New Delhi: Lawyers, engineers, information technology consultants, chartered accountants, venture capitalists as well as small- and medium-scale entrepreneurs may soon get to choose whether the tax liability of their business should fall on them or their firm.
The government may allow a pass-through status to such professionals if they opt for limited liability partnership (LLP) status with the passage of the proposed Limited Liability Partnership Bill, which is expected to be passed in the Budget session of Parliament.
A limited liability partnership is an alternative business structure falling between a partnership firm and a corporate body, combining the limited-liability benefits of a company with the flexibility of a partnership.
According to the draft Bill, existing corporate bodies or partnership firms will also be eligible to convert to the limited liability structure. A pass-through is a mechanism whereby the tax liability won’t be borne by the firm but, instead, will be absorbed by the partners.
In the UK and most European nations the tax liability falls on individual partners. In the US, a flexible system exists where partners decide whether they or the firm be taxed.
The final note on the Limited Liability Partnership Bill sent to the cabinet notes that entrepreneurs should be given the flexibility of choosing the taxation structure that suits the nature and size of their business. Besides, the note, a copy of which has been viewed by Mint, suggests that taxation structure of limited liability partnership firms should be in line with global practices.
Once the cabinet clears it, the finance ministry will make appropriate amendments in the Income-tax Act, 1961, to incorporate flexible tax structure for such firms.
Earlier, a parliamentary standing committee on finance, headed by Ananth Kumar, a member of the Lok Sabha representing the Bharatiya Janata Party, had submitted its recommendations in the winter session of Parliament and had suggested providing such flexibility.
“While a body corporate attracts a tax of more than 40% including corporate tax, surcharge, education cess and dividend distribution tax, a partnership firm’s liability is up to 33% because it does not have to give dividend distribution tax. Under the pass- through, the partners will be taxed as individuals and therefore get basic exemption, which currently is at Rs110,000, and therefore is even more beneficial than a partnership firm,” explained a senior official at the ministry of corporate affairs.
Gaurav Taneja, national tax director of consulting firm Ernst and Young, says both a pass-through as also a flexible system will work well in India. “For smaller projects, fixed-period projects and special-purpose vehicles, a pass-through will work well because it will be easier to wind up such projects without getting into tangles of complicated tax structures,” said Taneja.
He added that in cases of cross-border transactions, it will help if the firm is taxed. “This will help the firms take benefit of bilateral tax treaties between India and other countries because the LLP firm will be a legal tax entity,” said Taneja.
Taneja, however, cautioned that a time limit should be prescribed for firms, say four or five years, before which they cannot switch over from one kind of taxation structure to another.
“This will help check misuse of flexibility,” he added.
The Bill, which was introduced in the Rajya Sabha in December 2006 by the ministry of corporate affairs, is pending approval in Parliament.
Largely seen to benefit those in the service sector, such as chartered accountants, lawyers and consultants, limited liability partnerships may also be useful in forging smaller firms where one partner provides the technical expertise and the other invests capital.
The concept also comes handy in the small-scale sector, as companies in this sector need not go to the capital market to raise funds.