Infusion of capital is one method of expanding the business. Due to the separation of management and ownership, as well as an increase in the companies’ supervisory compliances, investors often feel more secure and comfortable investing in a company rather than an LLP. This is one of the primary reasons why various entities, including LLPs, convert to corporations.
Furthermore, they prefer not to incorporate a new company because they may lose the existing entity’s history and branding. Furthermore, incorporating a new company and then transferring business and assets from the LLP to the new company will result in capital gains tax, as well as stamp duty implications. As a result, conversion is preferred.
Elements to Consider Before Conversion
The firm or LLP must have at least seven members.
However, it should be noted that under the Companies (Amendment) Act, 2017, a firm or LLP with even two members may be converted into a private company via the Companies (Authorised to Register) Amendment Rules, 2018, but this only became effective on 15.08.2018.
The partnership firm/LLP must be registered only once.
However, if the partnership firm is not registered, an application for registration of partnership firm must be filed with the SDM having jurisdiction over the district of the partnership firm’s registered address.
The Process of Conversion of LLP into Pvt Ltd Company
For the conversion of LLP into a Private Limited Company the entity must first file the necessary forms with the registrar of companies and request conversion permission. Once the conversion permission is granted, the LLP ceases to exist and the company is formed. According to Section 366 of the Companies Act, 2013, an LLP can be converted into a Private Limited Company. The conversion process entails:
- Request a No objection certificate from the SDM with jurisdiction over you.
- Obtain name availability under section 4 of the Companies Act of 2013.
- After reservation of name, publish an advertisement in Form URC-2 in an English newspaper and any vernacular language newspaper (seeking objections within 21 days of publication) circulating in the district in which the LLP is located.
- Within twenty-one days of the advertisement’s publication, file URC-1 along with the necessary SPICE Forms, such as INC-32, INC-33, INC-34, and so on, with the Registrar.
- Submit E-form URC-1 with supporting documentation, such as
- No objection certificate from the relevant Registrar of Firms/LLP.
- Certificate from a CA/CS/CWA certifying compliance with all Stamp Act provisions, to the extent applicable.
- Statement of accounts of the company, prepared not later than 15 Days before the date of application and duly certified by an auditor, if applicable.
- The Registrar will decide whether or not to grant registration (Certificate of Incorporation (COI) in form INC-11) within 30 days of filing the form.
All The Compliance Issues You Might Face
A. GST on Conversion
There is no provision on the GST portal for updating conversion information with the GST authorities. The only option is to cancel the LLP’s registration and apply for a new GST registration for the company. However, if there are any unutilized Input Tax Credit (ITC) and a balance in the Cash ledger, problems arise. The real difficulty is transferring unutilized ITC from the LLP GST registration to the company GST registration. Form GST ITC-02, along with a request to transfer the unutilized ITC, must be filed in order to achieve this.
The only option for a cash ledger balance is to request a refund. Ironically, this refund is also made to the LLP’s bank account, which is supposed to be closed or updated with the company’s information.
B. Taxability on Conversion
You must pay capital gains tax if the conversion is taxable. The conversion to non-taxable status must comply with Section 47 of the Income Tax Act. The provisions state that the conversion to non-taxable status must meet all of the conditions listed below; if the conversion is successful, there will be no capital gains tax:
- Entire assets and liabilities of the firm, relating to the business immediately before the succession (meaning conversion) become the company’s assets and liabilities;
- Every partner of the firm immediately before the succession become shareholders of the company in the same proportion as their capital accounts stood in the firm’s books on the date of the succession;
- The partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner other than by way of allotment of shares in the company;
- The aggregate of the firm’s partners’ shareholding in the company is not less than 50% of the total voting power in the company, and their shareholding remains as such for a period of five years from the date of succession.
C. Claim for Outstanding IT Refund
Due to inherent system limitations, refunds and assessments must be performed in the “Old” LLP PAN. The Income Tax website has not yet addressed this issue because the release of refund is related to the Pan and Bank Account of the LLP, which must be surrendered / closed following conversion. Following conversion, the LLP ceases to exist, and any bank accounts operated on behalf of the LLP are no longer legally valid.
In practise, we have seen entities keep their bank accounts open until the refund is issued, but as previously stated, the bank account should ideally be closed on conversion or changed to the bank account of the converted company.
D. Carry Forward of Losses
Section 72A of the Income Tax Act allows the company to carry forward business losses and unabsorbed depreciation from an LLP. Although there is a clear provision for loss carry forward, there are practical difficulties due to limitations in the current ‘Income Tax Forms’ available for filing the company’s income return.
Because there are no separate columns in the Income Tax Forms where the brought forward losses from the LLP can be declared, carrying forward the losses, even though allowed by the Income Tax Act, becomes difficult. Even when the company tries to carry forward the losses and then set them off against the profits, it is denied due to system limitations. Due professional judgement is required in this case in order to carry forward the losses because the existing Income Tax forms and the Centralised Processing Centre have inherent limitations in their systems that are being improved.
E. Other Compliances
A conversion of LLP into Private Ltd Company will attract different compliance apart from taxation like, Conversion information must be updated, or new registrations with
- Profession Tax Act,
- DGFT regulations