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No tax-free conversion of unlisted cos
October, 12th 2009

The government will look at withdrawing capital gains tax that is levied when unlisted companies convert to limited liability partnerships (LLPs) once the new business vehicle finds acceptance in the country.

The finance ministry is not willing to allow tax-free conversion of unlisted companies to LLPs, but it is open to giving the benefit if the number of promoters going for conversion increases, a ministry official told ET on condition of anonymity.

Capital gains tax will increase the cost of conversion for companies that have capital assets including immovable property. This tax is charged on the value of appreciation of a capital asset, excluding the effect of inflation. Long-term capital gains from transfer of property attract 20% tax after three years of purchase.

A flexible internal structure and lower taxability compared to companies makes LLP an ideal business structure. However, when unlisted companies are converted to LLPs to take advantage of these benefits, the government taxes the gains from transfer of capital assets. Experts see this as a speed-breaker in the growth of this globally-preferred business form.

The government will consider tax-free conversion of a company to an LLP when this form of business finds wider acceptance, the official said. However, the ministry does not see such a sharp rise in LLPs in near future and, as a result, the new direct tax code will not give tax-neutral status to company-LLP conversion, he added. The poor response to the LLP model may be because of lack of awareness, the official said.

Budget 2009 had allowed tax-neutral conversion of a general partnership to an LLP if the rights and obligations of the partners dont change. The rider on rights and obligations was introduced to ensure that the sale of a company is not passed off as a conversion to an LLP.

However, the Budget did not mention conversion of an unlisted company to an LLP. The tax regime for LLPs introduced in the Budget is soft compared to that for companies. These partnerships dont have to pay 16.9% dividend distribution tax or the surcharge.

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