Understanding the Concept of LLP and its tax implications

Introduction

LLP act was implemented from 1st of April 2009 in India. The enactment of the companies act, reinvigorated interest in the LLP structure. There is a high inquiry from both new businesses who intend to make an informed decision as to whether to set up themselves as a private limited company or as LLP or from the existing companies to explore the possibility and advantages of conversion into LLP. In this article we will talk about the different characteristics of LLP, LLP Taxation, etc.

Primary characteristics of LLP

LLP is a body corporate and legal entity different from its partners. LLP has continuous succession. All the partners of the LLP should act as the agent of the LLP but not of the other partners. It has the potential to enter into contracts and holding properties in its own name.

Also Read: How to add new partner in an LLP?

• The LLP operates based on the LLP agreement and the framework outlined in the LLP Act of 2008. In cases where the LLP agreement does not cover specific matters, the determination of partner liabilities and the execution of mutual rights follow the provisions outlined in Schedule I to the LLP Act. LLP agreement should specify the partner’s remuneration and interest on capital to be beneficiary of deduction in income tax.
• LLP registration is mandatory under the act. The incorporation certificate is conclusive proof of its formation. All partners will have to acquire DSC and DIN (form-7), take the approval for LLP name (form-1), submit for incorporation (form-2), acquire incorporation certificate, submit for LLP agreement (form-3) and submit for partner consent (form-4). Stamp duty on the LLP agreement has to be paid according to the state stamp act.
• Only body corporate or individual can become a partner in LLP. A HUF or firm is neither a body corporate or an individual, and thus they are not allowed to be a partner in LLP. There is no upper limit on a maximum number of partners in LLP, but it requires a minimum of two partners.\

Other Important Pointers

• LLPs must maintain accurate accounting records at their registered office and file a statement of account and solvency (Form-8) within one month of the fiscal year-end, along with an annual return (Form-11) within two months. Audits are required for LLPs with turnovers over Rs. 40 lakhs and contributions exceeding Rs. 25 lakhs. LLPs can choose between mercantile or cash accounting.
• LLPs have a minimum capital contribution of Rs. 1, unlike private limited companies with Rs. 1 lakh minimum. However, they can’t raise funds from the public.
• Private companies, firms, or unlisted public companies can convert into LLPs, with all assets and liabilities transferring automatically upon registration. LLPs must operate for profit, but professionals can form multi-disciplinary professional LLPs.
• The LLP Act is simpler than the Companies Act, with fewer restrictions. LLPs dont need to register charges, affecting their ability to secure loans, leading to some resistance in granting loans to LLPs.

LLP Taxation

There are some important things to keep in mind when it comes to taxation for limited liability partnership. Partnership formulated under the LLP Act, 2008 will be treated as partnership firm akin to a partnership formed under Indian partnership act, 1932. According to income tax, 1961, the word partner, partnership, and firm should include LLP, partner of the LLP, and LLP. Both of them can get a deduction of interest on loan and capital from partners up to 12% on salary, PA, bonus commission, royalty or remuneration by whatever name called to a working partner can deduct up to the maximum following limit. The income tax rate for LLP is:

1. On first Rs. Three lacs of book profit or in case of loss Rs. 1.5 lacs or 90% book profit, whichever occurs first.
2. On the balance of book profit at the rate of 60% of such book profit above Rs. 1.5 lacs (section 40(b)).

And such interest, remuneration will be chargeable as business profit in the hands of a partner. Share of profit of partner from the LLP/firm is exempted under section 10(2A). That’s why though LLP is a body corporate, but taxation for limited liability partnerships is similar to a firm. The only distinction is that while section 44AD is applicable to a firm, it is not applied to LLP.

Also Read: LLP Taxation – Income Tax & Alternate Minimum Tax (AMT)

Specific aspects related to Taxation of LLP partners

Introduction of capital asset into partnership

Section 45(3) of income tax calculates the income tax rate for LLP partner’s capital gain based on the value recorded in the books by the LLP/partnership. However, regarding taxation of LLP partners, Rule 23 of the LLP Rules, 2009, requires the valuation of non-cash contributions by a partner in the LLP’s books, as determined by a Chartered Accountant.

Capital withdrawal

• Section 45(4) deems the Fair Market Value (FMV) on the transfer date as the total consideration for capital asset distribution by the firm. Be it during dissolution or otherwise.
• The conversion of a firm into an LLP is exempt from capital gains tax if partner rights and obligations remain unchanged. And there’s no transfer of liabilities or assets post-conversion.
• When a private limited or unlisted public company converts into an LLP. Adhering to the conditions in section 47 prevents it from being classified as a transfer for the company or its shareholders.
• Section 72A allows for the carry-forward of losses upon the conversion of a company to an LLP, provided that the requirements of section 47 are met. However, it does not permit the carry-forward of MAT tax credits.
• Distinction in taxation with a corporate. The company must pay MAT (minimum alternate tax), whereas the LLP is obliged to pay AMT (alternate minimum tax).

Conclusion

In conclusion, the concept of Limited Liability Partnership (LLP) and LLPs tax implications present a dynamic landscape for businesses in India. Since its inception in 2009, the LLP structure has gained renewed interest. Especially in the wake of changes in the Companies Act. This legal entity, characterized by its separate existence from its partners, offers flexibility and streamlined regulations.