Taxability of LLP

Taxability of LLP

Introduction:

Limited Liability Partnership (‘LLP’) is governed by the Limited Liability Partnership Act 2008 (‘LLP Act’) with effect from April 1, 2009. LLPs provide flexibility of a partnership firm along with limited liability. India has been a bit late in recognizing this extremely popular form of business entity. The introduction of LLPs in India is a good beginning towards a long Journey, especially for the Small and Medium sector which is seeing a rapid growth. The Income Tax Act, 1961 (‘the Act’) did not contain any specific provisions for taxation of LLPs. The Finance Act (No. 2) of 2009 has enacted the provisions regarding taxation of LLPs. As per the said provisions, LLP would be treated at par with Partnership firms for the purposes of the Income Tax and would be taxed like a partnership firm. Thus, the profits of LLP would be taxed at firm level and the profits distributed to the partners shall be exempt from tax in the hands of the partner. The said Provisions are effective from A.Y. 2010-11. Some of the important provisions are summarized as under:-

1. Change in Definition of Firm, Partner and Partnership:

Section 2(23) of the Act which defines the term ‘firm’, ‘partner’ and ‘partnership’ has been amended to include a LLP as defined under the LLP Act and has been put on par with a partnership firm under the Indian Partnership Act, 1932 for the purpose of income tax.

2. Eligibility for being assessed as a Partnership firm:

Section 184 of the Act prescribes the conditions which need to be satisfies for a LLP to be assessed as a Partnership firm under the Act which are as under:

(a) The LLP should be evidenced by an instrument i.e. there should be a written LLP Agreement.

(b) The individual shares of the partners should be clearly specified in the LLP Agreement.

(c) A certified copy of LLP Agreement must be filed with the return of income of the LLP of the previous year in which the LLP was formed.

(d) If during a previous year, a change takes place in the constitution of the LLP or in the profit sharing ratio of the partners, a certified copy of the revised LLP Agreement needs to be submitted along with the return of income of the previous year in question.

3. Tax rate:

The profits of the LLP would be chargeable to tax @ 30% plus education cess of 3%. Hence, the effective tax rate would be 30.9%. The provisions applicable to companies such as Minimum Alternate Tax and Dividend Distribution Tax shall not be applicable to a LLP.

4. Remuneration and interest paid to Partners:

(a) LLP would get a deduction for remuneration paid to its working partners. Section 40(b) of the Act prescribes the ceiling limit upto which any payment of salary, bonus, commission or remuneration would be allowed as deduction from income of LLP. The limits of remuneration

are outlined below:

On First Rs. 3,00,000 of                        Rs. 1,50,000 or at the rate of 90% of the book-profit,

book profit or in case of loss                 whichever is more

On the balance of book profit               at the rate of 60%

(b) As per Section 40(b) of the Act, any interest payment by LLP to a partner in excess of 12% p.a. would be disallowed and any salary, remuneration, commission to non-working partners would be disallowed.

(c) Remuneration to partner not to be treated as salary income. Further, Section 28(5) of the Act provides that interest and remuneration received by a partner from his LLP shall be chargeable to Income- Tax as profits and gains of business.

5. Signing of Income tax Return :

Under Section 140, return of income of an LLP is to be signed by a designated partner. A designated partner is a partner who is responsible for carrying out all the compliance obligations imposed by the LLP Act. However, if for any unavoidable reason designated partner cannot sign or where there is no designated partner, any partner may sign the return.

6. Liability of the partners :

Under the new Section 167C of the Act, each partner of an LLP is jointly and severally liable for tax due from LLP, if it cannot be recovered from the LLP unless the partners proves that the non recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on their part in relation to the affairs of the LLP.

7.

LLPs have been excluded from the provisions of presumptive taxation contained in section 44AD of the Act.

Conclusion :

The taxation of income of the LLP in the hands of the firm is not consonance with practice of treating the LLP as a transparent entity as adopted in several countries. Although, the Finance Act (No.2) of 2009 has enacted the provisions relating to taxation of LLP, there are certain areas which have remained unclarified such as provisions relating to merger, demerger and amalgamation of LLPs. The LLP Act also allows the conversion of general partnership and private limited companies into LLP. However, no amendments in relation to tax implications of such a conversion have been carried out in the Income-Tax Act. In this regard, the explanatory

memorandum to the Budget clarifies that conversion from a general partnership firm to an LLP will have no tax implication, if the rights and obligation 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 provision of capital gain will apply. Accordingly, more clarity in respect of the above mentioned issues is required from the Government.