This article is written by Harsh Gupta from the School of law, HILSR, Jamia Hamdard. This is an exhaustive article which deals with the concept of double taxation and provisions of taxation regarding LLP in great detail.
Limited liability partnerships combine the advantages of both partnerships and corporations. These two forms are incorporated in it. Limited liability means that partners are not liable for the debts of the company, as indicated by their name. As many entrepreneurs are opting for this form of business today, it has become very popular. The firm has several partners, so they cannot be held responsible for the misconduct of other partners. Everyone is responsible for their actions. Limited liability partnerships are governed by the Limited Liability Partnership Act of 2008. In India, however, LLPs were introduced in April 2009.
Legally speaking, it exists apart from the owners. Property can be acquired in its name through a contract. India is not the only country where LLP forms are prevalent. It is also prevalent in countries like the United Kingdom, Australia, etc.
Concept of double taxation
A situation of double taxation is when a tax is charged twice on an income. This can happen on an economic or a juridical basis. When an income or part of it is taxed twice in the same country, in the hands of two individuals, that is economic double taxation. Additionally, juridical double taxation occurs when income earned outside of India is taxed twice in the hands of the same individual, once abroad and once at home. In this situation, the taxpayer is double taxed, resulting in an undue burden.
What can be done to prevent double taxation?
It is uncommon for an individual taxpayer to be able to avoid double taxation, but the Income Tax Act provides certain provisions to provide relief to an individual whose income is likely to be taxed twice. Double Taxation Avoidance Agreements (DTAA) is at the core of this relief measure.
What is a DTAA?
Double Taxation Avoidance Agreements are tax treaties signed by India with other countries. By utilizing the provisions of this treaty, an individual can avoid being taxed twice. DTAA can be comprehensive agreements that cover all types of income or specific agreements that target only certain types of income.
India and Singapore, for instance, have a DTAA under which income is taxed based on a person’s residence status. In this way, taxation is streamlined and the individual is not taxed twice on income earned outside India. Over 80 countries currently have bilateral DTAAs with India.
In what ways does the Income Tax Act provide relief from double taxation?
Relief from double taxation can be unilateral or bilateral.
A unilateral exception to double taxation as provided by Section 91 of the Income Tax Act, 1961. An individual can be exempted from paying double taxes by the government under this Section, regardless of whether there is a DTAA between India and the foreign country in question. Individuals must, however, satisfy some conditions before they can be granted unilateral relief. The conditions are as follows:
- In the previous year, the individual or corporation must have been a resident of India.
- According to the previous year’s tax return, the income must have accrued to the taxpayer and received by him or her outside of India.
- Taxes should have been collected in both countries where DTAAs do not exist.
- Taxes should have been paid in that foreign country by the individual or corporation.
Under the Income Tax Act of 1961, bilateral relief is covered under Section 90. By implementing the DTAA, it offers protection from double taxation. There are two ways to receive this type of relief.
By using the exemption method, you are protected from being taxed twice. In other words, if an income earned outside India has been taxed in the relevant foreign country, it is not taxable in India.
Tax credit method
Individuals or corporations can claim tax credits (deductions) for the taxes paid outside India by using this method. An assessee can use the tax credit to offset the tax due in India, thereby reducing its overall tax bill.
As a result, individuals earning income in other countries may minimize their tax liabilities by taking advantage of the provisions of DTAAs and the relief measures available under the Income Tax Act.
Relationship of LLP & taxation
- In terms of taxes, LLPs avoid the double taxation that applies to some corporate entities. Profits from a partnership are taxed solely on the partners’ personal tax returns. With some other types of business formations, the profits are taxed first at the corporate level before the dividends of shareholders are taxed on their individual tax returns. Although sometimes LLPs pay state franchise taxes, they are not required to do so.
- Business entities in India primarily exist as sole proprietorships, partnerships, and companies. Identify the advantages and disadvantages of each of these business structures so that you can choose one that is right for you to different regulatory and tax regimes. The taxation of LLPs in our country shall be governed by the Income Tax Act, 1961.
- The Limited Liability Partnership Act, 2008 has come into effect in 2009. LLP Rules and forms have been notified w.e.f. 1st April 2009, the Finance No.2 Act, 2009 has incorporated the taxation scheme of LLPs in the Income Tax Act.
- According to the Income Tax Act, 1961 (the Act), LLPs are treated as firms for tax purposes. The structure is the same as with partnership firms, i.e. taxation is in the hands of the firm and exemption is in the hands of its partners.
- An LLP, like a partnership firm, will pay tax on its profits after deducting business expenditures, salaries, and interest paid to partners. A share in profits is exempt from taxation, but a partner’s salary and interest are taxable.
- If an LLP cannot recover an amount due taxes, every partner is jointly and severally liable for it, unless he can prove that the non-recovery is not the result of gross negligence, misfeasance, or breach of duty on the part of its Partner.
Is LLP is the most tax-efficient structure
Whether a company or a limited liability company is the most tax-efficient structure depends on the particular facts of each case. In terms of dividend payouts, various assumptions are taken into account, including the type of business (manufacturing/non-fabrication), the taxable income, the shareholders ‘/partners’ income level, and so on. Companies are the only ones entitled to deductions for in-house R&D, such as weighted deductions. This implies a large degree of subjectivity. When deciding which entity will be more lucrative tax-wise, it is important to take a few assumptions into consideration. An LLP is generally a better option if the payout exceeds 25%. When the pay-out is lower, the company is better off. The pay-out ratio exceeds 60-65% in most cases for a company that qualifies for the reduced tax rate of 15%, with a few exceptions. LLPs are entitled to other tax benefits like additional depreciation, Chapter VI-A benefits, etc. that a company is not entitled to. Although LLPs are subject to an Alternative Minimum Tax of 18.5%, they may still be beneficial due to tax-free distributions. Partners claim credits and deductions on their individual tax returns based on the company’s credits and deductions. Credits and deductions are determined by the percentage of each partner’s interest in the company.
The following points apply to LLPs in India:
- Income tax will not be surcharged.
- Profits will be taxed in the hands of the LLP rather than the partners.
- LLPs will not be subject to the Minimum Alternate Tax.
- Dividend distributions are not taxed.
- Taxation of partners’ remuneration is based on “income from business and profession”.
- Conversion of partnership firms into LLPs does not result in capital gains.
- Designated partners will be liable to sign and file the income tax return.
Some of the conditions for tax implication on LLP
- Taxes are paid by partnership firms to their partners, but LLPs pay tax on the LLP itself.
- Changing from partnership to LLP will not have any tax implications, except for the fact that (a) rights or obligations will not change and (b) assets and liabilities will not be altered.
- A breach of any of the above conditions will be handled according to Section 45.
- LLPs have more responsibility for their designated partners. Due to this, the tax return for the LLP will be signed by the designated partner. However, if the designated partner is not available, then any other partner may sign the income tax return of the Limited Liability Partnership (LLP).
- The new healthcare program introduced as a form of business Limited Liability Partnership was taxed in the 2009-10 Budget.
- Budget 2009-10 declared that LLPs are to be treated as Partnerships for income tax.
Change in definition of firm, partner & partnership
Budget 2009-10 had amended the definition of the terms Firm and Partners as follows:
- The term company shall have the meaning given to it in the India Partnership Act 1932 and shall include a limited liability partnership as defined in the Limited Liability Partnership Act 2008.
Indian Partnership Act, 1932 defines partner as follows and shall include:
- Anyone who is a minor has been admitted to the benefits of partnership;
- A partner of a limited liability partnership as defined by the Limited Liability Partnership Act of 2008.
- The Partnership Act of India 1932 shall apply in addition to the Limited Liability Partnership Act of 2008, which defines what a partnership is.
- A flat tax rate of 30% plus a 3% education levy.
- Taxes on dividend distributions and alternate taxes without a minimum.
- A Limited Liability Partnership must satisfy the following criteria under Section 148 of the Income Tax Act in order to be assessed as a firm under the Income Tax Act.
- The legal existence of the LLP is evidenced by a written agreement, i.e., the LLP Agreement.
- The deed identifies the individual shares of the partners.
- To be submitted with the return of income for the partnership year in which it was formed, a certified copy of the LLP Agreement must be enclosed.
- An updated copy of the revised LLP’s constitution or profit-sharing ratio may be required if changes occur in the previous year.
- During the previous fiscal year, a return of income should be filed along with the agreement.
- The LLP should not neglect to respond to notices sent by the income tax officer in order to complete the assessment of the LLP.
LLP can claim the following deductions
- As long as the LLP has authorized such interest payments to partners agreement.
- Salaries, bonuses, commissions, or remuneration (by whatever name they are called) to a working partner will be deductible if it is paid to an individual.
- The amount of remuneration paid to such working partners must be authorized by the LLP Agreement, and cannot exceed the set limits. If Section 184 is not followed, no deductions are allowed for interest and remuneration. According to Section 185, this is the mandate.
With India’s limited liability partnerships, foreign investors have the much-anticipated form of business organization that is free from double taxation and carries limited liability. According to the LLP Act, small and closely-held US companies will be able to target the rapidly growing Indian market with remarkable ease.
It is also susceptible to abuse, however, since it is a form of business structure. Private limited liability partnership agreements are probably the weakest link. OECD also identifies limited liability partnerships as corporate vehicles that can be misused since they are less regulated than corporations.
- What is double taxation and how can I prevent it? – FGILI
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