Conversion of a company into LLP – Tax implications

Rajdeep Saini

30 Jan, 2021

In India, LLP is the most emerging way of doing business. In this mode of business, the liability of the partners is limited. Every partner in the LLP is acting as an agent of the LLP, not of other partners. All the rights of the partners in the LLP to shares all posses and profits are transferable wither in part or in whole.

The LLP Act, 2008 has provided a provision for converting a private company into an LLP. The Income-tax Act 1961^[1] has further inserted and amended the provisions relating to the conversion.  Whenever there is a transaction relating to the transfer from one person to another, in that case, the transferor has to pay the capital gain tax.  Section 47(xiiib) has been inserted in the by amending the income tax act.

Transaction of the company into LLP not regarded as a transfer

According to section 47 (xiiib) the following shall not regard as transfer:

Any transfer of the intangible assets or the capital assets by an unlisted company or private company to a Limited Liability Partnership.

Further, any transfer of shares held by the company’s shareholder as a consequence of that conversion of private company into an LLP.

Exemption if the transactions of the company into LLP satisfy these conditions

According to the proviso under section 47 (xiiib) the conversion of the private companies into a Limited Liability Partnership is not taxable if it fulfils the below mention conditions:

• All the liabilities and the assets of the private company just before the conversion transfers and becomes the liabilities and assets of the LLP;
• All the Share Holders of the company just before the conversion immediately becomes a partner of the Limited Liability Partnership and the profit-sharing ratio and the capital contribution are in the same share as their shareholding is in the private company at the time of conversion;
• The company’s Share Holders must not relieve any benefit or the consideration, whether indirectly or directly, in any manner or form other than by the way of capital contribution or share in profit in the Limited liability Partnership;
• The total of the profit-sharing ratio on the company’s Share Holder in that particular Limited liability partnership shall not be less than 50% during the period of 5 Years from the date of conversion into the limited liability partnership;
• There must be no amount to be paid either indirectly or directly to any other partner out of their accumulated profits present in the accounts of the company at the time of conversion of the time period of 3 years. This would be from the time of the conversion.
• Where the value of the assets which are visible in the book of accounts of the company or any of the 3 previous financial years.

Affects of violation of section 47(xiiib) in the conversion of the company into LLP

Transfer of capital assets:

If the condition above mentioned is violated, the transfer related to the capital assets must be done at the market rate and similarly the capital gain must be calculated.

Transfer of Other Assets:

All the other assets including current assets, stock in trade etc should be transferred at the prevailing market value and the applicable tax to be paid.

Impact on the Share Holders

The entire shares are in the hand of shareholders of the private company will be converted into LLP’s capital. The shareholders will further surrender the shares and LLP capital is acquired.

Other analysis related to the conversion of the company into LLP

The list of interpretations is vast related to the transfer of the company into a Limited Liability Partnership. Simultaneously, the shareholders who are transferring the shares and the other person who is receiving it are the same. Hence, there will be no payment of the capital gain made to the shareholder because no one can make a profit just by selling to himself.

Reasons when Conversion of company into LLP is restricted

These are the following companies that cannot be converted into LLP

• Companies are involved in the business of finance, banking, and insurance;
• Companies which are engaged in businesses governed by the specific regulation and further not recognize as an LLP;
• Companies having security interests on assets;
• Companies having FDI where cognitions linked to performance are applicable;
• Companies having ECBs; and
• Companies that are having FDI under the approval route.

Price of acquisition of the asset associated with Conversion of Company into LLP

It is very simple to recognise the cost of the acquisition of the asset; it shall be estimated to the cost of the acquisition of the precursor company.

Period of holding assets related to Conversion of Company into LLP

As per Section 2(42A)(b), the reason to determine the period of holding capital assets for determining the nature of the capital gain is the time period for which the total assets was held by the predecessor company shall be included. Hence, the short term and long term will completely dependent on the total holding period of the company from the date of buying.

Conclusion

Read our article:Government Approval under Foreign Direct Investment (FDI) In India