We continue our examination of various laws and the issues arising therein in respect to an LLP.
1. Conversion of firm or company into LLP :
1.1 The LLP Act provides for conversion of a partnership firm and company into an LLP. This conversion is similar to the conversion of a firm into a company under Part IX of the Companies Act. Three issues which arise in respect of this conversion of a firm are the stamp duty, the income-tax liability thereon and the impact on tenancies of the firm/company. All of these contentious issues are very important for healthy growth of LLPs as a form of business in India. The Government must take steps to come out with clear-cut laws in this respect to avoid wasteful litigation.
1.2 Stamp duty :
(a) Para 6(b) of the Third Schedule to the LLP Act on Effect of Registration states that all tangible (movable and immovable) property as well as intangible property vested in the company and the whole of the undertaking of the firm shall be transferred to and shall vest in the LLP without further assurance act or deed.
(b) As explained earlier, stamp duty is on an instrument. If there is no ‘instrument’ of transfer, then no stamp duty can be levied.
(c) If there is a statutory vesting of the assets of the erstwhile firm/company in the newly incorporated LLP, there is no transfer under the Transfer of Property Act. Therefore, no conveyance is required and hence, there should not be any incidence of Stamp Duty.
(d) This view is also supported by the old decision in the case of Rama Sundari Ray v. Syamendra Lal Ray, ILR (1947) 2 Cal. 1 rendered in the context of a Part IX conversion. Applying the same principle, it is submitted that a conversion under Part X of the LLP Act, 2008 would not attract any stamp duty as it amounts to a statutory vesting of the assets of the firm/company in the LLP.
1.3 Income-tax :
(a) There is no transfer between the firm/private and the LLP and the word ‘transfer’ used is not in the sense of a ‘transfer’ as between a transferor and transferee, but is only meant to emphasise the vesting of the assets and liabilities in the LLP. Thus, there is no transfer as understood u/s.2(47) and u/s.45(1) of the Income-tax Act. Since there is no transfer u/s.45(1), the computation of capital gains should not arise.
(c) There is no transfer at the time of conversion of a firm/private company into an LLP as it is a case of a statutory vesting of assets and liabilities under the LLP Act like in case of Part IX of the Companies Act. In fact, it is possible to take a view that at no point of time do both the LLP and the firm/company exist. The firm/company is dissolved and the LLP is created simultaneously and it is the transfer which creates the LLP. Thus, since the two entities are not present at the same time, there is no transfer.
(d) This view has been upheld by the Bombay High Court in its decision of Texspin Engg. & Mfg. Works, 180 CTR 497 (Bom.). The Court held that a partnership firm can convert itself into a company under Part IX of the Companies Act, 1956 and further there would be no incidence of capital gains u/s.45(4) of the Income-tax Act. The ratio decidendi laid down by the Bombay High Court can also be applied in the case of conversion of a firm/company into an LLP. Hence, it is submitted that even though there is no express provision to this effect, the conversion should not attract capital gains tax. Incidentally, the Memorandum Explaining the provisions of the Finance (No. 2) Bill, 2009 provided as under :
“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 S. 45 shall apply.”
It may be noted that neither the exemption provision nor restrictive conditions mentioned above are found in the Bill or in the Finance Act 2009.
1.4 Tenancies of the firm :
One of the more contentious issues under the Rent Act is in regard to the position of a partnership firm which is a tenant when there is a change of partners. Can the landlord contend that there is an illegal sub-letting or assignment and hence, he can terminate the tenancy. There are several decisions on this subject and there is no clear-cut touchstone to determine under which situations can it be said that there is an illegal sub-letting and when there is not.
These decisions deal with the case where the partners of the firm change hands. In the case of conversion of a firm into an LLP, the entity remains the same. Only its status undergoes a change. It is not a case where there is a transfer of assets. Hence, in my view, the provisions of illegal sub-letting/ assignment of the Rent Act are not attracted and the tenant would not lose the tenancy. However, the issue is not free from doubt.
1.5 Other issues in relation to conversion :
1.5.1 Some other unanswered issues remain in relation to conversion of a firm/company into an LLP. One is relating to carry forward and set-off of unabsorbed losses. Would S. 79 of the Income-tax Act which denies such a set-off in the case of a change in shareholding apply ?
1.5.2 Another issue is in relation to the continuity of service clause of the employees in the case of a conversion. It is submitted that there would be a continuity of service.
1.5.3 Certain institutions such as the MIDC levy a very huge transfer charge for change of user. However, there is a concession in the case of involuntary transfers done by way of a Court order, e.g., mergers, demergers, etc. Such transfers attract a minimum processing fee of the MIDC. What would be the position in the case of conversion into an LLP is an interesting aspect which needs to be considered.
1.5.4 One issue which may gather steam in the coming years is that of reconversion of an LLP into a company. Can an LLP convert itself into a private/ public company is an aspect on which there is no clarity. The LLP Act is silent on this aspect. Part IX of the Companies Act also does not provide any clear-cut answer. The Companies Bill 2008 has done away with Part IX altogether. Hence, what would happen to a business which selects an LLP structure and after becoming profitable it desires to make an IPO is still a question. Obviously, an LLP cannot make an IPO. Would it ever be possible for the business to access the capital markets? This is one aspect which needs immediate attention or else LLPs would lose some of their sheen.
2. Merger of companies and LLPs:
2.1 One more issue which is worth consideration is whether an LLP can merge into a company or vice-versa. The LLP Act only deals with the amalgamation and restructuring of two or more LLPs.
2.2 However, the Companies Act is much broader in its coverage. It permits the merger of a transferor who is any body corporate with a transferee company which is an Indian company. The Companies Act defines a body corporate to include a company. The LLP Act provides that an LLP is a body corporate. Thus, it stands to reason that an LLP being a body corporate, it can be merged into a company. Since the ultimate authority for both companies and LLPs is the MCA, it would be desirable if they frame rules in this respect.
2.3 As stated above, the Companies Act provides that ‘transferor company’ includes any body corporate, whether a company within the meaning of this Act or not, but a ‘transferee company’ only means a company within the meaning of this Act. Hence, the Transferee Company cannot be an LLP and it must always be a company within the meaning of the Companies Act, 1956. Thus, the merger of a company into an LLP is not possible.
3. VCF regulations:
3.1 One of the main uses of LLPs globally is as Venture Capital Funds. In India, VCFs are regulated by the SEBIunder the SEBI (Venture Capital Funds) Regulations, 1996.
3.2 R.2 of these Regulations defines a Venture Capital Fund to mean a fund established in the form of a trust or a company including a body corporate.
Since an LLP is a body corporate, it can also be one of the forms for a VCF under the SEBI Regulations. However, R.15 provides that the VCF would raise money only through the private placement of its units. S. 32 and S. 33 of the LLP Act state only a partner of an LLP will make contributions to the LLP. There is no provision in the LLP Act for the issue of units. Hence, it is a moot point as to whether an LLP can issue units.
3.3 Further, the Regulations provide that the investee company must be a domestic company only. Hence, an LLP cannot attract funds from a SEBI Registered VCF.
4. Foreign tax credits:
4.1 Assuming that a foreign resident can invest in an LLP under the FEMA Regulations, another question which would arise is what would be the tax treatment of the income received by the foreign partner? An LLP is taxed as a firm and hence, the LLP would pay tax @ 30.9% in India. The draft Direct Taxes Code also continues this system of taxation. When the LLP distributes the after-tax income to its foreign partner, would he be able to claim a credit for the tax paid by the LLP ? Unfortunately, the answer is No. The tax treaty benefits will be lost in such a case and the foreign partner may once again pay tax on the income received by him. This is a great disadvantage for foreigners to invest in LLPs.
4.2 To address the above anomaly, the pass-through system wherein the LLP is ignored as a taxable entity and the partner is directly taxed in proportion to his share was desirable. In fact, press reports indicate that the MCA is keen on such an amendment to the Income-tax Act to bring taxation of LLPs in India at par with several western nations.
(To be continued)
