Conversion from a private limited company into a limited liability partnership is one of those restructurings that sounds straightforward and turns out, for most companies, to be unavailable.
The corporate law process is manageable. The tax conditions are not, and one of them — a turnover ceiling that has not moved in years — disqualifies the large majority of companies that would otherwise want to convert.
Understanding which side of that line a company falls on takes about ten minutes, and it should be the first thing established rather than the last.
Why companies consider it
The attractions are real.
No dividend layer. Profit share received by a partner from an LLP is exempt in the partner’s hands. Extracting profits from a company means salary taxed at slab rates, or dividend taxable in the shareholder’s hands.
Lighter compliance. An LLP files two annual forms. A company files more, holds board meetings at prescribed intervals, maintains statutory registers and carries a longer list of event-based filings. Our note on ongoing company compliance sets out what that involves.
Flexibility. The LLP agreement can allocate profits, management rights and duties largely as the partners choose, rather than through the Companies Act’s default architecture.
No audit at small scale. LLP audit obligations begin at prescribed turnover and contribution thresholds, rather than from the first year.
For a profitable, closely held business with no external investors and no intention of raising money, the case can be compelling. The question is whether the conversion can be done without a tax charge.
The corporate law conditions
Conversion is governed by section 56 of the Limited Liability Partnership Act, 2008 read with the Third Schedule. A private company may convert where:
- there is no security interest subsisting or in force on its assets at the time of application;
- the partners of the LLP comprise all the shareholders of the company and no one else.
The first condition is the one that catches companies unexpectedly. A charge registered years ago against a loan long since repaid, but never satisfied on the register, is a subsisting security interest on the record. Clearing it means filing the satisfaction of charge before the conversion application — which takes time and depends on the lender’s cooperation.
The second condition means the shareholder body and the partner body must be identical. A new investor cannot be introduced as part of the conversion, and an existing shareholder cannot be left out.
On conversion, all assets, liabilities, interests, obligations and undertakings of the company vest in the LLP, and the company is deemed dissolved and removed from the register.
The tax conditions, and the one that stops most conversions
Conversion is a transfer. Without a specific exemption it would attract capital gains — on the transfer of assets by the company, and on the transfer of shares by the shareholders.
Section 47(xiiib) of the Income-tax Act provides that exemption, but only where every one of the following conditions is satisfied:
- All assets and liabilities of the company immediately before conversion become the assets and liabilities of the LLP.
- All shareholders of the company become partners of the LLP, and their capital contribution and profit-sharing ratio are in the same proportion as their shareholding on the date of conversion.
- Shareholders receive no consideration or benefit other than by way of share in profit and capital contribution in the LLP.
- The aggregate profit-sharing ratio of the shareholders of the company in the LLP is not less than 50 per cent at any time during five years from the date of conversion.
- The total sales, turnover or gross receipts in business did not exceed ₹60 lakh in any of the three preceding previous years.
- The total value of the assets as appearing in the books of account of the company did not exceed ₹5 crore in any of the three preceding previous years.
- No amount is paid to any partner out of the accumulated profit standing in the accounts of the company as on the date of conversion, for a period of three years from the date of conversion.
Condition 5 is the one that ends most conversations. A ceiling of ₹60 lakh in turnover, tested across three preceding years, excludes the great majority of operating companies. A business large enough to be paying for advice on restructuring is usually well past it.
Condition 6 does similar work through the balance sheet.
The consequence is that tax-neutral conversion under section 47(xiiib) is, in practice, available to small companies — dormant holding vehicles, small professional practices, companies that never scaled. For a company that fails either threshold, conversion is still legally possible under the LLP Act, but it is a taxable transfer, and the capital gains consequence has to be computed and funded. Our note on capital gains and the exemptions available covers the computation framework.
What happens if a condition is breached later
Two of the conditions look forward, and a breach after conversion reopens the exemption.
Section 47A(4) provides that where any of the conditions in section 47(xiiib) is not complied with, the amount of profits or gains not charged by virtue of the exemption is deemed to be the income of the LLP or the shareholder, as the case may be, in the previous year in which the requirements are not complied with.
So the two forward-looking conditions carry a contingent liability for years after the event:
The 50 per cent profit-sharing condition runs for five years. A partner exiting, a new partner admitted on terms that dilute the original shareholders below half, a restructuring of the profit-sharing ratio — any of these can trigger the withdrawal.
The accumulated profits condition runs for three years. Paying out pre-conversion reserves to partners inside that window brings the exemption down.
The practical point: conversion is not finished on the date the LLP is registered. It is finished three years later on one condition and five years later on the other, and the LLP agreement should be drafted so that neither can be breached inadvertently by a routine partner change.
Losses, credits and accumulated profits
Three further consequences deserve attention because they are frequently discovered afterwards.
Carried forward losses and unabsorbed depreciation. Section 72A(6A) permits the LLP to carry forward and set off the accumulated loss and unabsorbed depreciation of the predecessor company, but only where the conditions of section 47(xiiib) are satisfied. Where they are not, those losses are lost on conversion — which can be a larger number than the capital gains charge itself.
MAT credit. Credit for minimum alternate tax paid by the company does not carry forward to the LLP. A company sitting on substantial MAT credit gives it up on conversion, and that should be quantified before deciding.
Accumulated profits. Beyond the three-year restriction in condition 7, the treatment of pre-conversion reserves distributed by the LLP has been a contested area. Where a company carries significant reserves, the position should be examined specifically rather than assumed to be free of consequence. Each of these sits within the wider business taxation picture and should be quantified alongside the capital gains position, not after it.
The process
The corporate steps, in sequence:
- Obtain DPINs for the proposed designated partners, and digital signatures.
- Clear the register of charges. Ensure no security interest is subsisting; file satisfaction of any charge that has been discharged.
- Obtain consent of all shareholders and of all creditors, as required.
- Board and shareholder approvals, and name reservation for the LLP.
- File the conversion application with the prescribed statements and attachments, together with incorporation of the LLP.
- On registration, all assets and liabilities vest in the LLP and the company is deemed dissolved.
- Execute and file the LLP agreement within the prescribed period after incorporation.
- Post-conversion housekeeping — intimate the Registrar of Companies, update PAN and TAN, amend the GST registration, inform banks, update contracts and statutory registrations, and notify every authority with which the company was registered.
Step 8 is routinely underestimated. Every licence, registration, lease, bank mandate and contract naming the company needs to be updated, and the LLP is expected to be able to demonstrate continuity where it matters. Conversion also carries a requirement to state the former company name and the fact of conversion on official correspondence for a prescribed period.
When conversion is worth it
The conditions point clearly at who benefits.
A small, profitable, closely held business below both thresholds, with no external investors, no intention of raising money, no employee equity, no MAT credit and no significant carried forward losses — for that business, the exemption is available, the compliance saving is real and the dividend layer disappears.
A dormant or holding vehicle below the thresholds, kept alive for a single asset, where the company form is pure cost.
When it is not
A business above ₹60 lakh turnover in any of the three preceding years, which is most operating businesses. Conversion is then a taxable event and the case has to be made on numbers rather than principle.
A business with any prospect of external investment or employee equity, where the LLP form removes both.
A business carrying substantial MAT credit or accumulated losses, where the amount given up on conversion may exceed the annual saving for years.
A business with subsisting charges it cannot clear, where the first statutory condition simply cannot be met.
A different route is worth mentioning for completeness: businesses currently operating as a proprietorship considering an LLP are in a different position entirely, with different conditions — dealt with in our note on converting a proprietorship into an LLP. And where the objective is a fresh structure rather than a conversion, company registration in India sets out the alternatives.
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