The conversion of a private limited company into an LLP is governed by Section 18 of the Limited Liability Partnership Act, 2008, and the LLP Rules, 2009. The conversion is attractive to companies that have a simple shareholding structure and that wish to reduce their compliance burden and avoid the dividend distribution tax. But the conversion is tax-neutral only where every condition of Section 47(xiiib) of the Income-tax Act is satisfied.
The Conditions for Tax Neutrality
Section 47(xiiib) exempts the conversion from capital gains tax only where all the shareholders of the company become partners of the LLP in the same proportion as their shareholding, the aggregate of the profit-sharing ratio of the shareholders in the LLP is not less than fifty per cent for five years from the date of conversion, no consideration or benefit is received by the shareholders, and the total sales, turnover, or gross receipts of the company in any of the three preceding years do not exceed sixty lakh rupees.
The turnover ceiling is the most significant constraint. A company that exceeds the ceiling cannot claim the exemption, and the conversion is treated as a taxable transfer. The company should verify the turnover before the conversion is proposed.
The Process
The conversion requires the approval of the shareholders by a special resolution, the consent of the creditors, and the filing of Form LLP-1 with the Registrar of LLPs. The LLP must adopt an LLP agreement that reflects the shareholding proportion and the profit-sharing ratio. The company must also comply with the dissenting shareholders’ rights and the other provisions of the Act.
The Consequences of a Breach
Where the conditions of Section 47(xiiib) are breached within five years, the exemption is withdrawn, and the company is liable to capital gains tax. The ITAT has held that the breach of the condition relating to the payment of accumulated profits to the partners triggers the withdrawal of the exemption, and the tax is levied on the company.
A technically sound conversion is structured to satisfy every condition of Section 47(xiiib), and the turnover ceiling is verified before the process is initiated.
Call to Action
Anuj Desai & Associates advises companies on the conversion into an LLP—from the Section 18 LLP Act procedure and the shareholder approval to the Section 47(xiiib) tax neutrality and the five-year compliance. If you are considering a conversion, we can help you assess the eligibility and the tax consequences.
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