Docstoc

Taxation on Conversion of Private Limited Company into Llp

Document Sample
Taxation on Conversion of Private Limited Company into Llp Powered By Docstoc
					                                                                                        E-NEWSLINE N JANUARY 2009




                                                                CONTENTS

 LIMITED LIABILITY PARTNERSHIP – AN ALTERNATE CORPORATE VEHICLE


                     Introduction .....................................................................................................2
              1.     Body Corporate................................................................................................2
              2.     Partners..............................................................................................................3
              3.     Incorporation....................................................................................................3
              4.     Limited Liability................................................................................................3
              5.     Financial Disclosure.........................................................................................3
              6.     Taxation .............................................................................................................3
              7.     Assignment and Transfer of Partnership Rights........................................4
              8.     Conversion into a LLP....................................................................................4
                     Conclusion ........................................................................................................4




                                                                             1
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.
                                                                               E-NEWSLINE N JANUARY 2009




                                                Limited Liability Partnership –
                                                An Alternate Corporate Vehicle




INTRODUCTION


        For those who have been awaiting the                                      The LLP form is proposed to enable
enactment of the Limited Liability Partnership                            entrepreneurs,     professionals    and      enterprises
(“LLP”) Bill, the wait appears to be finally over. After                  providing services of any kind or engaged in scientific
several years of consideration and recommendations,                       and technical disciplines to form commercially viable
the LLP Bill, 2008 (the “Bill”) which was recently                        vehicles suited to their requirements.1 Given that the
introduced in the Parliament has been passed on 12                        service sector is playing a major role in the national
December 2008 and has, in addition, received the                          economy and there i s a growing diversity in the range
presidential nod. Various committees and expert                           of services being offered, the anticipation is that LLP
groups had, from to time, recommended introduction                        would foster the growth of services sector and
of a separate LLP legislation as the traditional                          increase the productivity and global competitiveness
partnership model was outdated and in need of a                           of small and medium sized enterprises and especially
revision.                                                                 professional firms of chartered accountants, company
                                                                          secretaries and advocates.
         For the uninitiated, LLP is a new corporate
form that proposes co-existence of professional                           This newsletter focuses on giving an overview of the
expertise and entrepreneurial initiative. In India,                       Bill to give an insight into its enforceability. The main
businesses mainly operate as sole proprietorships,                        features of the Bill are set out below:
partnerships or companies. Each of these is subject to
different regulatory and tax regimes depending upon                       1.       Body Corporate
their organization and ownership. Essentially, LLP
shall fill the lacuna between sole proprietorships and                           LLP shall be a body corporate and shall have
partnerships which are fairly unregulated and                             a separate legal entity separate from its partners.2 It
companies which are regulated by the Companies                            will have perpetual succession.3 The Indian
Act, 1956 (the “Act”).                                                    Partnership Act, 1932 shall not be applicable to
                                                                          LLPs.4
        In a highly litigious business environment,
partnership has become a risky affair as the liability is
unlimited. In such a scenario, the personal property
of the partners is also attached for the satisfaction of
the debts in addition to the capital contributed by the
partners in the firm. Further, the partnership form                       1 As indicated in the “Statement of Objects and Reasons” dated
does not permit more than twenty (20) partners                            2 May 2008 annexed to the Bill.
                                                                          2 Clause 3 (1) of the Bill.
which can be restrictive to growing enterprises.                          3 Clause 3 (2) of the Bill.
                                                                          4 Clause 4 of the Bill.

                                                                    2
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.
                                                                                E-NEWSLINE N JANUARY 2009

2.         Partners                                                       4.          Limited Liability

        In a LLP structure, there need to be at least                              Unlike a partnership, where each of the
two (2) partners who are individuals and at least one                     partners is jointly and severally liable for any liability
(1) of them shall be a resident of India.5 There is no                    arising out of or in respect of the partnership, the key
limit on the maximum number of partners that it may                       selling point of a LLP is that it is a separate legal
have. Any individual or body corporate may be a                           entity wherein no member or partner is liable on
partner in a LLP.6 Any change in the partner does not                     account of the independent or unauthorized actions
affect the existence, rights and liabilities of the LLP. 7                of one’s partner and whose liability is limited to the
The duties and obligations of designated partners may                     respective stake of each in the LLP.10 The members
be provided in the partnership agreement, in the                          of a LLP would have the option to have a general
absence of which, provisions of the first schedule to                     partner or more with unlimited liability, but it would
the Bill shall be applicable.8 The first schedule                         not shield the partners from legal liability arising of
includes, amongst other things, provisions requiring                      their own personal acts which are not done for and
all partners of a LLP to share equally in the capital,                    on behalf of the LLP, that is, any act done beyond the
profits and losses; no partner to be entitled to                          acts and powers of the partners as laid down in the
remuneration for acting in the business or                                incorporation document. Further, a partner’s liability
management; and all matters to be decided by a                            is not limited when the misconduct is attributable to
majority of partners with each partner having one                         him or to an employee under the supervision or
vote.                                                                     control of that partner. A LLP only protects a partner
                                                                          other than a general partner from the liability arising
3.         Incorporation                                                  from the misconduct or personal acts of other
                                                                          partners.
         The Bill sets out that a LLP can be created by
either registering a new LLP or by conversion of an                       5.          Financial Disclosure
existing firm or company into a LLP. In the event of
registering a new LLP, the partners are required to file                          A LLP is required to maintain proper books
an incorporation document, which shall be in the                          of accounts relating to its affairs for each year of its
form as prescribed by the Bill and any manner and                         existence. A statement of account and solvency would
fees as prescribed by the Registrar of Companies                          also have to be filed by a LLP with the ROC every
(“ROC”). Another statement, made by a chartered                           year. The accounts of LLPs shall also be audited,
secretary, chartered accountant or cost accountant,                       subject to any class of LLPs being exempted from
engaged in the formation of the LLP and by any                            this requirement by the Central Government, as
subscriber to the LLP, would need to be filed, stating                    notified in the Official Gazette.11
that all the rules of the proposed LLP Act have been
complied with. The LLP partnership agreement and                          6.          Taxation
any changes, if any, shall be filed with the ROC as
well.9 The Bill also includes pertinent provisions                                In respect of taxation, whilst, there have been
wherein every designated partner shall obtain a                           reports about how the LLP would be treated as a
Designation Partner Identification Number from the                        partnership, the Bill does not reveal any taxation
Central Government. Furthermore, every LLP should                         policy towards LLPs.
have either the words “limited liability partnership” or
the acronym “LLP” as the last words to its name.                                  The general expectation is that, unlike in a
                                                                          company, the profits of a LLP shall be treated as the
                                                                          personal income of the partners, as if they had run
                                                                          their business as a partnership. Effectively, the status
5
                                                                          of a body corporate would be ignored and the
  Clause   7 (1) of the Bill.
6 Clause   5 of the Bill.
                                                                          partners shall be made individually liable for any tax
7 Clause   3 (3) of the Bill.
8 Clause   23 (4) of the Bill.                                            10   Clauses 26 – 31 of the Bill.
9 Clause   23 (2) of the Bill.                                            11   Clause 34 of the Bill.
                                                                    3
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.
                                                                              E-NEWSLINE N JANUARY 2009

liability on their share of the income. The taxation                      CONCLUSION
regime would be especially significant wherein Indian
LLPs or their individual partners extend their                                     Whilst the Bill is promising, enterprises will
operations in the global markets or where any of the                      hasten conversion to a LLP depending on some
partners’ is a foreign individual or body corporate                       crucial matters.
entitled to be taxed elsewhere in the world. The issues                            At the outset, how the legislation deals with
of double taxation and of carrying forward the losses                     the aspects of this transfer; stamp duty and capital
in the event of conversion from other forms to LLP                        gains, is essential. The Bill does not specify whether
and vice-versa would be key ingredients in                                the capital gains tax will be waived in the conversion
                                                                          of a partnership or limited company into a LLP.
determining the viability of a LLP.
                                                                          Similarly, the Bill does not specify whether stamp
                                                                          duty would be applicable in such a case. The levy of
        Similarly, it is projected that the LLP format
in UK in respect of taxes shall be implemented in                         capital gains tax on the succession of one form of
                                                                          organization by another is a matter currently
order that the assets of a LLP would be treated as
assets of its partners for the purpose of taxing capital                  governed by Section 47 (xiii) of the Income Tax Act,
                                                                          1961 (“ITA”) and suitable amendments need to be
gains. This would ensure that the partners of a LLP
rather than the LLP itself would be liable to tax for                     made to ITA to provide for relief from the capital
                                                                          gains tax. It would also be necessary to align the LLP
capital gains on the disposal of LLP assets.
                                                                          legislation in tune with other economic legislations by
                                                                          making appropriate amendments to Foreign
7.     Assignment and Transfer of Partnership
Rights                                                                    Exchange Management Act, 1999/FDI Guidelines to
                                                                          make LLPs eligible entities for receiving foreign
        The Bill12 provides flexibility to devise the                     investments.
agreement to determine the mutual rights and duties
of partners of LLP and those of LLP and its partners.                             The ROC has been given the authority to
                                                                          regulate the LLPs. However, keeping the increasing
Moreover, a partner’s economic rights, which include
the rights of the partner to a share of the profits and                   deluge of companies on ROC in mind, the viability of
                                                                          this proposition is questionable.
losses of the partnership agreements, are freely
transferable. However, a transfer in whole or in part
                                                                                  Another important aspect required for the
of the transferable interest does not imply the
partner’s disassociations or dissolution and winding                      implementation of the LLP format is mandatory
                                                                          professional indemnity insurance which appears to be
up of the LLP’s activities. Further, they do not entitle
the assignee to participate in the management or                          absent from the Bill. Absence of any insurance cover
                                                                          could give rise to shell LLPs which would not really
conduct of the LLPs activities or access information
concerning the LLPs transactions. Moreover, the                           provide any relief to persons claiming against the
                                                                          LLP.
non-economic right will not be transferable unless
specified by the LLP agreement.
                                                                                  Additionally, it is evident that a lot remains
8.          Conversion into a LLP                                         unanswered in the Bill. The Bill is silent on
                                                                          substantive issues such as amalgamations,
        The Bill includes provisions regarding                            reconstruction, winding up of LLPs which have been
                                                                          relegated to the rules. Further, the Bill does not
conversion from a firm, private company, and
unlisted public company in to a LLP.13 The second,                        provide any basis on which the Central Government
                                                                          must make the above direction and the same could
third and fourth schedules to the Bill contain
provisions for conversion from firm to LLP,                               lead to misuse in the absence of proper guidelines.
                                                                          Any direction by the Central Government to apply
conversion from private company to LLP and from
unlisted company to LLP respectively.                                     strict and detailed procedures of the Act to LLP’s
                                                                          could prove to be a deterrent to those who wish to
                                                                          convert from proprietorships and private companies
12   As indicated in Clause 42 of the Bill.                               to LLPs.
13   Clauses 55 – 58 of the Bill.
                                                                    4
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.
                                                                              E-NEWSLINE N JANUARY 2009

        Entrepreneurs interested to convert into the                      substantive issues governing a LLP and the proposed
LLP format are presently also awaiting the                                enactment is made more comprehensive, small
amendments to the provisions governing private                            enterprises would prefer to play the wait and watch
companies to be liberalized. Thereby, unless and until                    game.
there is more clarity on the rules for the various                        (Pooja Yadava)




                                                                    5
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.
                                                                              E-NEWSLINE N JANUARY 2009


Contact Lawyer                                                                        Contact Details

Priti Suri                                                                            PSA
p.suri@psalegal.com                                                                   Legal Counsellors
Mobile +(91) 98100-92842                                                              E-601, Gauri Sadan
                                                                                      5, Hailey Road
Pooja Yadava                                                                          New Delhi – 110 001
p.yadava@psalegal.com                                                                 India
Mobile +(91) 99539-48751
                                                                                      Tel: + (91 11) 43500-500
                                                                                      Fax:+ (91 11) 43500-502




                                                                    6
Disclaimer – This new sletter is for information purposes and should not be construed as legal advice.

				
DOCUMENT INFO
Description: Taxation on Conversion of Private Limited Company into Llp document sample