Changing A Personal Restricted Legal responsibility Firm Into A Restricted Legal responsibility Partnership: Key Tax Concerns – Gross sales Taxes: VAT, GST

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.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.