No clarity on conversion to LLP
Please refer to your answer in The Hindu dated July 13, 2009, wherein you have stated that conversion of an existing firm to a Limited Liability Partnership (LLP) will avoid liability to capital gains tax and that Sec. 45 will, however, apply on distribution of the assets to the erstwhile partner of the firm, who continues as a partner of the LLP. There is no provision to this effect anywhere in the Bill. I would also like to know, what will be the position of a private limited company converting into an LLP. Will there be no liability for capital gains tax even in such a case?
The reader is right in pointing out that there is no provision for exemption of such conversion of a firm constituted under the partnership law to an LLP under the LLP Act, 2008. It was probably understood that the definition of firm to include LLP by the amendment will mean that there is no transfer. It is so explained in the Explanatory Memorandum in the following words:
“As an LLP and a general partnership is being treated as equivalent (except for recovery purposes) in the Act, 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 Sec. 45 shall apply”.
The answer given in The Hindu dated July 13, 2009, was based on the above extract from the Memorandum accompanying the Bill. As pointed out by the reader, there is no provision in the statute.
The other point made in the Explanatory Memorandum is that Sec. 45 imposing tax on capital gains by deeming transfer, would have application in the event of distribution of assets to a partner, subject to the condition that the rights and obligations remain the same. They cannot remain the same, so that Sec. 45 cannot possibly apply to the detriment of revenue. It may also be pointed out that Clause 7(c) of Second Schedule to Limited Liability Partnership Act, 2008, deems a firm on conversion to be dissolved. The decision of the Bombay High Court in CIT v Texspin Engineering and Manufacturing Works (2003) 263 ITR 345 (Bom) inferring that there is no transfer even of a firm to a company should also avoid tax at the stage of conversion of a firm to an LLP, the condition for exception indicated in the above extract of the Memorandum will not be enforceable. The proper course was to exempt such conversion of a firm to an LLP under Sec. 47 and provide for taxation in the event of distribution of assets to erstwhile partners under Sec. 49.
As for the query whether conversion of a company into an LLP will have incidence of liability for capital gains tax, there is no answer in Explanatory Memorandum or in the Bill. There are similar problems which may arise on amalgamation or any other arrangement covered by Sec. 62 of the LLP Act, 2008, so that there is no provision for tax liability in the Bill either in respect of shareholders or the company/ LLP in such cases. These are only some of the issues that would arise in consequence of conversion to an LLP, which should require greater application of mind on the part of the tax administration with further clarifications so as to avoid uncertainty of law and consequent litigation.
S. RAJARATNAM
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