A misconceived proposal on LLPs

Limited Liability Partnerships (LLP) are governed by the Limited Liability Partnership Act 2008.

It has been conceived of as a body corporate with legal entity – separate from a firm governed by the Partnership Act – as a form of business organisation which permits individual partners joining with a view to shielding profit from joint liability caused by another partner's business decision or misconduct.

The chief reason for supporting LLPs was to provide flexibility to small and medium level units, especially among professionals such as lawyers, accountants, architects, engineers, doctors etc.

There is no restriction on the number of partners in LLP, unlike a partnership firm. LLP can enter into contracts in its own name in the same way as a company and the members of the LLP have the advantage of limited liability similar to the shareholders of a company. Thus LLPs have the basic attributes of a limited company.

Income taxation

Strangely enough, when it comes to income taxation aspects of LLPs, the same have been treated as akin to firm and hence the taxation pattern in their cases is the same as in the case of firms (unlimited liability partnerships). The scheme pronounced for taxing LLPs by the Finance (No.2) Act 2009, applicable from the Assessment Year 2010-11, is that it will be on the same lines as taxation scheme prevalent for general partnership i.e. taxation in the hands of the entity and exemption from tax in the hands of its partners.

In other words, LLPs are to be accorded the same tax treatment as is in cases of general partnerships. In the matter of recovery of income-tax, LLP has been treated as equivalent to general partnership providing that in case of liquidation of an LLP, every partner will be jointly and severally liable for payment of tax unless he proves that non-recovery cannot be attributed to any gross neglect, misfeasance of breach of duty on his part. Such provision is not there in the case of shareholders of companies.

MAT levy treatment

The Finance Bill 2011 provides that LLPs would be liable to Minimum Alternate Tax (MAT) as in the case of companies. In the Explanatory Memorandum , the justification for levying MAT has been stated, though it has accepted that the LLP has features of both a body corporate as well as a traditional partnership. The Income-Act provides for the same taxation regime for a limited liability partnership as is applicable to a partnership firm.

The Bill says that LLP being treated as company for MAT is justified because it enjoys the following benefit vis-à-vis a company under the Income-Tax Act: it is not subject to Minimum Alternate tax; it is not subject to Dividend Distribution Tax (DDT); and it is not subject to surcharge. The proposal therefore is that where the regular income-tax payable for a previous year by a limited liability partnership is less than the alternate minimum tax payable for such previous year, the adjusted total income shall be deemed to be the total income of such limited liability partnership and it shall be liable to pay income-tax on such total income at the rate of 18.5 per cent.

The reasons given do not justify MAT on LLPs. Since for tax purposes LLP is equivalent to a firm, , it is not required to pay MAT. The LLP does not distribute dividends and hence cannot be liable to pay DDT. As a policy, surcharge is not paid now by non-corporate assessees. These seem perfunctory.

The proposal is prima facie misconceived. The LLP concept is, on most aspects, akin to a Company as mentioned earlier. So apparently, MAT could be justified on LLPs. However, the policy that in the matter of taxation of LLPs ‘heads, tax department would win and tails, LLPs would lose' does not seem to be fair. For tax purposes, LLPs are an admixture of ‘companies' and ‘firms' according to what suits the revenue best. In some aspects the status of ‘firm' and in most situations the status of ‘companies' do not seem justified. The very objective for which LLPs have been thought of will get frustrated by such a policy. What are needed are a balanced approach and a separate entity for LLPs for income taxation instead of making it a hybrid body!

(The author is a former chairman of CBDT.)