The Interconnect

Holding Vehicle -Company or an LLP? – Part 2

Ketan Dalal (Managing Partner, Katalyst Advisors LLP)
Oct 5, 2018

Continued from Part 1

In part 1 of this article, we tried to understand the characteristics of a company and an LLP as a holding vehicle, identified particular taxation issues, discussed aspects of extraction of funds and identified other factors relevant for decision making. In this part, we deal with the several other aspects below.

Funds extraction from holding company by promoters:

Extract of funds from a holding company entails DDT.  As such, buyback of shares and capital reduction scheme could be resorted to; however, both now, have tax implications which may lead to each of these options not be much more beneficial than DDT.

Buyback is subject to conditions prescribed in section 68 of the CA, 2013 and rules thereunder. Incidentally, only a limited amount can be repatriated. Buyback of unlisted shares is taxable to the company under section 115QA of the ITA and exempt for shareholders under section 10(34A) of ITA, whereas buyback of listed shares is taxable only in the hands of shareholder under section 46A of ITA.

Capital reduction can also be resorted to; however, the scheme of capital reduction is time consuming since NCLT approval is required. Also, as per Section 2(22)(d) of the ITA, any distribution on scheme of capital reduction to the extent of ‘accumulated profits’ is in the company shall be regarded as ‘deemed dividend’ and such deemed dividend is subject to DDT under section 115O of the ITA in the hands of the company.

Funds extraction from LLP by promoters:

In case of an LLP, a partner can withdraw any amount from capital contribution subject to provisions in the LLP agreement. Further, as per section 42 of the LLP Act, a partner can either wholly or partly transfer his right of receive profit to others. In such case, transferee only gets limited right to receive profit and not the status of a partner i.e. such other person cannot participate in management of the LLP. The transferring partner continues to be the partner of the LLP and subject to all duties and rights except to receive share of profit/loss or asset on dissolution.

As far as taxability is concerned, such assignment of right amounts to transfer within section 2(47) and hence, taxable as capital gain. However, if such right is transferred without consideration which could happen if the transfer is to a related party, then it cannot be subject to tax in the hands of the transferor (since no such provision to tax) nor in the hands of the transferee under section 56(2)(x) of the ITA, as such right is not covered under the definition of ‘property’ under section 56 of ITA.

Exit by transfer of equity shares:

Taxability on the transfer of equity shares by a company or an LLP, is same except for the MAT implications. In case of a company, the capital gain earned above is subject to MAT. However, whilst an LLP IS subject to AMT, the AMT is not applicable to capital gains; hence, an LLP could be a better vehicle than a company from the perspective of monetising the holding in an operating company.

The above tax implication is illustrated by following example: Assuming the Sale proceeds of investment in shares of operating company is INR 100 crore, book value of such investment is INR 50 crore and indexed cost is INR 70 crore. The tax implication and net income received by promoters are as follows:

(INR in Crores)

Particulars

Company

LLP

Normal Tax

MAT

Sale proceeds of investment

100

100

100

Less: Indexed cost/Book Value

(70)

(50)

(70)

Long term capital gain/ Book profit

30

50

30

Tax payable

7

-

7

MAT payable

-

10.78

-

Tax or MAT whichever is higher

(10.78)

(7)

Proceeds available for distribution

89.22

93

Less: DDT

(18.70)

-

Proceeds received by promoters

70.52

93


It would be seen that, in an exit context, an LLP holding vehicle is better than a company holding vehicle from the tax point of view.

REGULATORY ASPECTS:

Some of the regulatory aspects are dealt with above, such as the provisions of Section 186 of the Companies Act and applicability of NBFC regulations etc.  Additionally, there are certain regulatory aspects, some of which are linked to extraction of funds out of the holding vehicle.  For example, as per section 123 of the CA, 2013, dividend shall be paid out of the profits only. Such profits specifically exclude any unrealised gains, notional gains or revaluation profits. Dividend cannot be declared if past years losses/ depreciation is not provided for. However, on the other hand, there is no such requirement under LLP Act. Hence, in case of an LLP, promoters can freely withdraw funds, if required, at any time subject to the LLP agreement.

The flexibility in terms of timing and process is also far greater in an LLP; for example, if promoters wish to withdraw profits in the middle of the year from the company, the company has to declare interim dividend as per provisions of section 123(3) of the CA, 2013whilst on the other hand, there is no such requirement under the LLP Act.

Further, as mentioned above, a company held for only investment purpose, would be classified as an NBFC or a CIC whereas an LLP is not covered by NBFC regulations. An NBFC or a CIC has to follow additional regulations under FEMA for overseas direct investment.

Borrowing by Promoters from Holding Vehicle:

A holding company can provide loan to promoters as per section 185 & 186 of the CA, 2013 whilst in case of the holding LLP, there is no such restriction. In case of a company, such loan may be treated as deemed dividend under section 2(22)(e) of the ITA; however, a loan given by an LLP is not covered under section 2(22)(e) of the ITA.

Listing of Holding Vehicle:

If for some reasons, listing of holding vehicle is required, then a company can be listed in stock exchange, but an LLP cannot be listed as such. For listing of an LLP, first it has to be converted such LLP into a company. Conversion of an LLP into a company is tax neutral, but subject to conditions specified in section 47(xiii) of the ITA. However, immediate listing of the company after conversion could result into breach of specified conditions and result into taxable capital gain.

Extraction of Investment amount and exit from the Operating Company:

Promoters can monetise investment in operating company by transfer of equity shares, or by merger or demerger (of an undertaking) from the operating company into another company.  However, an exit from the holding company itself is challenging, since a potential acquirer of the operating company may not want to acquire it at holding level and hence, the holding company may not have a choice but for the holding company to transfer its holding in the operating company; however, in such an event, the liquidity could be trapped in the holding company. In case of an LLP, a partner can withdraw any amount from capital contribution, subject to provisions in the LLP agreement.

CONCLUDING REMARKS:

There are pros and cons of having either a company or an LLP as a holding vehicle. From a regulatory standpoint, an LLP seems to be better as a holding vehicle, but an LLP purely as a holding vehicle can be a regulatory challenge and it may need to have an operating business also. From a tax point of view, a company may be better, provided that the promoters do not need to extract dividend received by the holding company from the operating company; however, in the context of a liquidity event (i.e. a holding vehicle transferring the shares of an operating company), an LLP seems to be better from the tax point of view. One important issue is that most holding vehicles today are in the form of a holding company, rather than in the form of an LLP and hence, in such cases, if the holding vehicle is intended to be an LLP, then converting a company into an LLP could be a choice, but that has its own challenges, particularly tax challenges. However, in case a structure is being devised from a future point of view, then there would be a choice between a company and an LLP as a holding vehicle, but, as would be obvious from the discussion above, the choice has to be made very carefully, depending upon the circumstances.

This article has been co-authored by Bhavik Gandha, Katalyst Advisors LLP.

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