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New partnership law in place, but legal and tax hurdles remain
April, 06th 2009

The Ministry of Corporate Affairs (MCA) has started registering firms under the newly-enacted Limited Liability Partnership (LLP) Act. However, a flow of applications is unlikely till tax laws are changed, say experts. At present, the Income Tax Act does not recognise LLP firms.

Proposals to amend the laws have been made by both the ministry and Parliaments Standing Committee on Finance. However, there has been no action on this.

Yet another demand, for a one-person company, will not be possible under the LLP route as the minimum requirement is two persons.

A limited liability entity is a hybrid of existing partnership firms and full-fledged companies. A minimum of two partners will be required for formation of an LLP and there will not be any limit to the number of partners, unlike the current limit of 20 members in a partnership firm.

Under the LLP structure, the liability of a partner is limited to his stake and no partner is liable on account of independent or unauthorised acts of other partners. Individual partners are shielded from the joint liability created by another partners wrongful acts or misconduct.

On the other hand, in the traditional law on a partnership firm, every partner is liable, jointly with all other partners and also severally, for all acts of the firm done while he is a partner, irrespective of his stake.

India recognises several forms of business entities, including sole proprietorship, Hindu Undivided Firms, partnership firms (which provide flexibility, but with unlimited liability jointly or severally) and companies, which have limited liability but far less flexibility and high compliance requirements.

The LLP would help partnership firms clock corporate-level growth, said a New Delhi based corporate lawyer who didnt want to be indentified. In India, most partnership firms are family-owned and theres lack of trust in having outsiders, but LLP will change that because the liability here is limited, according to ghim.

Under the LLP model, chartered accountants, company secretaries or even advocates can set up multi-disciplinary firms that will act as one-stop shop for people to avail of various professional services. Existing laws impose the restriction that these professional services cannot be carried out through companies but only through partnership firms.

According to Vinod Jain, a member of the central council of the Institute of Chartered Accountants of India (ICAI), unless theres clarity on tax issues, firms will not convert into LLP.

The income tax law does not recognise an LLP. According to Jain, there are two ways to tax an LLP: The first is to tax only the partners and not the firm. This is followed in the US under what is called a pass-through vehicle. The second way it to tax an LLP firm on the lines of corporates.

The tax rules will be formed as the Bill is enacted, a ministry official had earlier told Business Standard.

Clarity on taxation issues is crucial if an LLP registered in India expands its operations in other nations to avoid double taxation, experts say.

According to Akil Hirani, partner at Majmudar & Co, a Mumbai-based law firm, tax issues are still unresolved with regards to capital gains and stamp duty, which will make firms wary of shifting to LLP.

Both the corporate affairs ministry and the parliamentary panel had recommended that companies and firms be exempted from capital gains tax for the purpose of conversion to LLP.

The ICAI Act hasnt recognised LLP but it is being considered by the council. A group has given draft recommendations to the council, which would come out with a regulation soon. According to Jain, there wont be any need to amend the act. If the tax treatment is good, then many CA firms will come forward to convert to LLP, he added.

A New Delhi-based legal consulting firm, Handoo and Handoo, is the first firm to register under the new Act.

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