J. B. Nagar CPE Study Circle Topic : Limited Liability Partnership Presented by:

Property of M/s Vinod K Mehta & co

J. B. Nagar CPE Study Circle

Topic: Limited Liability Partnership

Presented by:

Mr. Divyesh V. Mehta(Chartered Accountant)


TAXATION OF LLP

Conversion of Private Limited Company or Unlisted Company

A corporate business vehicle that enables professional expertise and entrepreneurial initiative to combine and operate in flexible, innovative and efficient manner, providing benefits of limited liability while allowing its members the flexibility for organizing their internal structure as a partnership.

Section 56 and 57 of the Limited Liability Partnership Act, 2008 allow conversion of a private company or an unlisted public company (hereafter referred as company) into an LLP.

In the Budget 2010 , There are amendments in Income tax Act relating to conversion of Private / Unlisted Limited Company into Limited Liability Partnership (LLP) These amendment at a glance are : 1) Capital Gain Exemption. 2) Carry forward and set off of losses. 3) Written down value of assets. 4) MAT credit. 5) Amortization of expenditure


CAPITAL GAIN EXEMPTION

Condition for Exemption :

It is proposed that the transfer of CAPITAL ASSETS on conversion of a company into an LLP will not attract capital gains tax as per Sec. 47(xiiib) subject to satisfying the following conditions:

a) All assets and liabilities of the company become the assets and liabilities of the LLP

b) Shareholders of the company become partners of the LLP in the same proportions as their shareholdings in the company.

c) No consideration other than share in profit and capital contribution in the LLP arises to partners.

d) The erstwhile shareholders of the company continue to be entitled to receive at least 50 per cent of the profits of the LLP for the period of five years from the date of conversion.

e) Total sales turnover or gross receipts in business of the company do not exceed Rs.60 lakh in any of the three preceding previous year.

f) No amount is paid, either directly or indirectly to any partner to any partner out of the accumulated profit of the company for a period of three years from the date of conversion


Analysis of various conditions relating to Exemption

Definition of word “sales, turnover or gross receipts” are not defined in Act but the same analyzed in Guidance note issued by ICAI on Audit Under Section 44 AB of IT Act. Relevant Para of the Guidance note is reproduced as under :

“Para 5.6 : The term turn over for the purposes of this clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprise. If sales tax and excise duty are included in the sale price , no adjustment in respect thereof should be made for considering the quantum of turn over. Trade discounts can be deducted from sales but not the commission allowed to third parties. If however, the excise duty and/or sales tax recovered are credited separately to excise duty or sales tax Account(being separate accounts) and payments to the authority are debited in the same account , they would not be included in the turnover. However, sales of scrap shown separately under the heading “Miscellaneous Income “ will have to be included in turn over .”

“Para 5.7 : Considering that the word “sales” , “Turnover“ and “Gross receipts” are commercial terms, they should be construed in accordance with the method of accounting regularly employed by the assessee. Section 145(1) provides that income chargeable under the head “Profits and gains of Business or Profession“ or “Income From Other Sources” should be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee . The method of accounting followed by the assessee is also relevant for the determination of sales, turnover or gross receipts in the light of the above discussions.”


Comments / Observations On the term Turn Over

Whether Share of Profit From Partnership Firm Constitute TURN OVER ?

Excise , VAT should be included in turn over ?

Interest Income ?

Rental Income ?

As such companies carrying on business and having turnover beyond this limit will not be able to get the benefit.

But those companies which are investment companies or which have income from house property , capital gains and income from other sources irrespective of the amount of such income can take the advantage of conversion . Companies in business need to plan for three years so as to bring the turnover below Rs. 60 lakhs before it can take the advantage of this newly-introduced provision.


CASE STUDY ON SALES , TURN OVER ETC

Income / Revenue Situation - I Situation - II Situation - III

Sales 100 75 60

Less: Excise 20 15 12

Net Sales 80 60 48

Rental Income 30 30 30

Interest Income 30 30 30

Capital Gain 30 90 30 90 30 90

Total 170 150 138


Whether Condition Relating to Sales Turn over Exceeds Rs.60 Lacs

Situation I - Turnover Exceeds, Benefit of Exemption not available ( However the same is possible through amalgamation –Refer separate case study)

Situation II - Gross Turnover just touched 75 lacs Net turnover is 60 lacs

Situation III - Gross Turnover just touched 60 lacs Net Turnover is 48 Lacs

Benefit of Exemption can be availed


Comments / Observations On the term Share Holder

Whether Registered Share Holder or Beneficial Share Holder ?

(Supreme Court in the context to Sec 2 (22) (e) in case of Rameshwarlal Sanwarmal v CIT 122 ITR 1 (1980) has held Share Holder means registered share holder and not beneficial owner)

Share Holder means Equity Share Holder or Preference Share Holder ? Only paid up share capital as capital in the same proportion and balance reserves in

any ratio? till when ? Next day?? Warrant holders?


Comments / Observations of the term Consideration

Whether Interest on Capital / Remuneration will be consideration ?

Whether Bonus Shares issued out of Revaluation Reserve can be consider as consideration ?

Whether Revaluation Reserve can be credited to Partners capital post conversion ?


Meaning of the term “at least 50 per cent of the profits of the LLP remains for the period of 5 years “

Share of Remuneration to Partners (Working Partners) different from Share of Profit is eligible for exemption ?

Change in Partnership due to Death , Insolvency, etc ?


Meaning of the term amount is paid, either directly or indirectly to any partner to any partner out of the accumulated profit

Comments & Observations – Accumulated Profit

Accumulated Profit is not defined , but reference may

be invited to various judgements delivered in case of sec 2(22)(e) Supreme Court in case of CIT v Urmila Ramesh (96 Taxmann 533) has held that “The amount should in other words be in the nature of profits which the company could have been distributed to its share holder. This would clearly exclude return of part of capital to the company, as the same can not be regarded as profit capable of being capitalized, the return of capital itself.”

Profit u/s 41(2) is not part of accumulated Profit (CIT v Urmila Ramesh (96 Taxmann 533)


Comments & Observations – Accumulated Profit

Share Premium is Accumulated Profit ?

Revaluation Reserve is accumulated Profit ?

Bonus Shares issued before conversion to Share Holder before Conversion ?

How payment to be considered as paid out of accumulated profits Original or new partners also??

Whether indirectly covers loan etc like 2(22)?

Whether it means no dissolution for 3 years of exempted LLPs ??

A person should be partner at the time of formation or payment or both ??


CASE STUDY ON ACCUMULATED PROFIT

Income / Revenue Situation Whether Accumulated

Profit

SHARE CAPITAL 1000 NO

SHARE PEMIUM 500 NO

REVALUATION RESERVE 500 NO

GENERAL RESERVE 300 YES

PROFIT & LOSS 300 YES

Total 2600

WHETHER FOLLOWING TRANSACTIONS AMOUNTS TO DISTRIBUTION

1) Loan to Partner

2) Loan to Company in which Partner is more than 20 % Share Holder

3) LLP opens FD and Against which Partner / Sister Concern Borrow Loan

4)Comemrcial Transactions in the nature of Sales / Purchase


ISSUES UN RESOLVED – STILL PENDING

Applicability of the Provisions ONLY to CAPITAL ASSET

The Provision of Section 47 (xxxib) relating to exemption is applicable only to capital assets.

It means , where in case of a company , where the Stock in Trade ( such as Properties or Bullion) are transfer on conversion NO EXEMPTION WILL BE AVAILABLE

Supreme Court in case of ALA Firm v CIT (189 ITR 285) has held that in taking accounts for the purpose of dissolution , since the firm and the partners , being commercial men , would value assets on real basis and not on cost or other value appearing in the books of accounts. There for at the time of dissolution value of closing stock should be taken at market value and not at cost and the difference is income. Similarly ,principles would apply at the time of conversion of a company into LLP


CASE STUDY ON CAPITAL ASSETS

Income / Revenue Amount (Cost)Amount (Market

Value)

Fixed Assets 1,000 5,000

Investments 500 2,000

Stock In Trade

Gold 250 1,000

Shares 250 1,000

Total 2,000 9,000

1) If converted into LLP Tax liability will arise on Stock in Trade Valuation Difference

2) In order to AVOID the following option can be considered

a) Convert Stock in Trade into Investments b) Introduced Stock at cost as Capital Contribution

into LLP


Other LAWS should be consider before conversion :

The Exemption is not available laws are involved and the same are

STAMP DUTY STATE TAXES (VAT ) CENTRAL EXCISE SERVICE TAX BANK BORROWING

While stamp duty causes substantial outflow, in other matters necessary paper work needs to be done. Inder Indirect Taxes , carry forward of Cenvat Credit and set off not consumed may not available,

Further, one needs to be cautious about the penal provision in the LLP Act for various defaults such as not filing documents in time, etc, which are quite harsh.


Impact on Share Holder of converted Pvt. Ltd. Company

In case of conversion of closely held company in to LLP (section 45 applies) , there will be an extinguishment of Rights of the share holder in the shares of company.

But, there is Failure of computation mechanism as no consideration flowing to shareholders directly

Alternate View : No exemption provided in any case , so whether it can be interpreted to mean that legislature in its wisdom feels that no liability arises to shareholders in any case

If Taxable , It will create great Hardship , if the shares were acquire at discount and resultant difference will be capital gain.

In case of Demerger and Amalgamation there is specific exemption as specified in section 47(vid) and (vii). Which is not exist for LLP


CASE STUDY ON TAX IMPLICATION ON SHARE HOLDERS

Income / Revenue Situation -I Situation - II Situation - III

SHARE CAPITAL (Face Value Rs.10 ) 1000

SHARE PEMIUM 10000

GENERAL RESERVE 5000

PROFIT & LOSS 2000

NET WORTH 18000

COST OF PURCH OF SH.HOLDER 10 100 1

CAPITAL GAIN (DUE TO EXTINGUISHMENT) 0 -90 9


HOW TO MANAGE CONVERSION SO AS TO MAKE IT REVENUE NEUTRAL (NO GAIN / NO LOSS)

SITUATION - I : REVENUE NEUTRAL

SITUATION - II : ISSUE BONUS SHARES ( SO AS TO MAKE REVENUE NEUTRAL)

Income / Revenue PRE BUNUS POST BONUS

SHARE CAPITAL (Face Value Rs.10 ) 1000 10000

SHARE PEMIUM 10000 1000

GENERAL RESERVE 5000 5000

PROFIT & LOSS 2000 2000

NET WORTH 18000 18000

COST OF PURCH OF SH.HOLDER 100 100

CONSIDERATION DUE TO EXTINGUISHMENT 10 100

CAPITAL GAIN (DUE TO EXTINGUISHMENT) 90 0

SITUATION - III : REFER AMALGAMATION CASE STUDY


CASE STUDY ON AMALGAMATION PROIR TO CONVERSION IN TO LLP

Balance Sheet of A Pvt. Ltd (With Sales Exceeding Rs.60 Lacs for last 3 yrs)

Liability Amount Assets Amount

Share Capital 10000 STOCK - IN TRADE 10000

Reserve 0

Total 10000 Total 10000

Balance Sheet of B Pvt. Ltd (With Sales Less Than Rs.60 Lacs for Last 3 Yrs)


Share Capital 1000 Investments 10000

Reserve 9000



Amalgamate A Pvt Ltd with B Pvt. Ltd.

Resultant Balance Sheet (Post Amalgamation) will be




Reserve 9000 STOCK - IN TRADE 10000

AMALGAMATION RESERVE 9000


NOW B PVT LTD can be Converted in to LLP


CASE STUDY ON DEMERGER PROIR TO CONVERSION IN TO LLP

This Option can be considered in case of CASH RICH Corporate to hive off Investment Division and LLP

Balance Sheet of A Pvt. Ltd (With Sales Exceeding Rs.60 Lacs for last 3 yrs)

Liability BUSINESS INVEST Assets BUSINESS INVEST

Share Capital 500 500 Investments 5000

Reserve 4500 5500 STOCK 6000

Total 5000 6000 Total 5000 6000




Reserve

Total 100 Total 100


DEMERGED INVESTMENT DIVISION IN TO B LTD AND RETAIN BUSINESS IN A LTD

Resultant Balance Sheet (Post DEMERGER) will be




Reserve 0


NOW B PVT LTD can be Converted in to LLP & A LTD CAN DO EXISTING BUSINESS


WITHDRAWAL OF EXEMPTION

It is also proposed to amend the section 47A to provide that if the conditions stipulated above are not complied with , the benefit availed by the company shall be deemed to be the profits and gains of the successor LLP chargeable to tax for the previous year in which the requirement are not complied with.

It may be noticed that of the conditions stated above, while the conditions a,b,c,e (Sec 47 (xiiib)) are one time conditions.

The conditions d and f (Sec 47 (xiiib) ) are conditions which have to be satisfied in future years.

Therefore , it can be seen that if the conditions above stated are not satisfied , no benefit would be available under the amendments to the LLP and consequently, the section 47A would not apply.

However, if the conditions d or f or both are violated, it is then that the section 47A would come into play.


CARRY FORWARD AND SET OFF OF LOSSES

Carry forward and set off of business loss and unabsorbed depreciation to the successor LLP, will be allowed if the above mentioned conditions 1 to 6 satisfied.

The business loss to be set off against ANY SOURCE OF INCOME in the year of conversion and to allow carry forward of business loss for a fresh period of eight years.

This would mean that in the year of conversion the business loss of the company can be set off against income from any source or head and the balance , if any can be carried forward and set off against the business income of the LLP for eight further years.

It will, however, be necessary that the company in the year of loss must have filed the returns within the time allowed under the Section 139(1) and further that in the hands of the company the eight year period should not have elapsed.

Unabsorbed depreciation, of course, in any case can be set off against any source or head and can be carried forward indefinitely.

In the year of succession, the depreciation is to be computed as though no such conversion took place and is to be pro-rated between the predecessor company, and the successor LLP based on the date on which succession took place.


WRITTEN DOWN VALUE ( SEC 43(6) )

It is proposed that the actual cost of the block of assets as in the case of the successor LLP shall be the written down value of the block of assets as in the case of the predecessor company on the date of conversion.

It is also provided that the cost of acquisition of the capital asset for the successor LLP shall be deemed to be the cost for which the predecessor company acquired it.


MAT CREDIT

Credit under the section 115JAA in respect of the MAT paid by the company shall not be allowed to the successor LLP.


AMORTIZATION OF EXPENDITURE

The successor LLP shall be eligible to claim the amortization of expenditure incurred under the VRS (Voluntary Retirement Scheme) by the company for the remaining period in terms of the Section 35DDA.


Company as a partner in LLP

Contribution of investments at book value Sec 45(3)

If contribution is of unlisted companies, it should be before 1st june,2010

It saves future MAT and DDT on funds generated and long term capital gain

earned on sale of such transfer portfolio

it may save liability on dividend distribution , if any under Sec2(22) (c )

Date of holding for investments for LLP starts from date of transfer. it

means LLP needs to hold the same for one year to claim long term benefits

Whether interest payment on capital account balance of company as

partner is fatal to claim for LTC exemption???


COMPARISION BETWEEN COMPANY AND LLP

COMPANY LLP

MAT

Under the existing provision , a company is liable to pay regular tax and MAT on book profits if the regular tax is less than that MAT.

MAT

It is not liable for MAT.

DIVIDEND DISTRIBUTION TAX

Company has to pay Dividend Distribution Tax while distributing profit to the shareholders.

DIVIDEND DISTRIBUTION TAX

It is not liable for Dividend Distribution Tax.


COMPARISON BETWEEN COMPANY AND LLP

DEEMED DIVIDEND

In addition thereto , there is a restriction on payment of any money or advance to Shareholders which is considered to be deemed dividend under the section 2(22)(e) of the Act.

DEEMED DIVIDEND

The provision of the section 2(22)(e) is applicable for three years post conversion as stipulated in the conditions.

INTEREST ON CAPITAL

The company cannot pay interest on capital.

INTEREST ON CAPITAL

The LLP can also pay interest on the amount of capital of the partner but the restriction is regarding the rate of interest at 12 percent under the section 40(b)(iv).


COMPARISION BETWEEN COMPANY AND LLP

REMUNERATION - DIRECTORS

The remuneration paid to directors subject to the section 40A(2)(b) is fully allowable.

REMUNERATION - DIRECTORS

The remuneration paid to directors subject to the section 40A(2)(b) is fully allowable.

RATE OF INTEREST

The rate of interest paid to shareholders / directors in case of company has to be commensurate with the fair market value.

RATE OF INTEREST

LLP is recognized under the Income – tax Act as a firm However, there is no restriction on the rate of interest but in view of the section 40(b)(iv) it will be max 12%.


Tax Savings under LLP Structure as compared with Private/Public limited Company (When the annual net Profit is upto 25 Lacs) Rs. 5,65,720 Savings

Private Limited Company

Income Tax Rs. 7,72,500 (30.90% on Rs. 25 lacs)

Net Profit available for net distribution Rs. 17,27,500

Dividend distribution Tax Rs. 2,66,900 (15.45% on Rs. 17,27,500)

Total Tax Rs. 10,39,400


Tax Savings under LLP Structure as compared with Private/Public limited Company (When the annual net Profit is upto 25 Lacs) Rs. 5,65,720 Savings

Limited Liability Partnership

Net Profit Slabs Taxation Slabs Taxation : LLP Taxation : Partner

Rs. 3,00,000 10% Taxed in the hands of LLP

Tax (31% on Rs.30000)

9300 NIL

90% distributed to partners as remuneration

Rs. 2,70,000 is distributed among Partners.

(If equal distribution then Rs.1.35lac among each partner)

NIL NIL


Tax Savings under LLP Structure as compared with Private/Public limited Company (When the Annual Net Profit is Upto 25 Lacs) Rs.5,65,720 Savings

Net Profit Slabs Taxation Slabs Tax to LLP Tax to Partner

Rs. 22,00,000 40% Taxed in the hands of LLP

Tax (31% on Rs.880000)

272800 NIL

60% Taxed in the hands of LLP

Rs.13,20,000 is

distributed among Partners.

(If equal distribution then Rs.6.60lac among each partner)

NIL NIL

Total Remuneration paid to each partner is Rs. 795000


Tax Savings under LLP Structure as compared with Private/Public limited Company (When the Annual Net Profit is Upto 25 lacs) Rs.5,65,720 Savings

Net Profit Slabs Taxation Slabs Taxation : LLP

Taxation : Partner

Each partner has to

Pay Tax on Rs.795000On Rs.160000

On Rs.340000

On Rs.295000

3% Education Cess

NIL

NIL

34000

59000

2790

Total Tax Rs.473680 282100 191580

Tax Saved Rs.565720


C.A Divyesh V MehtaPartnerVinod K Mehta & Co(Chartered Accountants)Email id: [email protected]; Contact Nos:+91 9819238681

J. B. Nagar CPE Study Circle Topic : Limited Liability Partnership Presented by:

Documents

Transcript of J. B. Nagar CPE Study Circle Topic : Limited Liability Partnership Presented by: