The Hindu Business Line : Leg-up for LLPs?

While the Finance Minister did not mention any of it in his speech, in the fineprint in the Finance (No. 2) Bill, 2009, he has laid down the roadmap to the taxation of Limited Liability Partnerships (LLPs).

As expected, LLPs will now be taxed on same lines as general partnerships. That is, LLPs will now pay tax and the partners will not. Coupled with the new provisions relating to presumptive taxation of small businesses with a turnover of up to Rs 40 lakh, the concept of LLPs is likely to take off well with the small-scale and the services sector.

These features make LLPs a preferred choice of entity for small and medium sized businesses that would like to limit their liability while getting the flexibility to do business in an unhindered manner. There are, however, a few key aspects that will need the attention of the Government so as to facilitate LLPs in becoming one of the preferred choices for investors.

Migration to LLP

While the LLP Act, 2008 permits partnerships and companies to convert into LLPs, there is some degree of ambiguity on the tax treatment of such conversions in the Income-Tax Act. One would have expected tax neutrality in such conversion, but the Finance (No. 2) Bill does not clearly address all the possibilities envisaged.

While the Memorandum explaining the Bill does mention that the conversion from a partnership 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, it would have perhaps been better if Section 47 specifically exempted this conversion. Especially, because the LLP would be incorporated under a different law and lose its status as a partnership under the Partnership Act.

So also when a company is converted into an LLP where it seems that such a conversion would be subject to capital gains tax.

Clarity on foreign investment

Today, the provisions of the Foreign Direct Investment (FDI) policy read with the Foreign Exchange Management Act, 1999 (FEMA) permit foreign investment in shares or convertible instruments of Indian companies in almost all sectors except a few regulated or prohibited ones.

However, FEMA regulations continue to provide for specific permission of the Reserve Bank of India (RBI) for foreign investments in partnerships and sole proprietorships. So, it is logical to expect the Government to put foreign investments in LLPs on a par with investments in companies under the FDI policy.

Tax holiday provisions

There are special provisions under Section 80 IA of the Income-Tax Act, 1961 that permit an assesee to claim exemption on income from the development, operation and/or maintenance of an infrastructure facility.

The term infrastructure facility for this purpose means a road, highway project, port, airport, water supply project, water treatment system, irrigation project, sanitation and sewerage system or a solid waste management system. One of the conditions for claiming the exemption is that the undertaking must be owned by a company registered in India or by a consortium of such companies.

In view of the urgent need to develop infrastructure, it would have been logical for the Government to extend the tax holiday to LLPs formed under the LLP Act. More so for the reason that the features of an LLP are akin to that of a company and any such inclusion would not dilute the policy of permitting only companies to claim the exemption.

This would have facilitated a more flexible option to the developers of such infrastructure facilities. It will also give certainty to consortiums of companies to claim the advantage while allowing a flexible tax treatment as partnership to such infrastructure development.

While there is potential loss of income-tax revenue on account of non-applicability of the Minimum Alternative Tax and the Dividend Distribution Tax, the economic advantages of allowing the holiday to LLPs perhaps outweigh the revenue loss. Again, perhaps this was deliberate considering the nascent stage of development of the concept of LLPs.

(The authors are Executive Director and Associate Director, respectively, PricewaterhouseCoopers.)

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