FEATURE

Tax Files

Limited Liability Partnerships: Aspects of Tax

This article discusses the income tax, GST and stamp duty treatments of limited liability partnerships.

With the coming into operation of the Limited Liability Partnerships (‘LLPs’) Act (No 5 of 2005), an entirely new form of legal entity will be created. The LLP will combine the organisational flexibility and tax status of a partnership with some measure of limited liability for its partners. A measure of limited liability is enjoyed as the LLP is a legal person distinct from its constituent partners and the partners are protected from debts or liabilities arising from negligence, wrongful acts or misconduct of another partner (see Yeo Hwee Ying, Liability of Partners in a Limited Liability Partnership Regime (2003) 15 SAcLJ 392). At the same time, the LLP is tax-transparent or enjoys a ‘flow-through’ tax treatment in that the LLP will not itself be chargeable to tax on its profits and does not incur any tax liability. Instead, each partner will be taxed on his share of those profits according to his personal income tax rates. Where the partner is a company, it is taxed at the prevailing corporate tax rate which is currently 20%. With tax transparency, the choice between using a LLP and a partnership is therefore a tax-neutral one.

Events Leading to the LLP Act

In March 2002, the Law Reform and Revision Division of the Attorney-General’s Chambers published a consultation paper on LLPs. The Company Legislation and Regulatory Framework Committee (‘CLRFC’) in its final report released in October 2002 also recommended that legislation be enacted to introduce the additional business structures of LLPs and limited partnerships to broaden the menu of legal structures available in Singapore. Following the CLRFC recommendation, a study team was then set up in November 2002 to work out the details of the legal framework governing LLPs and limited partnerships. The study team duly released its final report in February 2004 and made the following recommendations in relation to matters concerning taxation:

(a) tax transparency ie partners should be taxed on their share of the income or gains of the LLP according to their personal income tax rates;

(b) ‘tax attributes’ incurred previously by a partnership firm to be allowed to be a LLP registered for the purpose of the transfer to it of all the business, assets and liabilities of a partnership firm, with no time limit imposed on the utilisation; and

(c) stamp duty relief with respect to any transfer of property to the LLP in connection with any ‘conversion’ to a LLP, at least for the initial period.

On 15 July 2004, the IRAS issued a circular on the ‘Income Tax Treatment of Limited Liability Partnerships’. At the same time, the Ministry of Finance conducted a public consultation from 15 July 2004 to 1 August 2004 and invited feedback on the proposed amendments to the Income Tax Act (Cap 134) and Stamp Duties Act (Cap 312) relating to the taxation of LLPs. After considering the feedback, the Income Tax (Amendment) Bill 2004 (No 58/2004) and the Stamp Duties (Amendment) Bill 2004 (No 60/2004) were tabled for their First Reading in Parliament on  19 October 2004.

Tax Transparency

Tax transparency or flow-through taxation which is central to the design of the LLP structure, is catered for in the proposed s 36A(1) in the Income Tax (Amendment) Bill 2004 which makes the following provisions:

(a) where all the activities (whether or not in the course of carrying on a trade, business, profession or vocation) of the LLP ‘are treated as carried on in partnership by its partners and not by the partnership’;

(b) anything done by, to or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the partners; and

The provisions of s 36A(1) therefore pave the way for the application of the existing s 36 which governs the taxation of partners where they are taxed on their share of the partnership income at their personal income tax rate. In respect of the application of s 36, Chua J in Ng Chwee Poh v PP [1975-1977] SLR 603 at 621, made the following observation:

The Income Tax Act does not recognise a partnership as a distinct taxable persona. It follows that a partnership is not a separate entity distinct from the partners forming the partnership and has not direct liability for the payment of tax. The partnership is liable only to lodge a return of income through its partners. The next step then is for the Comptroller to determine first the taxable income of the partnership on the basis of what is submitted in the partnership return, and the Comptroller will then apportion such taxable income according to their rights to share in the profits of the partnership and such apportioned income is accrued to the individual partner’s return of income.

One interesting point to note from the Ng Chwee Poh case is that the court took the position that the usual rule in s 36 that partnership profits should be apportioned among the partners applies only where the profits are declared in the normal course of events. The court indicated that ‘the Income Tax Act does not provide for any apportionment of evaded taxable income among its partners where a prosecution has already been instituted against one partner in respect of that evaded taxable income’.

As a consequence of the tax transparency status, each partner’s share of (a) capital allowance and industrial building allowance in excess of his income from the LLP; (b) trade or business loss from the LLP; and (c) qualifying donation, will be available for set off against his income from other sources. This lateral set off has been referred to as ‘sideways relief’ in professional parlance in the UK. However, the sideways relief is restricted under certain circumstances in order to counter schemes of ‘tax shelters’. Those restrictions are discussed in the following paragraphs in connection with the concept of ‘contributed capital’ introduced in the Income Tax (Amendment) Bill 2004.

Contributed Capital

Unlike a partner in an ordinary partnership, the right of a partner in a LLP to sideways relief to set off losses from the partnership trade against income from other sources, is restricted under provisions in the Income Tax (Amendment) Bill 2004 to the aggregate amount of his capital contribution and undrawn profits. This restriction recognises the position that the partner in a LLP is not liable for losses which exceed that amount.

The ‘loss restriction rule’ in the Income Tax (Amendment) Bill 2004 follows that in the UK, such a rule has been put in place to restrict the flow-through of tax losses to limited liability partners who are not at risk beyond the limit of their stipulated liability. If partners in LLPs were to be treated in the same way as partners in an ordinary partnership such that there is no restriction on the sideways relief, the partners in LLPs will benefit from the distribution of losses that exceed their limited liability. Those losses could be used to reduce the partners’ other taxable income even though the losses do not expose the partner to any risk of having to meet those obligations or make good those losses. The ‘loss restriction rule’ is clearly made for good policy reasons.

Similar provisions relating to the ‘loss restriction rule’ in the UK were themselves introduced after the case of Reed (Inspector of Taxes) v Young [1986] 1 WLR 649, where the House of Lords upheld a deduction claimed by a limited partner of a share of a tax loss significantly in excess of her capital at risk in the limited partnership. There was also a similar decision by the High Court in Ireland in MacCarthaigh (Inspector of Taxes) v D [1985] IR 73. In Reed v Young, Mrs Young became a limited partner in a limited partnership formed to produce and exploit films. Her capital contribution to the partnership was £15,000 and this was the limit of her liability under s 4(2) of the Limited Partnerships Act 1907. Mrs Young sought to deduct £41,423 being her share of the partnership loss for the 1977-78 income year against her other income for the year. The Revenue argued that she did not ‘sustain a loss’ of £41,423 in terms of s 168 of the Income and Corporation Taxes Act, but only sustained a loss to the extent of her capital at risk ie £15,000. The House of Lords however decided in favour of Mrs Young and held that the fact that the Limited Partnerships Act 1907 afforded Mrs Young protection against liability beyond her capital contribution was entirely immaterial to the question of whether that partner has ‘sustained a loss’ for tax purposes.

It can therefore be seen that without a ‘loss restriction rule’, the LLP may become a vehicle for schemes to flow through tax losses in excess of the capital at risk. For example, a LLP may be established for a business which acquires a capital asset that qualifies for accelerated capital allowances under s 19A. The partners then obtain capital allowances through the LLP equal to the full purchase price of the asset. If the business does not produce profits, the partners will be able to set off the resulting partnership tax losses against their other income although they are not at risk to the full extent of those losses. The ‘contributed capital’ concept has therefore been put into the provisions in s 36A to deter such ‘tax shelter’ schemes. The ‘contributed capital’ of the partner in a LLP is defined in the proposed s 36A(10) of the Income Tax (Amendment) Bill 2004 as the aggregate of the following:

(a) the amount which he has contributed to the LLP as capital (in cash or in kind but not including any loan) and has not, directly or indirectly, drawn out or received back (whether as a distribution or a loan or otherwise); and

(b) the amount of any profits or gains of the trade, business, profession or vocation to which he is entitled but which he has not received.

Essentially, sideways relief is only available to the extent of the contributed capital and any undrawn profits. The ‘contributed capital’ may, however, be subsequently reduced where a partner of a LLP makes a withdrawal (whether as a distribution or a loan or otherwise) of:

(a) the capital he has previously contributed to the LLP; or

(b) any portion of his share of the profits or gains of the trade, business, profession or vocation derived by the LLP in respect of past years which he has not previously withdrawn.

If the reduction in contributed capital occurs in any subsequent Year of Assessment (‘YA’) such that it results in the partner’s cumulative tax deductions exceeding his reduced contributed capital, it is provided that the excess is deemed as income of the partner which is chargeable with tax under s 10(1)(g) of the Income Tax Act which charges ‘profits and gains of an income nature’ to tax. Effectively, the reduction in the contributed capital has resulted in an over-allowance of the tax deductions beyond the contributed capital. The charge to tax under s 10(1)(g) therefore claws back the amount that has been ‘over-allowed’.

At the same time that an amount is deemed as income chargeable under s 10(1)(g), an equal amount is deemed as the partner’s share of the loss incurred by the LLP for the YA: s 36A(5). Where the partner’s share of partnership profits for that YA is greater than the deemed loss, the deemed loss will be totally absorbed by the profits. However, where the LLP is in a loss position or where the partner’s share of the LLP profits for that YA is less than the deemed loss, any deemed loss that is unabsorbed for the YA will be available for carrying forward to future YAs for set off against his future profits from the LLP. This is in line with the purpose of the loss-restriction provision, which is basically to curtail any sideways relief beyond the amount of the contributed capital. There is no intention to deny the carrying forward of losses which may be set off in future YAs should there be an increase in the contributed capital in future.

Tax Attributes

The Government has agreed with the recommendation of the study team that succeeding LLPs should be allowed to claim ‘tax attributes’ (meaning unabsorbed capital allowances, industrial building allowances, trade losses and qualifying donations are allowed to be carried forward to be set off against income in future YAs) incurred previously by the ordinary partnership, without any time limit imposed on the utilisation. However, such relief does not apply where a company converts to a LLP. This is consistent with the current tax treatment where companies involved in mergers and conversion to partnerships are not allowed to claim ‘tax attributes’ previously incurred.

In a straightforward case where an ordinary partnership is converted to a LLP and the LLP continues with the trade, business or profession that is taken over, the unabsorbed capital allowances, industrial building allowances and trade losses are carried forward to future YAs to be set off against the future income of the partners. The ‘business continuity test’ under s 23(1) of the Income Tax Act will have been satisfied in this case to allow the carrying forward of the unabsorbed capital allowances and industrial building allowances. In respect of the trade losses of the partners, they may also be so carried forward, and unlike the situation with regard to the carrying forward of capital allowances and industrial building allowances, there is no ‘business continuity test’ to be satisfied. Where the transferor of the business is a company, there is the additional shareholding test in sections 23(2) and 37(5) of the Income Tax Act, to be satisfied for the carrying forward of unabsorbed capital allowances, industrial building allowances and  trade losses.

Admission and withdrawal of partners

The admission of new partners to and the withdrawal of existing partners from a LLP does not affect the carrying forward of the unabsorbed capital allowances, industrial building allowances and trade losses of the other existing partners who continue to carry on with the same trade, business or profession.

Balancing adjustments

Where a LLP succeeds to a business previously carried on by an ordinary partnership, this will not by itself give rise to any balancing adjustments as the conversion to the LLP is not treated as a sale triggering balancing adjustments. Partners of the LLP will therefore continue to claim capital allowances and industrial building allowances in the normal way.

Stamp Duty Relief

To facilitate the conversion of ordinary partnerships to LLPs, stamp duty relief is provided with the legislative amendments to the Stamp Duties Act. Section 15 is amended under the Stamp Duties (Amendment) Act 2005 (No 6 of 2005) to provide relief from any ad valorem stamp duty that may be levied in the event of a conversion of a firm to a LLP under s 20 of the LLP Act. Under para 2 of the Second Schedule to the LLP Act, such a conversion is only possible where the partners in the LLP to which the firm is converted, comprise all the partners of the firm and no one else. It is therefore presumed that the partners’ interests in the original partnership and in the succeeding LLP are the same. If not for the relief afforded by the legislative amendments to s 15 of the Stamp Duties Act, ad valorem stamp duty would otherwise be levied should there be immovable property and stocks and shares owned by the firm that is involved in the conversion.

It is to be noted that stamp duty is chargeable on instruments and not on transactions and the head of charge in the First Schedule to the Stamp Duties Act relating to the transfer of immovable property and stocks and shares (other than shares listed in the name of the Central Depository System), is ‘conveyance on sale’. Section 31 inserted by the Stamp Duties (Amendment) Act 2005 therefore treats the notice of registration issued by the Registrar of LLPs for the conversion of a firm or a private company as the case may be, to a LLP as a ‘conveyance on sale’ for a consideration equal to the value of the chargeable property so vested in the LLP upon the conversion. With the issue of the notice of registration, all movable and immovable property vested in the firm or company will vest in the LLP without further assurance, act or deed as provided under para 6(b) of the Second Schedule and para 6(b) of the Third Schedule to the LLP Act respectively. The notice of registration therefore serves as the chargeable instrument and is therefore to be ‘stamped’. However, under the amendment to s 15, relief from ad valorem duty is accorded to the notice of registration in the case of a conversion from a firm (but not a company) to a LLP.

Significant change of partners

After the coming into existence of a LLP, there may be subsequent changes of the partners in the LLP. Where the LLP is ‘rich’ in immovable property and stock and shares, the ‘beneficial ownership’ of those assets would have effectively changed hands with each change of partners. In line with the income tax transparency accorded to LLPs, the stamp duty impacting on any transfer of any interest in the LLP is computed by looking at the value of the underlying assets (ie immovable property and stocks and shares) although the LLP has a personality separate from its partners. Provisions have been made in sections 32, 32A and 32B inserted by the Stamp Duties (Amendment) Act 2005 to introduce elaborate rules for the levy of stamp duty where there is a ‘significant change of partners’ in a LLP.

Basically, the provisions are to impose a levy of stamp duty where there is a transfer of interests in ‘asset-rich’ LLPs resulting from a change of the partners in a LLP. However, not every change of partners in such LLPs will attract the levy of stamp duty. Only a ‘significant change of partners’ does. As to what amounts to a ‘significant change of partners’, this is provided in the new s 32 which determines when a change of LLP partners would constitute a significant change of partners for the purpose of new sections 32A and 32B of the Stamp Duties Act.

As stamp duty is chargeable on instruments and the relevant head of charge in the First Schedule to the Stamp Duties Act is ‘conveyance on sale’, it has been provided in s 32A(4) that the instrument effecting or evidencing a significant change of partners of a LLP is treated as a ‘conveyance on sale’ for the purposes of stamp duty. Where there is no such instrument, it is provided in s 32A(5) that the notification to the Commissioner of Stamp Duties informing him of the significant change of partners is treated as a ‘conveyance on sale’. Essentially, s 32A(5) creates the chargeable instrument which is to be ‘stamped’ for stamp duty purposes where there is none created by the transaction. The ad valorem stamp duty is computed on the value of the consideration as stated in the instrument or may be computed under the formula provided in s 32A(6), whichever is the higher.

Transfer of chargeable property between LLP and partner

Any chargeable instrument made between a LLP and a partner in connection with the transfer, conveyance or assignment of beneficial interest in immovable property or stock and shares, is not looked at as an instrument made between two distinct and unrelated persons for stamp duty purposes. Ad valorem duty is therefore not charged on the full value of the immovable property and stock and shares. Instead, the partner’s proportionate interest in the underlying assets of the LLP before the transfer, conveyance or assignment is recognised. If, for example, a partner has an ‘asset share’ of 25% in the LLP before the transfer, conveyance or assignment, the duty will be reduced by 25% to recognise his prior interests. The ‘asset share’ to be adopted depends on whether there has been a ‘significant change of partners’ before the transfer, conveyance or assignment. If there are one or more of such changes, the ‘asset share’ of the partner closest in time to the transfer, conveyance or assignment is used for the reduction of the duty. If there has been no ‘significant change of partners’, the ‘asset share’ of the partner upon the formation of the LLP is used instead.

Where there is such a transfer, conveyance or assignment of any beneficial interest in immovable property or stock and shares by a person who becomes a LLP partner to the LLP, the duty on the chargeable instrument is reduced by the ‘asset share’ of the person upon his becoming a partner. For example, a person may become a partner in a LLP with a 25% ‘asset share’. The duty on the chargeable instrument is reduced by 25%. The reduction basically recognises that even after the transfer, conveyance or assignment, 25% of the interest in the chargeable property is still attributable to the partner, albeit that the property is now under the ownership of the LLP.

The concept of ‘asset share’ is provided in s 32. It is basically the proportion of the chargeable property that the partner is entitled to on the winding up of the LLP. If there is no such proportion specified, the ‘asset share’ will be the proportion of profits of the LLP that the partner is entitled to on the date of the change of partners or the formation of the LLP, as the case may be.

Goods and Services Tax (‘GST’)

While legislative amendments have been proposed to the Income Tax Act and the Stamp Duties Act to provide for the advent of the LLP, none has, however, been proposed to the GST Act (Cap 117A). Hence, a LLP will be viewed as a body corporate as far as GST is concerned. The LLP will be registered as an entity for GST purposes. This is not very different from the current GST treatment of an ordinary partnership where registration of ‘the same persons carrying on separate businesses in partnership, may if the Comptroller thinks fit, be in the separate names of the respective firms’ as provided in s 31(1)(b) of the GST Act.

Concluding Remarks

For most professional partnerships converting to LLPs, they will probably not encounter many tax issues as they are generally ‘asset-light’ and will generally not have any unabsorbed capital allowances, industrial building allowances or losses from their trade, business or profession. Even where an ordinary partnership has such ‘tax attributes’, the conversion to a LLP is generally a tax-neutral one as the conversion will not, of itself: (a) give rise to a cessation of the business; (b) give rise to a balancing event for the purposes of the capital allowance and industrial building allowance provisions; or (c) constitute a disposal by the partners of their interests in the old partnership’s assets. The carrying forward of the unabsorbed capital allowances, industrial building allowances and losses for the partners who continue with the business in the LLP will generally not be affected. However, where the partner is a company, there is also the shareholding test in sections 23(2) and 37(5) to be satisfied for the carrying forward of the unabsorbed capital allowances, industrial building allowances and  trade losses.

Leung Yew Kwong

Ong Sim Ho

E-mail: leungyk@ongsimho.com