Limited Liability Partnership (LLPS) & Taxation Issues


By

Dr. Pradeep Kumar Singh
(Ph.D, M.Com (TAX), M.Com (AE&BM), PGDF&TM)
Lecturer
Department of Commerce
Mahatma Gandhi Government Arts College
Chalakkara, New Mahe-673311 (U.T. of Pondicherry)
 


ABSTRACT

Limited liability partnership concept was introduced in order to adopt a corporate form, which combines the organizational flexibility and tax status of partnership with advantage of limited liability for its partners. LLP is a body corporate formed and incorporated under the LLP Act, which is a distinct legal entity separate from that of its partners. Introducing LLPs, as a new business structure would fill the gap between business firms such as sole proprietorship and partnership, which are generally unregulated and Limited Liability Companies, which are governed by the Companies Act, 1956. In addition to an alternative business structure, LLPs would foster the growth of the services sector. The regime of limited liability partnership will provide a platform to small and medium enterprises and professional firms of Company Secretaries, Chartered Accountants, Advocates etc. to conduct their  business/ profession efficiently which would in turn increase their global competitiveness.

As per the international experiences of the countries like UK and USA, and of the recommendations of the various corporate law reforms committee (Naresh Chandra Committee 2003, JJ Irani Expert Committee on Company Law 2005) the long and eagerly awaited Limited Liability Partnership Bill 2006 was tabled in Rajya Sabha on 15th December 2006. The Bill, introduced by the Ministry of Company Affairs, is viewed as a path-breaking reform initiative. This research article highlights, the Genesis of the LLP in Indian environment, main provisions of the LLP Bill, some taxation and accounting issues related with LLP.

I. INTRODUCTION:

Limited liability partnership (here after LLP) concept was introduced in order to adopt a corporate form, which combines the organizational flexibility and tax status of partnership with advantage of limited liability for its partners. LLP is a body corporate formed and incorporated under the LLP Act, which is a distinct legal entity separate from that of its partners. It has perpetual succession. The word "Body Corporate" is defined in the Bill to include LLPs registered under the LLP Act, LLPs incorporated outside India, and Companies incorporated outside India. Any change in the partners will not affect the existence, rights or liabilities of the LLP. The Bill provides for entry of new partners in accordance with LLP agreement and exit of existing partners both with due notice to the Registrar. The provisions of the Indian partnership Act, 1932 has no application to LLPs.

II. RATIONALE OF LIMITED LIABILITY PARTNERSHIP:

In India, businesses mainly operate as companies, sole proprietorships and partnerships. Each of these is subject to different regulatory and tax regimes reflecting their organization and ownership. Introducing LLPs, as a new business structure would fill the gap between business firms such as sole proprietorship and partnership, which are generally unregulated and Limited Liability Companies, which are governed by the Companies Act, 1956. In addition to an alternative business structure, LLPs would foster the growth of the services sector. The regime of limited liability partnership will provide a platform to small and medium enterprises and professional firms of Company Secretaries, Chartered Accountants, Advocates etc. to conduct their business/profession efficiently which would in turn increase their global competitiveness.

The issue of Limited Liability Partnership (LLP) has been a matter of discussion for many years - the Abid Hussain Committee recommended legislation on LLP in 1997. Later, the concept of LLP and the pressing need to introduce it in India found mention in the report of Naresh Chandra Committee (2003) set up on regulation of private companies. More recently, the JJ Irani Expert Committee on Company Law (2005) recommended introduction of a LLP law. While Naresh Chandra Committee preferred the application of the LLP to the service industry, Irani Committee recommended that the small enterprise should also be included in the scope of LLP. In India need for introduction of a L.L.P legislation was felt for a long time but the process gained momentum when 2 nd Naresh Chandra Committee submitted its report on 23rd July 2005 and made the following observations: "In increasing litigious market environment, prospect of being a member of a partnership firm with unlimited liability is, to say the least, risky and unattractive. Indeed the chief reason why the firms of professionals, such as accountants, have not grown in size to successfully meet the challenge of the international competition. This makes an L.L.P a most attractive vehicle for partnership among professionals such as lawyers and accountants." In the Committee's view, the scope of L.L.P. should be made available to firms providing professional services, as opposed to trading firms, and/or manufacturing firms for the reason it will help evaluate its advantage and risks; and based on such evaluation and experience, the L.L.P. form could be considered for extension to small-scale industries.

The Central Government, in the meanwhile appointed an Expert Committee on Company law under the Chairmanship of J.J.Irani, its Report recommended as follows: "Limited Liability Partnerships should be facilitated through a separate enactment. Companies Act need not prescribe limitations on the number of members of other kinds of organizations." In view of the potential for growth of service sector, requirement of providing flexibility to small enterprises to participate in joint ventures and agreements that enable them to access technology and bring together business synergies and to face the increasing global competition enabled through W.T.O. etc, the formation of Limited Liability Partnerships (L.L.Ps) should be encouraged. It would be a suitable vehicle for partnership among professionals who are already regulated such as company Secretaries, Chartered Accountants, Cost Accountants, Lawyers, and Architects, Engineers and Doctors etc. However, it may also be considered for small enterprises not seeking access to capital markets through listing on stock exchange.

III. LLPs – International experiences:

The LLPs are very popular form of business in United States and United Kingdom. In the UNITED STATES1, Limited partnerships emerged in the early 1990s; while only two states allowed LLPs in 1992, over forty had adopted LLP statutes by the time LLPs were added to the Uniform Partnership Act (UPA) in 1996. In the United States, each individual state has its own law governing their formation. Although found in many business fields, the LLP is an especially popular form of organization among professionals, particularly lawyers, accountants and architects. UNITED KINGDOM2: The Limited Liability Partnership is a recent innovation of UK law, has been introduced by the Limited Liability Partnerships Act 2000. The Act became law on 1/4/2001. In an LLP, all partners have a form of limited liability, similar to that of the shareholders of a corporation. However, the partners have the right to manage the business directly, and (in many areas) a different level of tax liability than in a corporation. Under UK law, the LLP is a "fiscal transparency". In other words, it is not subject to taxation. Only the members are liable to taxation.

IV. INTRODUCTION OF LLPS IN INDIA:

Limited Liability Partnership Bill 2006: The long and eagerly awaited Limited Liability Partnership Bill was tabled in Rajya Sabha on 15th December 2006. The Bill, introduced by the Minister of Company Affairs, is viewed as a path-breaking reform initiative. Not only will the passing of the Bill bring the Indian partnership law framework more in line with international practices, it will provide an effective alternate corporate business vehicle to professionals and enterprises keen to institutionalize their activities and graduate to the next level. The main object of this new device is as "With the growth of the Indian economy, the role played by its entrepreneurs as well as its technical and professional manpower has been acknowledged internationally. It is felt appropriate that entrepreneurship, knowledge and risk capital combine to provide a further impetus to India's economic growth. In this background, 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."3 The Bill defines "limited liability partnership" as a partnership formed and registered under this Act. This stipulates two requirements: (a) a partnership; and (b) registration. Thus, the LLP would be a partnership and its registration under the LLP Act would be compulsory.

The LLP Bill, 2006 is broadly based on the UK and Singapore LLP Acts. The Central Government has retained the power to make rules for carrying out the provisions of the Act. The LLP Bill does not have provisions related to taxation of LLP, which are expected to be addressed in the Income-Tax Act like all other business entities. The Bill is divided into XIV Chapters having 73 Sections and Four Schedules. The following are the main provisions of the Bill are as follows:

1. The LLP shall be a body corporate and a legal entity separate from its partners. Any two or more persons, associated for carrying on a lawful business with a view to profit, may by subscribing their names to an incorporation document and filing the same with the Registrar, form a LLP. The LLP will have perpetual succession.

2. The mutual rights and duties of partners of an LLP inter se and those of the LLP and its partners shall be governed by an agreement between partners or between the LLP and the partners subject to the provisions of the proposed legislation. The Bill provides flexibility to devise the agreement as per their choice. In the absence of any such agreement, the provisions of law shall govern the mutual rights and duties.

3. The LLP will be a separate legal entity, liable to the full extent of its assets, with the liability of the partners being limited to their agreed contribution in the LLP, which may be of tangible or intangible nature or both tangible and intangible in nature. No partner would be liable on account of the independent or un-authorized actions of other partners or their misconduct.

4. Every LLP shall have at least two partners and shall have at least two individuals as Designated Partners, of whom at least one shall be resident in India. The duties and obligations of Designated Partners shall be as provided in the law.

5. The LLP shall be under an obligation to maintain annual accounts reflecting true and fair view of its state of affairs. A statement of accounts and solvency shall be filed by every LLP with the Registrar every year. The accounts of LLPs shall also be audited, subject to any class of LLPs being exempted from this requirement by the Central Government.

6. The Central Government shall have powers to investigate the affairs of an LLP, if required, by appointment of competent inspector for the purpose. 

7. The law would confer powers on the Central Government to apply such provisions of the Companies Act, 1956 to provide, inter-alia, for mergers, amalgamations, winding up and dissolutions of LLPs, as appropriate, by notification with such changes or modifications as deemed necessary. However, such notifications shall be laid in draft before each House of Parliament for a total period of 30 days and shall be subject to any modification as may be approved by both Houses.

8. The Indian Partnership Act, 1932 shall not be applicable to LLPs. Other entities may convert themselves to LLP in accordance with provisions of law.

9. The Central Government shall have powers to make rules for carrying out the provisions of the proposed legislation.

V. TAXATION & ACCOUNTING ISSUES:

The aspect of tax treatment of LLPs remains an area of uncertainty, since the Bill states that an LLP will be treated as a firm as defined under the Income Tax Act 1961 for the purpose of taxation. This show the way one to the following two implications:

1. That on the same basis as an ordinary partnership firm, the LLP will pay tax on its profits after deduction of business expenditure, salaries and interest paid to the partners. Partners will be liable to pay tax on salary and interest receipts, whereas the share in profits is exempt; same as the current provisions of the income tax Act 1961related with Firm. 

2. Another way that only the profits in the hands of the LLP partners will be taxed. A L.L.P. will have Pass through Status (proposed by the Naresh Chandra Committee), the partners will be liable to pay tax on share of LLP's profits received in their hands. This also known as tax transparency.

Of the above two options the second option  appears to be logical and acceptable on account of the following two reasons :  The Naresh Chandra Committee Report as well as the Concept Paper on LLPs which was released by the Ministry of Company Affairs in November 2005 had very clearly recommended tax transparency  for LLPs viz only the LLP partners should be subject to tax and not the LLP itself; The Bill has vide its First Schedule (CLAUSE No. 5) prohibited partners of LLPs from accepting any remuneration. This implies that they will be subject to Income Tax in respect of their share of profits received by them.

Naresh Chandra Committee has, said in its report that "the LLPs should be governed by a taxation regime that taxes the partners as individuals, rather than taxing the LLP itself, i.e., the LLPs should be treated in the same manner as the firm under the tax laws". This is, however, contrary to the system of taxation of firms under the I.T. Act. Presently, under the I.T. law, a partnership firm pays tax on its profits after deduction of business expenditure, salaries and interest to partners. Partners are then taxed on their salary and interest, whereas, their shares in the profits in the firm are exempt. Firms are not exempt from tax. As per the First Schedule, no partner of an LLP shall be entitled to remuneration for acting in the business or management. This, of course will apply only if there is no requirement regarding remuneration in the agreement constituting LLP. Hence, if no remuneration is to be paid, its allowance in the hands of LLP and taxation in the hands of the partners shall not arise. However, practically it is difficult that a partner working as working partners and he will not get any salary or commission for their works. Since the LLP is, visualize of as a company as it is under the Companies Act, it would be just and logical to tax an LLP like a company and ignore the existence of partners for tax purposes like shareholders. If the partners receive any income like interest from the LLP, the income so received would be taxable in the hands of the partners. 

Even in under UK law, the LLP is a fiscal transparency. In other words, it is not subject to taxation despite being a body corporate with separate legal personality and providing limited liability to all its members. Only the members are liable to taxation. As the members (statutory minimum of two) may be non-UK resident persons–including offshore companies–then it follows that an LLP can trade in its own right free of UK corporation tax liability outside the United Kingdom. Similarly, in USA as in a partnership or limited liability company (LLC), the profits of an LLP are distributed among the partners for tax Purposes, avoiding the problem of "double taxation" often found in corporations.

Concept paper on LLP also provides the following provisions regarding taxation and accounting treatment of transactions. (1) Income Tax and Capital Gains, for the purposes of taxation, any activity carried on by a limited liability partnership with a view to profit shall be treated as carried on in partnership by its partners not by the LLP and, accordingly, the property of the limited liability partnership shall be treated for those purposes as property of the partners. (2) Where a limited liability partnership carries on a trade or business with a view to profit- assets held by the limited liability partnership shall be treated for the purposes of tax in respect of capital gains as held by its partners; and any dealings by the limited liability partnership shall be treated for those purposes as dealings by its partners in partnership (and not by the limited liability partnership as such), in respect of capital gains accruing to the partners of the limited liability partnership on the disposal of any of its assets shall be assessed and charged on them separately.

With the above discussion, it is clear, that the provisions are not clear in the proposed LLP bill.  In one way they are proposing application of current provisions of income tax act related with the taxation of the Firm, on the other hand they said that LLP will not we liable for tax, their partners are liable for taxation, with the advantage of pass through statues of LLP, which will create controversy at the time of practical application of law.  

Some of the other accounting issues related with LLPs are as follows:

1. Another major issue is related with Capital gains tax Liability. It is not clear–whether the partners contributing assets towards the Capital at the time of formation of LLP or receiving their share of capital and accumulated profits on transfer of their share.  What is the mode of valuation of assets for income tax purpose and who will pay the capital gains tax on transfer of the assets of a partnership or a private limited company or an unlisted company, upon their conversion into a L.L.P. under the provisions of the Clauses 54 or 55 or 56, will tax as Capital Gains.

2. Another major issue related with Stamp Duty Liability on transfer of the Assets. Whether the assets transferred by a partnership or private limited company or an unlisted company at the time of their conversion into L.L.P or in the event of their merger or amalgamation will suffer the Stamp Duty on the book value of assets. What are the rates of stamp duty is there are any concessional rates provided by the government and what is mode for the valuation of assets.

3. In the bill it is provided that, contributions made by the partners are in form of money or intangible assets. How it should be disclosed in the books of account and what is the methodology for the valuation of assets, are not clear in this bill this will create problems at the time of practical application of

VI. CONCLUSION:

LLPs have been in trend in various other countries such as UK, USA, Australia, Singapore etc. It is a form of business entity, which allows individual partners to be restricted from joint liability of partners in a partnership firm. At present, this LLP bill is in form of mini companies act. The Liability of the partners incurred in the normal course of business is that of LLP and it does not extend to the personal assets of the partners. This is a great relief to the partners, particularly professionals like Company Secretaries, Chartered Accountants, Cost Accountants, Advocates and other professionals. These professionals may also form multi-disciplinary LLPs to meet the changing economic environment. The Government of India should create a facilitating environment for entrepreneurs, service providers and professionals to meet the global competition. Along with that, it is necessary to made suitable changes in the provisions of income tax related with the taxations issues, because taxation is one the major motivational factor other then limited liability for the partners of LLPs. The introduction of LLPs in India is a good beginning towards a long journey. The hybrid structure of LLP will facilitate entrepreneurs, service providers and professionals to organize and operate in an innovative and efficient manner for effectively competing in the global market.

References:

1. Ministry of Company Affairs (2005
), "Concept Paper on Limited Liability Partnerships", Press Note 5/2005 dated November 2005.

2. Ministry of Company Affairs (2005), Concept Paper on Company Law Reforms Dr. J.J. Irani Committee on Company Law, May. 

3. Ministry of Finance and Company Affairs (2003), "Naresh Chandra Committee-Second Report on Regulation of Private Companies and Partnerships", Academic Foundation, Economica India, 2004, Page 87-96.

4. Institute of Company Secretaries of India (2005), "Seminar on Concept Paper on Limited Liability partnerships Law", PHD Chamber of Commerce, New Delhi, December 17, 2005.

5. Ministry of Company Affairs (2006 ), "Limited Liability Partnership Bill 2006" Presented in Rajya Sabha on 15 Dec 2006.

6. Kothri Vinod & Mukerjee Samik (2005): "Irani Committee Report-An Analysis of Corporate Law reform in India" The Chartered Accountant Vol 54 No1 July.

7. Jhaveri Shreyas & Sithapathy Vinita (2006): "Limited liability partnership: An insight", The Chartered Accountant Vol. 55 No 3 September.

8.
www.mca.gov.in

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1. See The Uniform Partnership Act 1996 of the United States.
2. See The Limited Liability Partnership Act 2000 of The United Kingdom.
3. Ministry of Company Affairs "Limited Liability Partnership Bill 2006" Presented in Rajya Sabha on 15 Dec 2006.
 


Dr. Pradeep Kumar Singh
(Ph.D, M.Com (TAX), M.Com (AE&BM), PGDF&TM)
Lecturer
Department of Commerce
Mahatma Gandhi Government Arts College
Chalakkara, New Mahe-673311 (U.T. of Pondicherry)
 

Source: E-mail August 10, 2007

         

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