Limited liability partnerships may lose sheen as new tax rates kick in

Limited liability partnerships (LLPs) may lose their sheen in the country as the tax differential vis-a-vis companies has widened following the government’s decision to slash corporation tax rates. 

The basic tax rate for companies has been reduced to 22 per cent from 30 per cent earlier, and that for new domestic manufacturing companies has been cut to 15 per cent. The effective tax rates for these entities, including surcharge and cess, is 25.17 per cent and 17.16 per cent, respectively. LLPs, on the other hand, are taxed at 30 per cent, with an effective tax rate of nearly 35 per cent, including surcharge and cess. 

Experts believe that those setting up manufacturing companies can opt for the company structure, as the tax rate of 17.16 per cent is attractive when compared with that for LLPs. For other companies, the decision to opt for a company or LLP structure will depend on whether the profits are more likely to be ploughed back into the business or doled out to shareholders as dividends. 

“The tax changes announced by the finance minister reduce the tax arbitrage between a company and an LLP, and will compel new businesses to look at legal entity options carefully,” said Tejas Desai, partner, EY India. 

“On the face of it, LLPs are an expensive option. But LLPs may score if one is looking to take the money out by way of dividends. In this case, LLPs can be considered by non-manufacturing companies as there is no dividend distribution tax,” said Abhay Sharma, partner, Shardul Amarchand Mangaldas & Co. 

For companies, the effective rate of dividend distribution tax (DDT) works out to 20.56 per cent. DDT is to be paid within 14 days of declaration, distribution or payment of dividend, whichever is earlier. On non-payment, interest at the rate of 1 per cent of the DDT amount is charged until it is paid to the government.

“If reinvestment is a goal, LLP is not an attractive option. But in the present environment, many clients would still prefer to have the flexibility to withdraw profits without being liable to pay DDT. There is a growing trend of entrepreneurs wanting to continuously de-risk from business, too. Some of these would still opt for the partnership option,” said Girish Vanvari, founder, Transaction Square. 

The ministry of corporate affairs (MCA) in March had come out with a circular, barring entities engaged in manufacturing from adopting the LLP structures, reportedly creating uncertainty for over 10,000 such LLPs. It said that LLPs as body corporates had been set up for carrying out activities related to the service sector, not manufacturing. However, the circular was withdrawn in April, following concerns among market players regarding its applicability and impact. 

 Promoters’ dilemma 

The higher tax rates for individuals vis-à-vis companies may also prompt promoters of companies to plough back the money in their companies, rather take it out by way of dividends or other avenues such as salaries. 

Mo “Reduced tax rates for companies and corresponding increased tax rates for the super-rich will encourage promoters to retain funds at the company level as against declaring dividends or extracting cash by way of salaries. These amounts may be ploughed back into business, which will help the economy,” said Bhavin Shah, leader – financial services tax, PwC India.

“The super-rich tax is here to stay as the government wants the profits or surplus cash to stay within the company. Only if the cash is redeployed in the companies can they generate jobs and spur consumption,” said Sharma.

 According to Vanvari, tax planning for the super-rich will vary depending on their investment and revenue streams. “Those investing in stock markets and funds will not bother too much about the surcharge. Those who get salaries do not have many options, other than getting into consulting roles. And those in business will have to think hard as they have the option to redeploy their earnings back into the company,” he added.