Taxation of Limited Liability Partnerships

Harold Tan and Sarah Kate Lee explain the tax treatment for LLPs in Malaysia

 

INTRODUCTION

In Issue 1/2012 and Issue 2/2012 of LEGAL INSIGHTS, we highlighted to our readers the main features of the Limited Liability Partnerships Act 2012 (“LLP Act”) that introduced the limited liability partnership (“LLP”) as an alternative business vehicle in Malaysia and discussed the procedure by which a conventional partnership or a private company may be converted into a LLP.

The Finance (No. 2) Bill 2012 (“Finance Bill”) which was recently passed by the Malaysian Parliament and is pending Royal Assent by the Yang Di-Pertuan Agong, will introduce amendments to the Income Tax Act 1967 (“ITA”) and the Real Property Gains Tax Act 1976 (“RPGT Act”) to provide for the manner in which income tax and real property gains tax will be levied on a LLP.  

The LLP Act came into operation on 26 December 2012. The amendments in the Finance Bill which relate to LLPs are to take effect on the same day when the Bill becomes law.

In this article, we shall examine the LLP from a tax angle. Where appropriate, we shall also compare the tax treatment for a LLP with that of a conventional partnership and a private company.

 

TAX STATUS

The Finance Bill seeks to introduce a new definition of “limited liability partnership” into the ITA as a LLP registered under the LLP Act and to extend the definition of “person” to include a “limited liability partnership”. For avoidance of doubt, the ITA will also be amended to exclude a LLP from the definition of a “partnership”. With these amendments, a LLP will be given a similar treatment as a company and be treated as an entity chargeable to tax under the ITA.  

The tax treatment for a conventional partnership differs from that of a LLP as it is the individual partners, and not the partnership, who are subject to tax.

 

RESIDENCE STATUS

The Finance Bill seeks to provide that the residence status of a LLP is to be determined based on the place where the management and control of the business or affairs of the LLP are exercised by its partners. This is similar to a company where tax residence is based on the place where the management and control of the affairs of the company are exercised by its directors or other controlling authority.

In contrast, the residence status of a partner in a conventional partnership is determined based on the number of days he is physically present in Malaysia.

 

BASIS PERIOD

The Finance Bill will amend the ITA to provide that the basis period for a year of assessment of a LLP to be similar to that of a company, namely that it is the financial year, which may not necessarily be the calendar year.

The basis period for taxation purposes of a partner in a conventional partnership, like any other individual taxpayer, is the calendar year that coincides with a year of assessment.

 

RATE OF TAX

Subject to the exception discussed below, the Finance Bill seeks to impose a tax rate of 25% on the chargeable income of a LLP.  

A LLP that has a capital contribution, whether in cash or in kind, of RM2.5 million or less at the beginning of its basis year shall be entitled to a preferential tax rate of 20% for the first RM500,000 of its chargeable income. Its chargeable income in excess of that amount shall be subject to the general tax rate of 25%. These rates are similar to the rates applicable to a company.

It is to be noted that the preferential tax rate mentioned above will not apply to a LLP which controls, or is being controlled by, a company that has more than RM2.5 million paid up capital in respect of ordinary shares.

Unlike a LLP, each partner of a conventional partnership is taxed at his individual tax rate, which ranges from 2% to 26%.

 

CHARGEABILITY OF INCOME DISTRIBUTED

The ITA will be amended to provide that all profits paid, credited or distributed to partners in a LLP are exempt from tax. Again, this treatment is similar to a company where dividends paid to shareholders out of profits which have been subject to full Malaysian taxation are exempted from tax.

In a conventional partnership, every partner is assessed separately for his share of the partnership income.

 

DEDUCTION OF REMUNERATION PAID TO A PARTNER

The Finance Bill provides that any remuneration paid to a partner by a LLP will not be eligible for deduction if it is not provided for in the LLP agreement made in accordance with section 9 of the LLP Act. This differs from a company where remuneration paid by a company to its directors and officers are tax deductible.

A conventional partnership, not being a separate entity chargeable to tax, is unable to claim a deduction in any event.

 

UNABSORBED BUSINESS LOSSES

The Finance Bill seeks to allow a company or a conventional partnership which converts to a LLP to carry forward its unabsorbed business losses to be utilised against the future income of the LLP.

 

DUTY TO FILE RETURNS

The Finance Bill imposes the responsibility for doing all acts and things required under the ITA, including the duty to file returns, on behalf of the LLP on the compliance officer who is appointed from amongst the partners of the LLP. If no compliance officer is appointed, then the responsibility will lie, jointly and severally, with the partners of the LLP.

Similar to the requirement imposed on a company, the Finance Bill seeks to require a LLP to furnish a tax return for a year of assessment within 7 months from the date following the close of its accounting period.

Although a conventional partnership is not assessable to tax, the partnership is nevertheless required to file a tax return no later than 30 June in the year following each year of assessment. The responsibility for filing the returns of the partnership rests on the precedent partner.

As each partner in a conventional partnership is chargeable to tax individually, he is required to file separate tax returns.

In the case of a company, the responsibility for doing all acts and things required to be done by the company (including the filing of tax returns) lie, jointly and severally, with (i) the manager or other principal officer of the company in Malaysia; (ii) its directors; (iii) its secretary; and (iv) any person (however described) exercising the functions of any of the aforementioned persons.

 

REAL PROPERTY GAINS TAX

The Finance Bill seeks to amend the RPGT Act to include a LLP as an entity chargeable to real property gains tax. It further seeks to impose on the compliance officer of a LLP, and if no compliance officer is appointed, on the partners, jointly and severally, the onus to be assessed and charged to tax under the RPGT Act.

The position of a conventional partnership under the RPGT Act is similar as it is considered as an entity, separate from its partners, chargeable to real property gains tax. Further, any person who at the time of disposal of a chargeable asset of the partnership is the precedent partner is to be assessable and chargeable with the tax payable by the partnership under the RPGT Act.

A company is chargeable to real property gains tax under the RPGT Act. If the company defaults in payment of such tax, its directors, secretary and manager or other principal officer in Malaysia can be held jointly and severally assessable and chargeable with the tax payable by the company.  

 

CONCLUSION

The advent of the LLP Act has brought into Malaysia the LLP, which is essentially a hybrid between a conventional partnership and a private company, as an alternative business model to conduct commerce.

The proposed amendments to the ITA and RPGT Act under the Finance Bill that establish the basis on which a LLP is to be taxed is an important missing piece of the LLP jigsaw that has now been put in place.

Under the Malaysian LLP model, the tax treatment for a LLP will be substantially similar to that of a company. This is a significant departure from several other common law jurisdictions that have also adopted the LLP, such as the United Kingdom and Singapore, where a LLP is treated for tax purposes in the same way as a conventional partnership and not as a separate taxable entity.

 

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