consider while such conversion.

Where any conditions laid down in the section 47(xiiib) are not complied then the amount of profit or gain arising out of such transfer of capital assets or intangible assets not charged under section 45 by virtue of condition laid down in the said proviso shall be deemed to be the profits and gains chargeable to tax of the successor limited liability partnership for the previous year in which the requirements of the said proviso are not complied with.

a. Where the Re organization has taken place and private company or Unlisted company is converted in to LLP and if the provisions of section 47 clause (xiiib) are complied with, then the accumulated losses and unabsorbed depreciation of the predecessor company shall be deemed to be of the successor LLP and then provision of the carry forward of the losses and Depreciation shall apply accordingly.

b. However if the provisions of the section 47 clause (xiiib) are not complied with, the set off of loss or allowable depreciation made in any previous year in the hands of LLP shall be deemed to be the income of LLP chargeable to tax in previous year in which it was not complied.

c. Credit in respect of tax paid by a company under section 115JB is allowed only to such company under section 115JAA. It is provided by sub-section (7) of section 115A that the tax credit under section 115JAA shall be allowed to the successor LLP. Interestingly, it appears that this benefit is available to any private company or an unlisted public company converted into LLP, whether conditions laid down under section 47(xiiib) have been complied with or not. However a provision of MAT is not applicable. However provisions of AMT(Alternate Minimum Tax) is applicable

d. These amendments are applicable from 1st April, 2011 and will apply in relation to the assessment year 2011-12 and subsequent years.

View possible regarding the calculation of gain or profit taxable to LLP on breach of the condition of Rs. 60 Lacs receipt/ Turnovers

Slump Sale of Private Limited Company to LLP: (By Acquisition)

i. On slump sale, the difference Between Consideration received for the transfer and net worth of the business transferred is treated as Capital Gains.

ii. Net worth of the business transferred is computed as the aggregate value of assets relating to the business transferred less the book value of liabilities.

iii. The Value of assets for this purpose is determined as follows, namely:

In case of depreciable assets- written down value determined in accordance with the provisions of the Act.

For other assets- Book Value

i. The nature of Capital gains, Long tern or Short term, would depend on the Period of holding of the undertaking (Capital gain will be long term if held for more than 36 Months). The Company is required to obtain a report of a Chartered Accountant Certifying the Computation of Net Worth, prior to filling the Income Tax return for the year of Transfer. In Case the Net Worth is negative, it can be argued that the Cost of Acquisition should be considered as NIL.

ii. In case the conversion the company took place at the book value then consideration will be equal to Net worth and hence no gain is going to accrue. But if there is the transfer of Land and Building then its valuation will be done as per section 50C of the Income Tax Act, which provides provision to substitute Book value with Stamp Duty value.

Dissolution of Company and Formation of new LLP: (By Dissolution)

Shareholders could be taxed on shares transferred on the basis that conversion leads to deemed dissolution of Company. Taxable value on deemed dissolution to be determined as per the provisions of section 46 of the Income Tax Act as Follows:

1. Amount to the extent of accumulated profits of company treated as deemed dividend under section 2(22)(C) of the Act. However, the same would be exempt under section 10(34) of the Income Tax Act in the hands of partner, subject to successor LLP paying Dividend Distribution Tax.

2. Receipts/ market value of assets distributed in excess of accumulated profits treated as full value of consideration and subject to Capital gains tax under section 46 of the Act.

Taxation in the hands of the successor LLP based on the deemed transfer of assets (At book value) to the LLP as per section 45(3) of the Act. For the land & Building, the stamp duty value would replace the book value (based on the provisions of section 50C of the Act.) Dividend Distribution Tax on deemed profits distribution at 16.223% on the deemed dividend would be Applicable.

Analysis and Issues

a. Limit of receipt/ Gross Turnover of Rs. 60 Lacs disentitle many organizations for the conversion to LLP.

b. If a shareholder is appointed as a working director or manager, will it amount to conferring any benefit on shareholder and resulting into forfeiture of exemption available under section 47(xiiib). It has been held that ‘Benefit’ is a word of wide importance; it means no more than ‘advantage.’ Gronia v. Grierson (1968) 1 All ER 593, 599(HL).

c. Can shareholders transfer the shares inter-se? Is it possibly to dispose of shares by some shareholders, as long as, in aggregate, shareholders hold not less than 50 per cent shares in the LLP?

d. It is noted that Law is recent origin and in many matters there is lack of clarity and it is creating ambiguity.

Conclusion

With FDI being permitted to LLPs, this can be a suitable and viable entity form for several businesses to compete with global players, considering its advantages over company form of organizations from tax and operational flexibility standpoint. For challenges need to be faced and there is also a steep learning curve.

This new business vehicle is so enormous that in the coming entities like Private companies, Public unlisted companies, and partnership firm will make their way to LLP.

Thank You

Smit Shah

Visit My Blog www.Knowledge4ca.blogspot.com

Contact me for starting LLP, One Person Company, Pvt Ltd Company etc.

Email- smit.shah3000@gmail.com

References

• ICAI member Journals and student journals

• Article by Caclubindia.com

• Presentation by Lakhani &Co. on LLP

•Article by CA Chandrashekhar Chitale on Conversion of Partnership firm and Company to LLP.

• Finance bill 2010-11 highlights regarding LLP, important circulars regarding Conversion of company to LLP

• Glimpse of The LLP Act, 2008

• Relevant sections of Income Tax Act, 1956

•  Application of own knowledge


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