With the growth of the Indian economy, and the role played by its entrepreneurs, a need has been felt for a new corporate form that would provide 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, in order to enable professional expertise and entrepreneurial initiative to combine, organize and operate in flexible, innovative and efficient manner. 

A LLP is a corporate business form that combines the flexibility of a partnership with the advantages of a separate legal entity. It has been called the ‘Hybrid’ of the company and partnership firm. With much lower compliance burden and almost very little restrictions, coupled with status of a body corporate, people have started favoring LLP as a medium for carrying on the businesses.

The LLP Act contains enabling provisions pursuant to which a private company or unlisted public company (incorporated under Companies Act) would be able to convert themselves into LLPs. Further, to bring clarity with regard to tax implications for such conversion section 47(xiiib) of the Income Tax Act, 1961 was introduced which read as under:-

 

Following shall not be regarded as “transfer”, therefore, no capital gain shall arise on the following:

• Any transfer of a capital asset or intangible asset by a private company or unlisted public company to a limited liability partnership
• Any transfer of a share or shares held in the company by a shareholder as a result of conversion of the company into a limited liability partnership in accordance with the provisions of section 56 or section 57 of the Limited Liability Partnership Act, 2008

 

Exemption shall be available only if the conversion satisfies all the below mentioned conditions:-

S.No.	Condition	Explanation
a.	Assets and Liabilities	All the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the limited liability partnership.
b.	Shareholders and     Capital Contribution and profit sharing ratio on conversion	Ø  All the shareholders of the company immediately before the conversion become the partners of the limited liability partnership. Ø  The capital contribution and profit sharing ratio of the shareholders in the limited liability partnership are in the same proportion as their shareholding in the company on the date of conversion.
c.	No other benefit to the shareholders	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.
d.	Profit sharing ratio after conversion	The aggregate of the profit sharing ratio of the shareholders of the company in the limited liability partnership shall not be less than fifty per cent at any time during the period of five years from the date of conversion.
e.	Turnover Limit	The total sales, turnover or gross receipts in the 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.
ea.	Value of assets (Inserted by Finance Bill 2016)	The total value of the assets as appearing in the books of account of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed five crore rupees.
f.	Accumulated profit (reserves)	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.

 

Analysis:-

• The above exemption is limited to capital assets and not any other assets like inventory.
• The limit on turnover is to restrict the tax benefit of this clause to smaller entities which will render a big section of companies willing to convert as ineligible.
• Size of assets is an additional parameter to judge the eligibility of the company to claim benefit.
• Reserves are a safeguard against misuse by a company to escape Dividend Distribution Tax since a LLP is not liable to DDT.

 

Section 47A Withdrawal of exemption in certain cases:-

 

 Where any of the conditions specified above are not complied with, exemption from capital gains shall not be available. The conditions should be satisfied at the time of conversion. Additionally, condition d and f should be satisfied for respective period specified therein. Where benefit is taken under section 47(xiiib) at the time of conversion, and subsequently there is non-compliance of condition d or f, benefit availed shall be charged to tax in the manner specified below:-

• Capital Gains exempted of the predecessor company will become income of LLP by way of capital gain in the year in which non-compliance takes place, and
• Capital Gains exempted of the shareholder of the predecessor company on transfer of shares at the time of conversion shall become income by way of capital gain in the year in which non-compliance takes place.

 

Other Relevant Points:-

• Cost of acquisition of the asset : Shall be deemed to be the cost of acquisition of predecessor company
• Cost of Improvement: Any cost incurred on improvement of the assets by Predecessor Company and LLP shall be the cost of improvement.
• Period of holding of asset: As per Section 2(42A)(b), for the purpose of determining period of holding of capital asset for determining nature of capital gain, period for which the asset was held by predecessor company shall be included.