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Tax Issues in Reorganisation Tax Issues in Reorganisation through Limited Liability Partnership (LLP)
- Pinakin Desai
Contents
► Overview of LLP law and regulations
► Tax analysis
► LLP in general
► Conversion of firm into LLP
► Conversion of company into LLPs
June 2011 Page 2 Tax Issues in Reorganisation through LLP
► Conversion of company into LLPs
Overview of LLP law and regulations
Indian LLP : A Snapshot
► Two or more persons associating for carrying on lawful business with
a view to profit can incorporate LLP [Sec11(1)(a) of LLP Act]
► Key attributes of an Indian LLP
► Incorporated entity: Body corporate
► Partners’ liability limited to contribution
June 2011 Page 4 Tax Issues in Reorganisation through LLP
Partners’ liability limited to contribution
► Perpetual existence independent of its partners
Indian LLP : A Snapshot
► LLP Agreement governs an LLP
► Mutual rights, duties of partners can be agreed in the LLP Agreement
► Contents of LLP agreement in public domain
► Partner of an LLP
► Can be an Individual, Indian/foreign company or LLP: minimum of 2
partners
June 2011 Page 5 Tax Issues in Reorganisation through LLP
partners
► is an agent of LLP for the purpose of business of LLP, but not of other
partners
► Not liable for LLP obligation unless it relates to his own wrongful act or
omission
Indian LLP : A Snapshot
► Contribution by partner
► Can be tangible movable or immovable or intangible property or other
benefit to the LLP
► Can be contracts for services performed or to be performed
► to be valued by a CA /cost accountant / a valuer on the panel
► Partner can assign, wholly or in part, his interest/ right to share of
June 2011 Page 6 Tax Issues in Reorganisation through LLP
► Partner can assign, wholly or in part, his interest/ right to share of
profits/losses etc. The assignee gets rights post suitable modification
of LLP agreement.
Indian LLP : A Snapshot
► Designated partner (DP)
► Requires a minimum of 2 “individual” DP, one of whom has to be an
Indian Resident
► Where LLP consists of only “body corporate” partners, can nominate a
DP
► A DP is responsible for
June 2011 Page 7 Tax Issues in Reorganisation through LLP
► A DP is responsible for
► compliance obligations, penalties, receive notices, verify statement of
account/annual solvency status, etc
► matters specified in the LLP Agreement
► DP remains responsible for his liability even after LLP name is struck off
The LLP Act creates various obligations on DP while not conferring any special power. DP has
right of management only to the extent conferred by the LLP Agreement.
Reorganization provisions in the LLP Act
► LLP Act has provisions dealing with the following*.
► Hiving off or separation (demerger) of undertaking, property or liabilities
of LLP.
► Compromise, arrangement or reconstruction between LLP and creditors.
June 2011 Page 8 Tax Issues in Reorganisation through LLP
► Compromise, arrangement or reconstruction between LLP and its
partners.
► Amalgamation of two LLPs.
► Voluntary, involuntary winding up of LLP.
* There are no specific provisions in ITL to deal with these
Regulatory framework
► Until recently,
► FDI allowed into “Indian Company”
► FDI allowed only in “capital instruments” i.e. Equity Shares, Compulsory
Convertible Preference Shares (CCPS) and Compulsory Convertible
Debentures (CCDs).
June 2011 Page 9 Tax Issues in Reorganisation through LLP
► “Partnership interest” in LLP not equated with such shares / CCPS /
CCDs
► FDI up to 100% permitted with prior approval of FIPB
► Only for sectors falling under 100% automatic route
► LLPs not permitted to avail External Commercial Borrowings (ECBs)
Tax Analysis – LLP in general
LLP provisions - Finance (No.2) Act, 2009 (FA 2009)
► FA 2009 amendments to the Income-tax Act, 1961 (IT Act) with reference to
the LLP Act. Definition of ‘firm’, ‘partner’ and ‘partnership’ amended to
accommodate LLP.
► “A “limited liability partnership” and a general partnership will be accorded
the same tax treatment”. *
► “As an LLP and a general partnership is being treated as equivalent (except
for recovery purposes) in the Act, the conversion from a general partnership
June 2011 Page 11 Tax Issues in Reorganisation through LLP
for recovery purposes) in the Act, the conversion from a general partnership
firm to an LLP will have no tax implications if the rights and obligations of
the partners remain the same after conversion and if there is no transfer of
any asset or liability after conversion. If there is a violation of these
conditions, the provisions of section 45 shall apply”. *
* Excerpts from Explanatory Memorandum to Finance Bill No.2 of 2009. Reiterated also in CBDT Circular 5/2010 dated 3 June 2010
Advantages of being assessed as a ‘firm’
► Tax rate of 30.9%, against Indian company tax rate of 32.445% ;
► No further tax (including MAT) on partners
► No tax on distribution during the life of or on winding up of LLP
► Internal change in the partnership composition, except retirement,
does not impact carry forward of loss
June 2011 Page 12 Tax Issues in Reorganisation through LLP
does not impact carry forward of loss
► Non applicability of section 2(22)(e), section 2(24)(iv) and section 73
► Deduction of interest, remuneration if authorised by LLP Agreement:
► Section 56(2)(viia) applicable only in respect of shares of CHC
Alternative Minimum Tax (AMT) [S.115JC] (W.e.f. 1.4.2012)
► Unlike companies, minimum tax for LLP is not w.r.t. ‘book profit
► AMT payable by LLP on Adjusted on total income i.e on total
income as increased by
► Income linked deduction under Chapter VIA
► Exempt income of SEZ u/s 10AA
June 2011 Page 13 Tax Issues in Reorganisation through LLP
► AMT not payable on:
► Exempt income (say, dividends, STT based LTCG, share of firm, etc.)
► Relief on account of investment linked tax holiday
*Rates need to be increased by cess
Alternative Minimum Tax (AMT) [S.115JC] (W.e.f. 1.4.2012)
► Brief mechanism of calculation of AMT
Total income as per normal provisions (TI)] NIL
Add:
► Income linked deductions under Chapter VIA
► Exempt income of SEZ u/s 10AA
250
250
Net Total Income (TI) 500
June 2011 Page 14 Tax Issues in Reorganisation through LLP
Net Total Income (TI) 500
Tax on ATI at @ 18.5%* - say X 90
Tax on TI at @ 30%* - say Y NIL
Tax liability of LLP Higher of X 90
Or Y
*Rates need to be increased by cess
Tax Analysis – Conversion of firm into LLP
Conversion of firm into LLP
Partners of Firm Partners of LLP
Company
A B C D
LLPAssets & liabilities vested on conversion
Partnership
interest
June 2011 Page 16 Tax Issues in Reorganisation through LLP
► Effect of Registration:
► In terms of section 58(4) of LLP Act:
► LLP comes into being from date of registration
► There is transfer of assets, etc
► Firm shall be deemed to be dissolved and removed from the records of the
ROF
► To take effect notwithstanding anything contained in any other law
Tax implications of conversion
► CBDT Circular 5/2010 dated 3 June 2010:
5.6 As an LLP and a general partnership is being treated as
equivalent (except for recovery purposes) in the Act, the conversion
from a general partnership firm to an LLP will have no tax implications
if the rights and obligations of the partners remain the same after
conversion and if there is no transfer of any asset or liability after
conversion. If there is a violation of these conditions, the provisions of
June 2011 Page 17 Tax Issues in Reorganisation through LLP
conversion. If there is a violation of these conditions, the provisions of
section 45 shall apply.
► No specific amendment in Sec 47 of ITA for conversion of firm.
► Process of statutory vesting akin to conversion of firm to company
under Part IX of Companies Act
*Section 47(xiiib) deals with conversion of company into LLP. This is captured in ensuing slides
Conversion of Firm into LLP (Chapter X Read with Schedule II)
► Pre-conditions of conversion
► Firm as defined in Indian Partnership Act may convert.
► Partners of LLP into which the firm is to be converted should comprise of
all the partners of the firm and no one else.
June 2011 Page 18 Tax Issues in Reorganisation through LLP
Conversion of firm into LLP….cont
► Transfer and vesting in LLP without further assurance, act or deed
as vesting in the firm as on the date of registration :
► All tangible (moveable and immoveable) property; all intangible property.
► All assets, interests, rights, privileges relating to the firm.
► All liabilities and obligations relating to the firm.
June 2011 Page 19 Tax Issues in Reorganisation through LLP
► Whole of the undertaking of the firm.
► All deeds, scheme, approval, licenses, Court proceedings etc etc
Judicial views on conversion of firm to company under Part IX*
� No “transfer” by firm in absence of simultaneous existence of two
parties
� No consideration received by the firm or partners as a result of
transfer
� Principle continues to govern conversion to LLP; recognized in
CBDT circular
June 2011 Page 20 Tax Issues in Reorganisation through LLP
CBDT circular
� Sec. 45(4) of IT Act not applicable to conversion; vesting of property
different from "transfer by way of distribution" in s. 45(4) of the IT Act
*Refer CIT v Texspin Engg & Mfg works (263 ITR 345)(Bom)
Tax Analysis – Conversion of company into LLP
Conversion of company into LLP
Shareholders Partners of LLP
A B C D
Partnership
Interest
June 2011 Page 22 Tax Issues in Reorganisation through LLP
Company LLPAssets & liabilities vested on conversion
Conversion of company into LLP
► Section 58(4) of LLP Act: Notwithstanding anything contained in any
other law:
a) there shall be a LLP by name specified in certificate of registration
b) all property (tangible and intangible) vested in firm/company shall be
transferred to and vest in LLP
c) firm or company shall be dissolved and removed from record of
June 2011 Page 23 Tax Issues in Reorganisation through LLP
c) firm or company shall be dissolved and removed from record of
registrar of firm/company
Section 47(xiiib) compliant conversion (w.e.f 1.4.2011) - Conversion of Private / unlisted Company into LLP
► Excerpts from Explanatory Memorandum to Finance Bill, 2010
reads as under:
“The Finance (No.2) Act, 2009 provided for the taxation of LLPs in the
Income-tax Act on the same lines as applicable to partnership firms.
Section 56 and section 57 of the Limited Liability Partnership Act,
2008 allow conversion of a private company or an unlisted public
June 2011 Page 24 Tax Issues in Reorganisation through LLP
2008 allow conversion of a private company or an unlisted public
company (hereafter referred as company) into an LLP. Under the
existing provisions of Income-tax Act, conversion of a company into
an LLP has definite tax implications. Transfer of assets on conversion
attracts levy of capital gains tax. Similarly, carry forward of losses and
of unabsorbed depreciation is not available to the successor LLP.”
Conversion of Private / unlisted Company into LLP
► CBDT Circular 1/2011 dated 6 April 2011 explaining provisions
introduced by Finance Act, 2010
“12.1 The Finance (No. 2) Act, 2009 provided for the taxation of LLPs
in the Income-tax Act on the same lines as applicable to partnership
firms. Section 56 and section 57 of the Limited Liability Partnership
Act, 2008 allow conversion of a private company or an unlisted public
June 2011 Page 25 Tax Issues in Reorganisation through LLP
Act, 2008 allow conversion of a private company or an unlisted public
company (hereafter referred as company) into an LLP. Under the
existing provisions of Income-tax Act, conversion of a company into
an LLP had definite tax implications. Transfer of assets or shares
held in the company by a shareholder on conversion attracted levy of
capital gains tax. Similarly, carry forward of losses, unabsorbed
depreciation, etc. was not available to the successor LLP.”
LLP taxation-Conversion of unlisted company to LLP [47(xiiib) (w.e.f 1.4.2011)
► Conditions for tax neutral conversions of companies into LLP1
► Conversion is in accordance with section 56 / 57 of LLP Act
► All assets and liabilities of company to become that of LLP
► All shareholders to become partners in LLP with capital contribution and
profit sharing ratio in the proportion of shareholding
► Shareholders not to receive any consideration or benefit,
directly/indirectly, in any form except by way of share in profit and capital
June 2011 Page 26 Tax Issues in Reorganisation through LLP
directly/indirectly, in any form except by way of share in profit and capital
contribution in LLP
► Aggregate of profit sharing ratio of the shareholders of company in LLP ≥
50% for a period of 5 years
► Sales, turnover or gross receipts in business of company in any of 3
years < INR 6 million
► No direct / indirect payment to any partner out of accumulated profits of
company for a period of 3 years post conversion date
Conversion of Company into LLP (Chapter X read with Schedule III)
► Provisions largely at par with conversion of firm into LLP
► Conversion is in accordance with section 56 / 57 of LLP Act
► Cannot be inter vivos transfer by way of sale
► Company can apply for conversion only if:
► There is no security interest* in its assets subsisting or in force at the
June 2011 Page 27 Tax Issues in Reorganisation through LLP
time of application; and
► The partners of LLP to which it converts comprise all the
shareholders of the company and no one else
► Condition relevant to the date of conversion
► RBI does not grant approval for conversion of NBFC to LLP
*Undefined term, ROC considers it as charge on the assets secured by the creditors as per Companies Act provisions
Conversion of unlisted Company into LLP
All assets and liabilities of company to become that of LLP
► Effective date of conversion :
► Date of application v/s date of registration
► Wholesale conversion; akin to amalgamation
► Unlike demerger or unlike transfer under section 47(xiii)
June 2011 Page 28 Tax Issues in Reorganisation through LLP
► Accompanied by dissolution of company
Conversion of unlisted Company into LLP
All shareholders to become partners in LLP with capital contribution and
profit sharing ratio in the proportion of shareholding
► Position of ‘minor’ shareholders
► No clarity on treatment of preference shareholders
► No clarity on share in losses
June 2011 Page 29 Tax Issues in Reorganisation through LLP
Conversion of unlisted Company into LLP
Shareholders not to receive any consideration or benefit,
directly/indirectly, in any form except by way of share in profit and
capital contribution in LLP
► Split of capital to loan account of shareholder
► Payment of remuneration unrelated to conversion;
June 2011 Page 30 Tax Issues in Reorganisation through LLP
► Avoid differential asset sharing ratio
Conversion of unlisted Company into LLP
Aggregate of profit sharing ratio of the shareholders of company in LLP
≥ 50% for a period of 5 years
► No lock in period upto which erstwhile shareholder continues to be a
partner, so long as condition of aggregate of 50% of profit sharing ratio
fulfilled;
► Involuntary transfers beyond the control of the assessee (such as death etc)
June 2011 Page 31 Tax Issues in Reorganisation through LLP
► Involuntary transfers beyond the control of the assessee (such as death etc)
arguably not covered
► Admission up to 50% is permissible
► Withdrawal by a retiring partner – any violation?
Conversion of unlisted Company into LLP
Sales, turnover or gross receipts in business of company in any of
3 years < INR 6 million
► Scope of ‘sales, turnover or gross receipts in business’:
► Advances received by the builder
► SEZ developer offering rental under HP chapter
June 2011 Page 32 Tax Issues in Reorganisation through LLP
► Investment company collecting dividend income
► Entity not in existence for 3 preceding previous years
► Receipts from non business activities not to be reckoned
Conversion of unlisted Company into LLP
No direct / indirect payment to any partner out of accumulated profits of
company for a period of 3 years post conversion date
► Unresolved questions : No guidance in LLP Act
► Security premium in books of company
► Bonus share capital
June 2011 Page 33 Tax Issues in Reorganisation through LLP
► Reserves on the books of company
► Lock in on withdrawal of funds, arguably , applicable to initially converted
capital contribution
► Retirement within 3 years; avoid withdrawal?
Other tax implications of conversion*
► Unlikely DDT implications u/s.2(22)(a) in absence of distribution by
company to shareholders
► Unlikely DDT implications u/s.2(22)(c) in absence of distribution;
► Unlikely S.2(24)(iv) implications for shareholders in absence of any
benefit passed on by the company
► corresponding sacrifice by shareholders
June 2011 Page 34 Tax Issues in Reorganisation through LLP
► corresponding sacrifice by shareholders
► No specific amendments to permit continuing tax holiday in the name
of LLP;
Tax neutrality of conversion : Back-up provisions
► Actual cost (WDV) of capital asset of company to be the actual cost
(WDV) to LLP [Section 49(1)(iii)(e)]
► LLP can carry forward unabsorbed business losses / unabsorbed
depreciation [Section 72A(6A)]. Arguably, fresh lease available.
► However, no carry forward of MAT credit to LLP [section 115JAA(7)]
► Cost of shares in company would represent cost of LLP interest for
June 2011 Page 35 Tax Issues in Reorganisation through LLP
► Cost of shares in company would represent cost of LLP interest for
partner [Section 49(2AA)]
Forfeiture of exemptions : Back-up provisions
► Also, S. 47(xiiib) violation leads to
► LLP paying tax in the year of violation on:
► Forfeiture of loss claimed by LLP [Proviso to section 72A(6A)]
► Capital Gains exempted in the hands of company [section 47A(4)]
► Commercial risk for newly admitted partners of LLP
June 2011 Page 36 Tax Issues in Reorganisation through LLP
► Shareholder paying tax in the year of violation on capital gains
exempted
► Partner who retired earlier also liable
► No provision for cost step up for LLP and the shareholder if capital
gains exemption forfeited requiring LLP to pay tax.
Tax Analysis – Non compliant conversion
Non compliant conversion: Implications for company
► Not correct to suggest that, absent S.47(xiiib) exemption, charge is,
per se, attracted
► No consideration accruing to the company; company is statutorily
dissolved
► No consideration payable by LLP to the company
June 2011 Page 38 Tax Issues in Reorganisation through LLP
► Capital gains or business income liability unlikely in absence of
consideration
► On principles, akin to case of amalgamating company transferring
assets
S.47(xiiib) non compliant conversion: Implications for shareholders
► Distinguishing features as compared to case of partners
► Firm and partners received income through common passage
► Consequences u/s.45(4) of ITA on the firm
► Shareholder: extinguishment of shares against receipt of consideration in
the form of LLP interest
June 2011 Page 39 Tax Issues in Reorganisation through LLP
► Legislative / CBDT thinking supports taxation in absence of compliance
with exemption conditions
Other tax implications of conversion
► Return of Income : As held by Ahmadabad ITAT in Amin Machinery
(P) Ltd [114 ITD 413] in the context of Part IX conversion
predecessor and successor are separate persons
► Permanent Account Number (PAN):LLP is a different entity
June 2011 Page 40 Tax Issues in Reorganisation through LLP
Thank you