Changing a non-public restricted legal responsibility firm right into a restricted legal responsibility partnership: key tax concerns

In February 2021, for the first time in its history, Rwanda enacted a law governing partnerships (law no 0082021 of 16/02/2021) aimed at providing more structuring options for investors intending to use Rwanda as a holding jurisdiction within the ambit of the larger Kigali International Financial Centre (KIFC) project.

The law governing partnerships provides for the possibility of converting a private limited liability company (“LLC”) into a limited liability partnership (“LLP”) and recently, the registrar general issued the requirements to effect these conversations. This means that companies can now start converting to LLPs.

This conversion option will be useful for various market players, including small and medium companies, professional service firms run as companies, and companies holding investments.

This is because LLPs offer the limited liability protection in the same way that companies do, but unlike companies, LLPs may be subject to less stringent compliance requirements, are free from the economic double taxation risk, as LLPs’ income accrues directly to their partners, at least in terms the changes proposed to the law nº 016/2018 of 13/04/2018 establishing taxes on income (Income Tax Law), and there is potentially no capital gains tax (CGT) in case of the disposal of interest in the LLP.

But what are the key tax considerations that should be borne in mind when converting an LLC into an LLP?

To begin with, and as legal consequence of converting an LLC into an LLP, article 110 of the law governing partnership provides that “(a)ll movable and immovable property vested in an (LLC), all assets, interests, rights, privileges and liabilities and the whole of the undertaking are entrusted with the (LLP), and the (LLC) is considered as dissolved.”

The reading of this provision clearly suggests that the conversion of an LLC into an LLP may be construed either as liquidation of the LLC and distribution of assets to the shareholders as the assets of the LLP are from a tax standpoint the assets of the partners, or transfer of the LLC business as a going concern to the LLP.

Where the conversion is construed as a sale/transfer of the converted LLC business to the LLP as a going concern, a valuation would have to be performed and the deemed proceeds from the transfer of the LLC assets would be taken into consideration in computing the LLC corporate income tax liability for its last tax year as per article 19 of the Income Tax Law, which provides that “business profit also includes proceeds of sale of any business asset…”

Such construction would also have value-added tax implications because unlike many jurisdictions, there is no exemption from VAT on slump sale transactions in Rwanda, and the conversion would be potentially taxed as a sale of business assets under article 4 of law n° 37/2012 of 09/11/2012 establishing the value-added tax as amended (VAT Law) which provides that “(t)he sale of any asset used by a person in the business is considered as a taxable action.”

Where the transaction is treated as a liquidation followed by distribution of assets to the shareholders (who would become the LLP partners), deemed proceeds from the transfer would, after deducting the value of the liabilities and the shareholders equity, be taxed as a dividend as per article 55 of the Income Tax Law. The VAT Law is not prescriptive on the tax implications of the distribution of assets in specie to the shareholders at the time of liquidation, but this may also potentially have VAT implications by being treated as a deemed sale on the basis of article 4 of the VAT Law.

However, if the proposed amendments to the Income Tax Law are enacted into law, the conversion of LLCs into LLPs will not have income tax implications considered above, as part of those amendments is the modification of the definition of tax-free restructurings for it to apply to other entities than companies as this currently is the case under the Income Tax Law. For instance, in terms of the proposed amendments, business restructuring includes the acquisition or transfer of the entire entity’s shares, assets or liabilities so that its existence is replaced by the purchasing or receiving entity, and this fully depicts the conversion of an LLC into an LLP. Under article 54 of the Income Tax Law, the transferring company is exempt from tax in respect of capital gains and losses realised on restructuring in case of a qualifying business restructuring.

Another tax consideration that is relevant to the conversion of an LLC into an LLP is the right to carry-forward losses. The provision of the law governing partnership that “all rights and privileges’ are entrusted with the LLP” would suggest that these rights include tax losses, and therefore, the LLP should be able to carry forward the losses of the converted LLC. However, this not being a provision in tax legislation, the tax administration should provide guidance regarding the tax implication, if any, of the conversion of an LLC into an LLP on the right of the converted LLC to carry forward losses.

The Income Tax Law is equally reticent on the cost basis for depreciation of assets transferred once on the LLP’s balance sheet i.e. whether they should be depreciated at their book value (as if the conversion did not take place) or there should be an adjustment of the cost basis of the transferred assets to their fair market value. This would however become irrelevant once the proposed amendments to the Income Tax Law are enacted into law as the conversion of an LLC into an LLP would constitute a qualifying business restructuring. Under article 54 of the Income Tax Law, the receiving entity would therefore have to value the assets and liabilities involved at their book value in the hands of the transferring entity at the time of restructuring and depreciate the business assets according to the rules that would have applied to the transferring entity as if the restructuring did not take place.

The conversion of an LLC into an LLP may be attractive to many companies, but there are a number of tax aspects to consider, all of which remain unclear. As such, specialist tax advice should be obtained before proceeding. The tax administration should also consider issuing guidance on the aspects discussed above, and particularly consider whether article 54 of the Income Tax Law can (pending the enactment of the proposed amendments) potentially be extensively applied to conversions of LLCs into LLPs given that the status quo is that partnerships are treated in the same way as companies for income tax purposes. Tax policymakers should also consider reviving the exemption of sale of a business as going concern from VAT which was provided for under the 2001 VAT Law.