Taxation of LLPs

Sanchit Uppal, Intern, Kaden Boriss Legal LLP

Introduction

There was a long felt need in India to provide for a business format that would combine
the flexibility of a partnership and the advantages of limited liability of a company at a
low compliance cost. The Limited Liability Partnership Act, 2008 was enacted so as to
upgrade the Indian corporate law at par with countries like the U.S and U.K. LLP is a
type of hybrid entity with the best features of companies and partnership firms.

The Limited Liability Partnership act was enacted on the recommendation of the Naresh
Chandra Committee of 20031 and the JJ Irani Committee of 20052; however the new bill
did not contain the tax provisions as were expected by the committee. For the purpose of
imposing income tax in foreign countries such as U.S.A, Singapore and Germany, LLP is
considered as transparent or pass through entity. In other words, the LLP is not itself
taxable but the individual partners are taxed with respect to the income coming from
LLP. In India it was initially expected that LLP would not be directly liable to taxation
and income germane to partners, for their association with LLP would be taxed in their
own hands. The Finance act, 2009 had made the necessary amendments with respect to
taxation of LLP in India based on the recommendations of Naresh Chandra committee
and general global practices. Further amendments have been made by the Finance Act,
2010 in regards to taxation of a limited liability partnership in India which has laid down
stringent regulations in regards to the LLPs in India.

Eligibility of the LLP for taxation

The finance Act, 2009 for the first time covered the taxation provisions of the Limited
Liability Partnership in India and has also made the relevant changes with regards to the
Indian Partnership Act, 1932. LLP is treated as Partnership firms for the purpose of
Income Tax3 and is taxed as per the rate fixed in the Finance Act, 2010.4

LLP can claim the following deductions:-

• When the partners are paid interest in the LLP, provided that such interest is
authorized by the LLP Agreement.
• When a working partner who is an individual gets any sort of salary, bonus,
commission, or remuneration (by whatever name it is called).
• When the working partner receives remuneration as stated above is authorized by
the LLP agreement and does not exceed the given limits.

1
http://finmin.nic.in/reports/chandra.pdf
2
http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf
3
Section 2(23) of Income Tax Act, 1961
4
Paragraph C, Part 3 of the 1st Schedule of the Finance Act, 2010
No deduction as given above is allowed if it does not comply with section 184 of the
Income Tax Act, 1961. This is a mandate with regards to section 185 of the Act.

Tax rate

The tax rate for an LLP for the finance year 2010-11 has been decided at a flat rate of
30% plus 3% education cess and Higher & secondary cess (total 30.9%)5 but LLP’s
incorporated outside India shall be taxed as a ‘company’ under the Income Tax Act,
1961. As LLPs are not treated as company for income tax purpose, there is no Minimum
Alternate Tax & Dividend Distribution Tax. Indian LLP will not be liable to wealth tax
but Foreign LLP will be liable.

Also now LLPs cannot avail presumptive taxation scheme under sections 44AC or
section 44AD of Income Tax Act, 1961.6

Conversion of partnership firm into LLP

The Finance Act, 2010 has made amendments to section 47 of the Income Tax Act, 1961
in regards to the transfer of assets of a company when it converts into a LLP in
accordance with section 56 and section 57 of the Limited Liability Partnership Act, 2008
and it shall not be regarded as a transfer for the purposes of capital gains tax under
section 45, subject to certain conditions. These conditions are as follows:

• All assets and liabilities of the company become the assets and liabilities of the
LLP;

• All the shareholders of the company become partners of the LLP in the same
proportion as their shareholding in the company;

• No consideration other than share in profit and capital contribution in the LLP
arises to partners;

• The shareholders of the company continue to be entitled to receive at least 50 per

cent of the profits of the LLP in the profit sharing ratio for a period of 5 years
from the date of conversion;

• That the total sales, turnover or gross receipts in business of the company do
not exceed sixty lakh rupees in any of the three preceding previous years; and

• No amount is paid, either directly or indirectly, to any partner out of the

accumulated profit of the company for a period of 3 years from the date of
conversion.

Carry forward and set-off of business loss and unabsorbed depreciation is now allowed to
the successor LLP if the above mentioned conditions are fulfilled. If the company so
converted does not complies with the above conditions; in such cases the benefit availed
by the company shall be deemed to be the profits and gains of the successor LLP and will
5
Paragraph C, Part 3 of the 1st Schedule of the Finance Act, 2010
6
The Chartered Accountant Student’s Journal, August 2010 Volume SJ1, Issue 8
be chargeable to tax for the previous year. Also the aggregate depreciation allowable to
the predecessor Company and successor LLP shall not exceed, in any previous year, the
depreciation calculated at the prescribed rates as if the conversion had never taken place.

Also the cost of acquisition of the capital asset of the predecessor company by the
successor LLP shall be deemed to be at cost at which the company had acquired it.
Further, tax credit won’t be allowed to the successor LLP with respect to section 115JAA
of the Income Tax Act, 1961.7

Conversion of partnership firm into LLP

When a partnership firm gets converted into a LLP, there will be no tax implications if
the case is such that the rights and obligations in the newly formed LLP do not change
and also if there is no transfer of any asset or liability after conversion. 8 If there is any
violation of this provision, provisions of section 45 of Income Tax Act will apply.

Liability of partner towards liability of income tax of LLP

The partners of a LLP are jointly and severally liable for income tax liability of the LLP,
but a partner can escape this liability if he is able to prove the fact that non-recovery
cannot be attributed to any gross neglect, misfeasance or breach of any duty on his part.9

Conclusion

The above aforesaid provisions of the Finance Act, 2010 came into force on 1 st April
2010 and will be effective from the assessment year 2011-12. These amendments have
been so formulated so as to bring the taxing norms of the Limited Liability Partnership in
India at par with partnership firms in India and limiting the benefits which were
previously thought of about this legal entity.

LLP’s development in its initial stages appeared as a boon for the corporate world in
India, but now with after passing of the Finance Act, 2010 seeking to impose a whole lot
of restrictions, thereby making it doubtful whether such conversion would actually be
feasible or not.

7
Finance Act, 2010
8
Explanatory memorandum to Finance (No. 2) Act, 2009
9
Section 167C of the Income Tax Act, 1961