"COMPUTATION OF TAX ON LLPS AND CRITICAL APPRAISAL."

8/12/2019 "COMPUTATION OF TAX ON LLPS AND CRITICAL APPRAISAL."

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LAW MANTRA THINK BEYOND OTHERS(National Monthly Journal, I.S.S.N 23216417)

"COMPUTATION OF TAX ON LLPS AND CRITICAL APPRAISAL."1

INTRODUCTION

The Limited Liability Partnership (LLP) is viewed as an alternative corporate business

vehicle that provides an alternative to the traditional partnership, with unlimited personal

liability on the one hand, and, the statute-based governance structure of the limited liability

company on the other.2

LLP is a body corporate formed and incorporated under the Limited Liability Partnership Act,

2008 and is a legal entity separate from that of its partners.3It has perpetual succession.

4Also

any change in the partners of a LLP does not affect the existence of rights or liabilities of the

LLP.5 Further, at its outset the LLP Act has also provided that Partners are the agents of LLP

for the purpose of its business but are not of one another.6Also any obligation of the LLP,

arising in contract or otherwise, is solely the obligation of the LLP.7A partner is not personally

liable, directly or indirectly for any obligation solely by reason of being a partner of the LLP.8

However, the liability of the LLP and the partners who acted with intent to defraud creditors or

for any fraudulent purpose is be unlimited.9

MCAs Press Note, dated 10-7-2009 explains the concept of LLP and its Legislative

framework as under:

LLP is a new corporate form that enables professional expertise and entrepreneurial

initiative to combine, organise and operate in an innovative and efficient manner. In

India, this need has long been recognised for businesses which may require a framework

that provides flexibility suited to requirements of service, knowledge and technology

based enterprises. Services sector is playing a major role in the national economy and

1Shruti Sethi, III year, BA.LLB. (Hons.), Hidayatullah National Law University, Raipur

2 Ministry of Corporate Affairs, Government of India, The New Corporate Form- LLP, available at

http://www.mca.gov.in/Ministry/pdf/LLP.pdf (Last visited on August 21, 2013).3LLP Act, 2008, 3(1).

4LLP Act, 2008, 3(2).

5LLP Act, 2008, 3(3).

6LLP Act, 2008, 26.

7LLP Act, 2008, 27(3).

8LLP Act, 2008, 28(1).

9LLP Act, 2008, 30.


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there is growing diversity in the range of services being offered. The services sector also

finds this form very useful.10

The concept of LLP is a direct outgrowth of the collapse of real estate and energy prices in the

late 1980s and the concomitant disaster that befell Texass banks and savings and loan

associations.11

The United States, which was the epicentre of that financial crunch, as it has

been for most other, including the sub-prime credit crunch, spearheaded the process of

legislating the concept of LLPs.12

Then came on the statute book, the first law on LLP with

Texas enacting the Texas House Bill 278 on 26 August 1991. 13With the promulgation of the

Revised Uniform Partnership Act (RUPA) in the US in 1994, a number of states permitted

the formation of LLPs, which was followed by the incorporation of comprehensive provisions

dealing with LLPs in the RUPA in 1997.14

By the end of 2001, the concept of LLPs had spread

to all 50 jurisdictions of the US.15

In UK as in the US, this form of partnership was introduced because of liability concerns of

large professional firms.16

This was achieved by a campaign in the 1990s calling for

proportional liability in partnership firms.17 All the efforts of these major accounting firms

finally led to the enactment of the Limited Liability Partnership Act, 2000.18

The UK LLP Act

is based on three broad principles- limited liability, corporate personality and partnership

flexibility.19

However the British LLP is very different from LLPs found in the US because

the rules that apply to LLPs in Britain are adaptation of the rules that apply to Limited

10Taxation of Limited Liability Partnerships {press note, dated 10-7-2009) available at

http://taxguru.in/partnership-act/press-note-on-taxation-of-limited-liability-partnerships.html (Last visited onAugust 21, 2013).11Hamilton, Robert W.,Registered Limited Liability Partnership: Present at the Birth (Nearly), 66 University of

Colorado Law Review 1065, 1069.12

Sachdeva, Sachin and Sachdeva, Amit M., The Indian LLP Law: Some Concerns for Lawyers and CAS (May

25, 2009). SEBI & Corporate Law, Vol. 92, No. 6, 2009. Available at SSRN:http://ssrn.com/abstract=1423766.(lastvisited on August 26, 2013).13

Weidner, Pitfalls in Partnership Law Reform: Some United States Experience, 26Journal of Corporation Law

1031.14

Amendment to Uniform Partnership Act, 1996 leading to the Uniform Partnership Act, 1997.15Nivedita Sen & Neha Mathen,Decoding The New Business Vehicle Of India: The Limited Liability Partnership ,

4 NUJS L. Rev. 669 (2011), 673.16

The Law Commission describes the rationale for the Limited Liability Partnership Act 2000 as follows: TheAct is a response to pressures from large professional firms, which are concerned about the unlimited liability of

partners for very large legal claims, particularly for professional negligence. In large partnerships one partner mayhave no opportunity to assist another partner to avoid such claims. Partners may not know each other and one

partner may have no knowledge of the other partners specialism. The result which is proposed is an entity giving

limited liability to the partners other than the negligent partner.17Ashish Ahuja, Limited Liability Partnership Act, 2008- Some Issues, available at

http://www.bcasonline.org/webadmin/res_material/resfiles/LM%20Ashish%20Ahuja%204Feb09.pdf (Last visitedon Aughust 26, 2013).18

Limited Liability Partnership Act 2000, available at http://www.legislation.gov.uk/ukpga/2000/12/contents.

(Last visited on August 21st, 2013).

19Nivedita Sen & Neha Mathen,Decoding The New Business Vehicle Of India: The Limited Liability Partnership ,

4 NUJS L. Rev. 669 (2011), 672.


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Companies, rather than that of general partnership rules.20

In Singapore, LLPs are governed by

the LLP Act 200521

. This legislation draws on both the US and UK models.

II. LIMITED LIABILITY CONCEPT IN INDIA:

During the process of the revision of the Indian Partnership Act, 1932 in 1957, a suggestion

was made by the merchants of the iron, steel and hardware industries to include a provision for

limited liability in partnerships.22

This was for the simple reason that the Companies Act had

too many restrictions and was proving to be very cumbersome, especially for small business-

es.23

This suggestion was rejected by the 7th Law Commission.24

It was the Naresh Chandra

Committee Report in 2003 that highlighted the grave need to introduce LLPs in the service

industry, which finally succeeded in launching the concept of LLPs in India. 25This was soon

followed by the recommendations of the J. J. Irani Expert Committee on Company Law in

2005 to enact a separate legislation for LLPs in India, and also to extend the scope of LLPs to

the small enterprises.26

Pursuant to the recommendations of the J.J. Irani Committee and the Naresh Chandra

Committee-II and the feedback received on the Ministry of Company Affairs Concept Paper on

LLP, a draft LLP Bill was prepared. The news about the drafting of the LLP Bill first became

official around the mid of September 2006. The bill was introduced in the Rajya Sabha on

December 15, 2006.27

Subsequently, the Bill was referred to the Department Related

Parliamentary Standing Committee on Finance. The Committee submitted its Report to both

the Houses of Parliament on November 27, 2007, recommending some changes in the draft

LLP Bill, 2006.28The Standing Committee (Finance and Corporate Affairs) then submitted the

final version of the Limited Liability Partnership Bill to the Ministry for Corporate Affairs.29

20Bradley & Caroline, Twenty-First Century Anglo-American Partnership Law, 30 Comm. L. World Rev.

330(2001), 338.21

Limited Liability Partnership Act 2005, available athttp://statutes.agc.gov.sg/aol/search/display/view.w3p;page=0;query=DocId%3A6f2b2128-60fe-43b1-89d7-

29c6748e6bb4%20%20Status%3Ainforce%20Depth%3A0;rec=0 (Last visited on August 21, 2013).22

Law Commission of India, Seventh Report on Partnership Act, 1932, 1957, 8 available at

http://lawcommissionofindia.nic.in/1-50/Report7.pdf (Last visited on August 21, 2013).23

Id24

Id25Naresh Chandra Committee-II, Report of the Committee on Regulation of Private Companies and Partnership,

3.11, Recommendation 3.1 available at http://www.llponline.in/naresh_chander_committee.php (Last visited on

August 21, 2013).26 See Recommendations of the J.J.Irani Committee available at http://www.llponline.in/jj_irani_committee.php

(Last visited on August 26, 2013).27

Available at http://www.mca.gov.in/LLP/faq_introduction.html . (Last visited on August 24, 2013).28

See Panel proposes key changes in limited liability partnership bill available at

http://articles.economictimes.indiatimes.com/2007-12-06/news/27680499_1_llp-bill-limited-liability-partnership-llp-act 6 December 2007, Last visited on August 22, 2013.29

Available at http://www.mca.gov.in/LLP/faq_introduction.html. (Last visited on August 24, 2013).


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The Cabinet on 1 May 2008 approved the introduction of a Limited Liability Partnership (LLP)

Bill, 2008 in Parliament by replacing the Limited Partnership Bill, 2006.30

On 21 October

2008, the Bill was introduced in the Rajya Sabha. This Bill was introduced first in the Rajya

Sabha since the Union Minister of Corporate Affairs, Shri Prem Chand Gupta, is a member of

the Rajya Sabha.31

After being passed in the Rajya Sabha on 24 October 2008, the Bill was

tabled in the Lok Sabha, which also passed the Bill without any changes. The Bill received the

assent of the President of India on 7th January, 2009. The Limited Liability Partnership Act,

2008 was thereafter notified in the Official Gazette of India dated 9th January 2009.32

III. TAXATION OF LLPS

The method of taxation of companies or for that matter partnership firms has not been

explained through the provisions of Indian Companies Act, 1956 or the Indian Partnership Act,

1932 but by the Income Tax Act. Therefore it is clear why the Indian LLP Act, 2008 is silent

on the taxation system applicable on the LLPs. The Finance Act, 2010, which has come into

effect from the assessment year 2010-2011, incorporates the mechanism for taxation of LLPs

by amending the Income Tax Act, 1961. Subsequently the Ministry of Corporate Affairs has

releases press notes on the taxation of LLP.

The Explanatory Memorandum to the Finance (No. 2) Bill, 2009 clarifies the taxation of LLPs

as follows:

The Income tax Act has been amended to incorporate the taxation scheme of LLPs in

the Income Tax Act on the same lines as the taxation scheme currently prevalent for

general partnerships, i.e. taxation in the hands of the entity and exemption from tax in the

hands of its partners. A limited liability partnership and a general partnership will be

accorded the same tax treatment.33

There are two popular options for taxation used in various foreign jurisdictions that provide for

LLPs. The first is the practice, as is seen in the French LLP model, of treating an LLP as a

fiscally transparent entity and taxing merely the income of the partners and not of the

30

See Revised LLP Bill enters Rajya Sabha available at http://articles.economictimes.indiatimes.com/2008-10-22/news/28439984_1_llp-format-limited-liability-partnership-chartered-accountants October 22, 2008 Last visited

on 22 August, 2013.31

See Revised LLP Bill enters Rajya Sabha available at http://articles.economictimes.indiatimes.com/2008-10-22/news/28439984_1_llp-format-limited-liability-partnership-chartered-accountants 22 October, 2008 Last

visited on 22 August, 2013.32

See Govt introduces Limited Liability Partnership available at

http://articles.economictimes.indiatimes.com/2009-04-01/news/28408183_1_limited-liability-partnership-llps-

hybrid-of-partnership-firms Last visited on 22 August, 2013.33

Explanatory Circular for Finance (No.2) Act, 2009 Pg. 13 of 63 available at

http://www.aadisol.in/aca/images/related_news/rn_747.pdf(Last visited on August 21, 2013).


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transparent entity.34

The alternative to this, based on the UK and Singapore LLP models, is to

accord similar treatment to an LLP as a partnership. India has adopted the latter practice. Under

the amended 140 of the Income Tax Act, 1961, the designated partner has to sign the return of

the income and due to some unavoidable reasons maybe signed by any other partner.

Keeping this in mind the Finance (No. 2) Act, 200935

amended 2(23) of the Income Tax Act,

196136 by inserting (i) "firm" shall include a limited liability partnership as defined in the

Limited Liability Partnership Act, 2008; (ii) "partner" shall include a partner of a limited

liability partnership as defined in the Limited Liability Partnership Act, 2008; (iii)

"partnership" shall include a limited liability partnership as defined in the Limited Liability

Partnership Act, 2008. Thus it was declared that LLPs formed and registered under the LLP

Act, 2008 in India shall be taxed as firms and those incorporated outside shall be taxed as

companies.37

An LLP will be considered an equivalent of a general partnership for taxation purposes and

will reap all the tax benefits that are available to a partnership.38

Income tax will be levied on

the LLP itself and the profits from the LLP which the partners obtain will not be computed for

their personal income as it will be considered as business income which is within the scope of

a deduction for computing income.39

In the event of failure to comply with 184 of the LLP

Act, the remuneration paid to the partners will not be allowed as deductions on their personal

income.40

Further, any contribution of capital assets by a partner to his LLP or distribution of

such assets by the LLP to any partner, will be considered to be income of the partner and LLP

respectively, and will be subject to income tax.

41

40(b) of the Income Tax Act, which pro-vides for restrictions on payment of interest and remuneration to partners, has been modified

now to uniformly apply to professional and non-professional firms. LLPs are beneficiaries of

the modification, thus making them an attractive business option for professionals forming an

association.42

While an LLP is generally treated as an equivalent of a general partnership for taxation

purposes, the Union Budget 2011-12 has announced the levy of Alternate Minimum Taxes

34

Mahajan, Yamini and Sachdeva, Amit M., Indian Limited Liability Partnership Law: Some Concepts andConcerns (February 22, 2010). Available at SSRN: http://ssrn.com/abstract=1557002 or

http://dx.doi.org/10.2139/ssrn.1557002(Last visited on August 26, 2013).35

Finance (No. 2) Act, 2009, Bill No. 33-F of 2009.36Available at http://law.incometaxindia.gov.in/DIT/ . (Last visited on August 24, 2013).37

Income Tax Act, 1961, 2(17)(ii), as amended by Finance Act, 2010.38

Income Tax Act, 1961, 184, as amended by Finance Act, 2010.39

Income Tax Act, 1961, 10(2A) and 28(v).40

Paras Savla,LLP and Partnership, 35(4) Income Tax Rev. 38, 39 (2009).41

Income Tax Act, 1961, 45(3) and (4).42

Id.


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(AMT) on LLPs similar to the Minimum Alternate Tax (MAT) imposed on companies.43

In

this regard, the Union budget has proposed to introduce a new Chapter XII-BA under the

Income Tax Act, 1961 providing for the levy of AMT at 18.5 percent of the adjusted total in-

come of LLPs.44

Thus the tax base for LLPs would be the adjusted total income and not book

profits as in the case of companies. Although the introduction of the AMT on LLPs may be

perceived as a disadvantage to the LLP business form, the LLP nevertheless remains an

attractive business form due to its inherent flexible structure along with the exemption from

dividend distribution tax.

The taxation scheme for LLPs may, however, deter prospective foreign investors given that

investment in LLPs may lead to double taxation- first, at the level of the LLP in India and

second, at the level of profits for the investor in the foreign jurisdiction.45

It may, however, be

of convenience to an Indian LLP doing business abroad depending on the legislation prevailing

in the foreign jurisdiction, as the LLP may be treated as fiscally non-transparent and taxed as a

separate entity. Hence, it will avail the benefits of tax credit. If the partners, and not the LLP,

are treated as beneficiaries of income in the foreign state, the tax credit cannot be utilised.46

Even the double taxation avoidance agreements that India has signed with some States have

not provided a suitable solution. At this point, it is interesting to note that in the US adopts a

truly unique system that, in accordance with the internal structure of the LLP, gives the option

of taxation either at the level of the LLP or at the level of the partners.47

This enables an LLP to

decide its structure depending on the laws of the countries where the LLP is investing and

doing business so as to avail of the tax credit advantage. Had India adopted such a mechanism,

the problem of double taxation could have been effectively put to rest.

The taxation system for an LLP can be explained according to the following table

Table 1: Taxation of LLP under various heads

Tax Percentage Comment

43Finance Bill 2011, Cl. 18, available at http://indiabudget.nic.in/ub2011-12/fb/bill31.pdf (Last visited on August

26, 2013).44

Id45

Sachdeva and Mahajan, supra note 34, 8; Anant Pai,LLP-Its Incidental Tax Considerations, 6 Income Tax Rev.

Vol. XXXV 61 (September 2009).46

See id. (for a detailed discussion on the contingencies which may arise in different jurisdiction).47

See Uniform Limited Liability Partnership Amendments to the Revised Uniform Partnership Act 1996.


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Income Tax 30% Income Tax Slabs and Rates

Assessment Year 2013-14 (Financial Year

2012-13).48

Education Cess 3% of Income Tax,

i.e. 30.9% effectively

If income exceeds 1 crore the rate of tax

(Income tax plus education cess is 33.99%

otherwise it is 30.9%.

Minimum Alternate

Tax (MAT)

Not applicable Not applicable

Alternate Minimum

Tax (AMT)

18.5% In order to save revenue on

account of companies converting to LLPs

to take benefits of tax exemptions and to

rationalize taxation of LLPs with

companies, this Union Budget has proposed

to introduce a new Chapter XII-BA under

the Income Tax Act 1961 which provides

for levy of Alternate Minimum Tax @

18.5% on the adjusted total income of

LLPs.49 The effective rate of AMT after

taking in account education cess will be

19.05%.

Dividend

Distribution Tax

(DDT)

Not Applicable Not applicable

Deemed Dividends under 2(22)(e) Loan by LLP to partner not taxable as

deemed dividend in his hands

Wealth Tax Not Applicable Not applicable

IV. LOOP HOLES IN THE TAXATION STRUCTURE OF LLPS

A. TAX EFFECT OF THE CONVERSION OF A PRIVATE COMPANY OR AN

UNLISTED PUBLIC COMPANY INTO LLP

48 Available at http://incometaxindia.gov.in/download_all.asp. (Last visited on August 21, 2013).

49Introduced through Finance Bill 2011.


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LLP Act, 2008 allows for the conversion of a private company or unlisted public company into

an LLP.50

The Finance (No. 2) Act, 2009, however, does not clarify the tax effects of

conversion of a private company or an unlisted public company into LLP on matters such as:51

i.Levy of capital gains tax on transfer of assets to LLP on conversion.ii.Availability of carry forward of losses and of unabsorbed depreciation to the successor

LLP.

iii.Availability of MAT credit to the successor LLP.iv.Carry forward of benefits under 35DDA to the successor LLP.Lack of clarity on these matters was a roadblock to conversion of a company into a LLP. To

remove these hurdles Finance Act, 2010 was introduced. The Honble Finance Minister Pranab

Mujkherjee while presenting the Budget 2010-11 clarified the objects to these amendments as

"To facilitate the conversion of small companies to LLPs, I propose that this will not be subject

to capital gains tax."52

The Finance Act, 2010 has inserted a new clause (xiiib) in 47 and a new sub-section (4) in

47A of the Act with effect from assessment year 2011-12. The said new clause (xiiib)

provides that the transfer of capital asset or tangible asset to LLP or any transfer of share or

shares held in the company by a shareholder on conversion of a private company or unlisted

company into a LLP in accordance with 56 and 57 of the LLP Act, 2008 shall not be

regarded as transfer for the purpose of capital gains tax, Subject to the following conditions:

(i) All the assets and liabilities of the company immediately before the conversion

become the assets and liabilities of the LLP;53

This condition is lop sided as it only provides that all the assets and liabilities of the company

immediately before the conversion become the assets and liabilities of the limited liability

partnership however there can be a situation where assets are transferred after conversion. The

only condition that appears prima-facie seems to be that transfer should not be erstwhile

shareholder who becomes partner of the LLP.

(ii) All the shareholders of the company immediately before the conversion become the

partners of the limited liability partnership and their capital contribution and profit

50LLP Act, 2008, 56 & 57.

51CA Srinivasan Anand G., Taxmanns Taxation of LLPs, I-3(Taxmann Publications Private Ltd. 2010).

52See Union Budget 2010: Govt exempts LLP firms from paying capital gains tax available at

http://articles.economictimes.indiatimes.com/keyword/limited-liability-partnership/recent/2 (Last visited onAugust 22, 2013).53

Income Tax Act, 1961, 47(xiiib)(a), as amended by Finance Act, 2010.


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sharing ratio in the LLP are in the same proportion as their shareholding in the company

on the date of conversion;54

It was held by the honble Supreme Court that the words all the shareholders mean all the

registered shareholders. A beneficial owner of shares whose name does not appear in the

register of shareholders cannot be said to be a shareholder.55

Here the question that arises is

with respect to minor shareholders. It was held by the Punjab High Court in the case of

Dewan Singh v. Minerva Films Ltd56that minors can be members of a company.

57However

the Indian Partnership Act, 1932 expressly bars a minor from becoming a partner of a firm and

instead allows a minor to be admitted to the benefits of partnership.58

This has given rise to a

controversy whether minor can be a partner or can he be admitted to the benefits of partnership

in LLP. It is desirable that the ministry of Corporate Affairs come out with suitable

clarifications on this issue so that the wheels of commerce roll on smoothly and general

partnership firms do not feel hesitant to convert to LLPs.

(iii) 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;59

The words consideration or benefits is not in any way qualified by the words for the

conversion or in connection with the conversion. The intention seems to be that the

shareholders should not receive any consideration or benefit in connection with the conversion

other than profit share and capital contribution in LLP.60

CBDT needs to clarify this too.

(iv) The aggregate of 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;61

If this condition is violated any time before the expiry of 5 years from the date of conversion,

the capital gains on transfer of assets in conversion shall be charged to tax in the hands of the

54Income Tax Act, 1961, 47(xiiib) (b), as amended by Finance Act, 2010.

55Rameshwarlal Sanwarmal v. CIT, Assam, [1980] 122 ITR 1.

56Dewan Singh v. Minerva Films Ltd (1959) 29 Comp Cases 263 (P&H); See also Master Gautam R. Pandival v.

Karnataka theatres Ltd. (C.P. No. 13/111/SRB/97, decision dated 16-2-1999); Diwan Jaffar v. Minerva Films Ltd.(1958) 28 Comp Cas 191 (Punj.).57

The position with respect to a minor becoming a member of a company would be in terms of the following two

circulars issued by the Department of Company Affairs in this regard: i) Government of India Publication,Clarifications and Circulars on Company Law, Circular No. 8/18/(41)/63-PR, dated November 2, 1963:1977

Edition, p. 23; and ii) Government of India Publication, Clarifications and Circulars on Company Law, 1977Letter No. 8/18(41)/63-PR, dated March 31, 1964, Edition, page 23.58

Indian Partnership Act, 1932, 30(1).59

Income Tax Act, 1961, 47(xiiib)(c), as amended by Finance Act, 2010.60

Supranote 51, I-10.61

Income Tax Act, 1961, 47(xiiib)(d), as amended by Finance Act, 2010.


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successor LLP under 47A(4) in the previous year in which this condition is violated. Also,

capital gains not earlier taxed in the hands of erstwhile shareholders (who become partners) on

account of exchange of shares in the company for interest in LLP shall be taxable. This raises a

question as to what happens if due to death of one of the partners, the share of profits in the

LLP of the erstwhile shareholders (who become partners in the LLP) falls below fifty percent

before the expiry of five years from the date of conversion. CBDT need to clarify this issue.62

Further, this condition envisages that the holdings of the shareholders of the company in the

LLP can be reduced to less than 50 percent of the profits of the LLP to even zero percent after

a period of 5 years from the date of conversion. When (ii) and (iv) are read simultaneously it

seems as if condition (ii) is also applicable only for 5 years after the conversion. CBDT should

clarify this. It should be clearly stated in the LLP agreement that if any erstwhile shareholder

who is a partner of LLP quits the LLP as partner anytime within 5 years from the date of

conversion, he shall compensate the LLP for loss of tax-benefits- capital gains exemption, loss

of carry forward of business loans etc. Further if any registered shareholder expresses inability

to guarantee that he will remain a partner of the LLP for atleast five years, it seems better that,

before conversion, the company buyback all his shares and transfers the same to some other

person who is willing to remain a partner for atleast 5 years.63

(v) The total sale, turnover or gross receipts in 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 and64

This has been done to ensure that tax benefit is available only for conversion of small

companies into LLPs. If this condition is not fulfilled then, according to 47A(4), the amount

of capital gains arising from the transfer of such capital asset or intangible asset or share or

shares not charged under 45 by virtue of the said conditions shall be deemed to be taxable

capital gains of the successor LLP or the shareholders of the predecessor company in the

previous year in which such non compliance takes place.

The terms total sales, turnover and gross receipts are not defined in 47(xiiib) nor in any

other provision of the Act. However ICAI has provided guidance note in order to clarify the

same.65

Further this condition is capable of peculiar interpretation in case a private company or

an unlisted public company converts itself into LLP before it completes three previous years

from the date of incorporation. The question that arises is whether this conversion will deny

62Supranote 51, I-10.


64Income Tax Act, 1961, 47(xiiib)(e), as amended by Finance Act, 2010.

65ICAIs guidance note on tax audit (revised 2005 edition).


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them of tax benefits such as capital gains tax exemption, carry forward of unabsorbed

loss/depreciation? CBDT must issue suitable clarifications to avoid unnecessary litigation.

(vi) 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.66

This requirement creates a controversy in case accumulated profits are exhausted by way of

issue of bonus shares before conversion. Further this requirement seems to serve no purpose. It

is not clear what help will retention of identity of these accumulated profits will do. Further it

might create unnecessary disputes with new partners who might be admitted by the LLP as to

whether they also have a claim on these reserves of the erstwhile company. The issue of bonus

shares before conversion would avoid cash outflow which dividend distribution entails.67

Further it is interesting to note that if the above conditions are not fulfilled then the conversion

shall not be treated as a transfer and shall attract capital gains. However a contrary view has

been established which states that as 2(47) of the Act gives an inclusive definition of

transfer. The conversion of a private/unlisted company as per the LLP Act, 2008 is not listed

anywhere in the definition as amounting to transfer. Therefore the normal meaning of transfer

needs to be examined to see whether such conversion amounts to transfer. It was held in Asstt.

CIT v. Unity Care and Health Services68

that From the ....Scheme of Part IX of the companies

Act, 1956, it is clear that the partners who were either to register as firm can register

themselves under the Companies Act. On such registration what was earlier called a firm is

now called a company. However both entities do not exist simultaneously. When firm comes to

an end, the company takes birth.

It is possible to take a view that conversion of company into LLP under the LLP Act, 2008 is

similar to the conversion of a firm into a company under part IX of the Companies Act, 1956.

Since the predecessor company and the successor LLP do not exist simultaneously, there is no

transfer in the normal sense of the word. Thus it can be argued that since conversion of a

company into firm under the LLP Act, 2008 does not involve transfer under 2(47), the

question of invoking the exemption provision under 47(xiiib) does not arise and capital gains

tax will be exempt even if the six conditions in 47(xiiib) are not complied with. Thus this

controversy will persist unless the government includes expressly the conversion of company

into LLP in the inclusive definition of transfer in 2(47).

66Income Tax Act, 1961, 47(xiiib)(f), as amended by Finance Act, 2010.


68Asstt. CIT v. Unity Care and Health Services, [2006] 103 ITD 53 (Bang.).


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B. TAX EFFECT OF THE CONVERSION OF A PARTNERSHIP FIRM INTO LLP

One controversial issue in relation to conversion of a firm to a LLP is set off/ carry forward of

losses. The Indian Partnership Act, 1932 states that when there is change in constitution of

firm, nothing in this chapter shall entitle the firm to have set off/ carry forward....in respect of

the previous year.69

However it is possible to take a view that firm in 78(1) refers only to

general partnership firm and hence will not include LLP. Such a view is possible as all the

definitions in 2 of the Act including that of firm are qualified by the phrase unless the

context otherwise requires. However this contention was rejected by the Income Tax tribunal

in the case of CIT v. Sant Lal Arvind Kumar70

, where it was held that now 2(23) incorporates

references to LLP and the LLP Act, 2008. Therefore drawing an analogy from the above ruling

it is possible to take a view that, in the context of taxation of the LLP, the concepts of the LLP

will have full application unless there is something in any particular provision which compels a

contrary view. Hence there will be no set off/carry forward of losses to a LLP. However a

clarification through Finance Act is required to make the matter crystal clear.

Further 78(2) states that Where any person carrying on any business or profession has been

succeeded in such capacity by another person otherwise than by inheritance, nothing in this

chapter shall entitle any person other than the person incurring the loss to have it carried

forward and set off against his income. However, according to Amin Machinery (P.) Limited

v. Dy. CIT71

it seems that conversion of Firm to LLP in accordance with the Second Schedule

to the LLP Act is succession (other than by inheritance) in accordance with 78(2). However it

is submitted that the above decision of the tribunal needs reconsideration as it is based on theassumption that conversion involves succession, this has been done without going into the

exact meaning of the word. As it was held in CIT v. KH Chambers72

that succession involves

change of ownership; i.e. the transferor goes out and the transferee comes in. However such a

change of ownership is not a pre requisite of a conversion.

V. CONCLUSION

Limited Liability Partnership (LLP) is an innovative initiative which came into existence as an

alternative corporate business vehicle in order to provide a substitute to the traditional

partnership, with unlimited personal liability on the one hand, and, the statute-based

governance structure of the limited liability company on the other. It provides for a hybrid in

which a partner is not personally liable, directly or indirectly for any obligation of another

69Indian Partnership Act, 1932, 78(1).

70CIT v. Sant Lal Arvind Kumar, [1982] 136 ITR 379.

71Amin Machinery (P.) Limited v. Dy. CIT, (2007) 111 TTJ Ahd. 892.

72CIT v. KH Chambers , [1965]55 ITR 674 (SC).


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partner solely by reason of being a partner of the LLP. This concept was first promulgated in

the US which later spread to the UK, Singapore and so on.

This concept was introduced in India during the process of revision of the Indian Partnership

Act, 1932 in 1957 however it was rejected. It was later in 2006 pursuant to the

recommendations of the J.J. Irani Committee, the Naresh Chandra Committee-II and the

feedback received on the Ministry of Company Affairs Concept Paper on LLP that a draft LLP

Bill was prepared. However due to the changing circumstances this bill was replaced by

another bill which was approved by the Cabinet on 1 May 2008. The bill was finally notified in

the Official Gazette of India on 9th January 2009.

The LLP Act, 2008 however is silent on the taxation system applicable on the LLPs. The

Finance Act, 2010, which has come into effect from the assessment year 2010-2011,

incorporates the mechanism for taxation of LLPs by amending the Income Tax Act, 1961.

LLPs are taxed on the same lines as general partnerships, i.e. taxation in the hands of the entity

and exemption from tax in the hands of its partners. This is based on the UK and Singapore

LLP models.

A LLP is subject to Income Tax, education cess and also Alternate Minimum Taxes (AMT),

which has recently been announces in the Union Budget 2011-12 through the introduction of a

new Chapter XII-BA under the Income Tax Act, 1961. However unlike private/unlisted public

companies, LLPs are not subject to MAT (minimum alternate tax), DDT (Dividend distribution

tax), and Wealth tax. This makes LLPs an attractive alternative to companies. The taxation

scheme for LLPs may, however, deter prospective foreign investors given that investment in

LLPs may lead to double taxation- first, at the level of the LLP in India and second, at the level

of profits for the investor in the foreign jurisdiction.

Due to recent introduction of this statutory structure, payment of taxes by LLPs is complicated.

Further there are various drawbacks in the taxation laws on LLPs. Especially the failure of

Finance Act in providing for the smooth conversion of private/unlisted public companies or

partnership firms to LLP. Also, The Finance (No. 2) Act, 2009 has failed in clarifying various

issues which ought to have been clarified keeping in view the fast growing popularity of LLPs.

Further there are various controversial provisions in 47(xiiib) of the Income Tax Act, 1961 as

amended by Finance Act 2010 which need CBDTs clarification like the ones relating to the

levy of capital gains tax on transfer of assets to LLP on conversion, availability of carry

forward of losses and of unabsorbed depreciation to the successor LLP, availability of MAT

credit to the successor LLP and carry forward of benefits under 35DDA to the successor LLP.

By:-

Shruti Sethi, III year, BA.LLB. (Hons.), Hidayatullah National Law University, Raipur


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"COMPUTATION OF TAX ON LLPS AND CRITICAL APPRAISAL."

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