The hybrid loses its appeal

T. C. A. Ramanujam | Updated on April 03, 2011

Limited Liability Partnerships will find few takers with the introduction of special tax provisions in the Budget.

The Limited Liability Partnership as a form of business organisation is a new entry into the Indian corporate world. The concept was popular in the US and Europe for the past 25 years. India passed the Limited Liability Partnership Act in 2008 providing the legal frame work for the formation of LLP. The Act came into force on April 1, 2009.

The law provided an alternative to the traditional partnership with unlimited personal liability on the one hand and statute-based governance structure of the limited liability company on the other, to enable professional expertise on entrepreneurship initiative to combine, organise and operate in a flexible, innovative and efficient manner. The liability of the partners in the LLP is limited to their capital contribution. He will not be liable for debts and obligations of the LLP except when fraud and negligence can be proved as in the case of the private limited company. The LLP is separate from the partners; it has perpetual succession and the partner is like a shareholder in a company. LLP is a hybrid between a company and a partnership.

A lot of research and debate had gone into the introduction of the concept of LLP in India. The Abid Hussian Committee of 1997, the Naresh Chandra Committee of 2003 and the Irani Committee later on in 2007 had all unanimously recommended the introduction of the LLP in India. LLP enjoys a pass-through status for purposes of taxation in the UK. There is no ceiling on the number of partners in the LLP.

Tax implications

The tax implications of the LLP were looked into by Finance Act, 2009. It will be taxed like the ordinary partnership firm. The share of the partners in the LLP will be tax-free. There is no joint and several liabilities for the individual partner. The partner in an LLP will not be affected by misconduct of other partners. The law also ensures that conversion of a general partnership firm to LLP will be tax-neutral even after conversion. Of course, the law was silent on payment of Stamp duty.

A problem confronting the Corporate India related to the levy of the Minimum Alternate Tax. At a time when companies were looking forward to find a way out from MAT, the LLP came as a boon. The law provided that MAT will not be applicable to LLPs. Since the LLP is not treated as a company, there can be no question of applying MAT to a firm. Nor is it possible to levy Dividend Distribution Tax and corporate surcharge on LLP. LLP being treated as a firm for taxation had the following tax advantages over a company under the Income-Tax act: (1) it is not subject to Minimum Alternate Tax; (2) it is not subject to Dividend Distribution Tax; and (3) it is not subject to surcharge

LLP came as a dream come true for the Indian companies.

New provisions

The dream has been shattered by Finance Bill 2011. A new Chapter XII-BA is now introduced in the Income-Tax Act containing special provisions relating to the LLPs. It is now laid down that where the regular income tax payable for the previous year by the LLP is less than the Alternate Minimum Tax payable for such previous years, the adjusted total income shall be deemed to be the total income of such LLP and it shall be liable to pay income tax on such total income at the rate of 18.5 per cent. The adjusted total income is defined as the total income before giving relief for Chapter VI-A deductions.

MAT credit will be available to the extent of the excess of the Alternate Minimum Tax paid over the regular income tax. The tax credit shall be allowed to be carried forward to ten successive assessment years. The amendment takes effect from Aril 1, 2012.

Why did the Government tinker with the LLP law so soon after its introduction in the last two years? The Memorandum accompanying the Finance Bill 2011 explains that the object behind the amendment is to preserve the tax base vis-à-vis profit-linked deductions. There is no sudden change in the law in this regard between 2010 and 2011 to warrant the amendment.

Legal pundits have pointed out that AMT is not on book profits, but effectively on gross total income. The amendment will affect LLPs having profit from businesses enjoying tax holiday. Book profit adjustments for levy of AMT will be different from adjustments for MAT.

There will be very few takers for the LLP hereafter. Why talk of long-term fiscal stability in Direct Tax law?

(The author is a former Chief Commissioner of Income-Tax.)

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Published on April 02, 2011

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