Taxation on conversion of a Company into a LLP

Taxation Aspect in Conversion of a Company into Limited Liability Partnership

Limited Liability Partnership (LLP) Act 2008 introduced a new form of organization in India. The year when the LLP Act was introduced there was lack of clarity on its taxability. The question was whether LLP will be taxed like a Domestic Company or Partnership Firm. Finance Act (No.2) of 2009 amended section 2(23) of Income Tax Act, according to which, clause (i) the word “firm” shall include LLP, clause (ii) the word “partner” shall include a partner of LLP and clause (iii) the word “partnership” shall include LLP as defined under LLP Act 2008. Post this amendment LLP became the attractive form of organization as it offered the safety to its partners with the feature of limited liability like a company and the same time it offers ease of operations in introduction and withdrawals of funds in and out of capital account. Further, Dividend Distribution Tax (DDT) not applicable to LLP made it popular form of organization from year 2009 onwards. The new small and medium start ups prefer LLP as it is tax efficient and burden of compliance is lesser as compared to company.

In order to introduce the taxation on conversion of such companies into LLP, a new clause (xiiib) was inserted in section 47 of Income Tax Act. According to proviso to section 47(xiiib),

1. Any transfer of a capital asset (Plant & Machinery/Building/Computer etc.) or intangible asset (Patent/Knowhow/Goodwill etc) by a private company or unlisted public company to a limited Liability partnership (Does not include tax on transfer of Fixed Deposit/Debtors/Bank etc) or

2. any transfer of a share or shares held in the company by a shareholder (transfer of share capital against capital contribution in LLP)

As a result of conversion of a company into a limited liability partnership is not taxable subject to following conditions:

(a) all the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the limited liability partnership;

(b) all the shareholders of the company immediately before the conversion become the partners of the limited liability partnership and their capital contribution and profit sharing ratio in the limited liability partnership are in the same proportion as their shareholding in the company on the date of conversion;

(c) the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership;

fifty (d) the aggregate of the profit sharing ratio of the shareholders of the company in the limited liability partnership shall not be less than per cent at any time during the period of five years from the date of conversion;(cannot close down LLP for 5 years)

(e) the total sales, turnover or gross receipts in the business of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed sixty lakh rupees;

(ea) the total value of the assets as appearing in the books of account of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed five crore rupees; and

(f) no amount is paid, either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of three years from the date of conversion.

If conditions specified in section 47 of Income Tax Act are not complied with after the years in which the conversion took place Section 47A(4) of IT Act will apply. According to which, in the case when the conditions of section 47(xiiib) are not complied with then profits and gains arising from transfer of capital asset shall be deemed to be the profits and gains chargeable to tax of the successor LLP or the shareholders of the predecessor company as the case may be.

If conditions of section 47 are not complied with in the year of conversion than section 45 will apply to the company and the shareholders accordingly.

The author can also be reached at ajsomani@gmail.com