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Conversion of a limited partnership into a limited liability company: taxation
Given current trends, more taxpayers are choosing the legal form of a limited liability company. The conversion process, especially taxation, can be problematic. First prepare the necessary documents: the converting company's financial statements, conversion plan and draft articles of the limited liability company. A notarial record is also required, as is consent from general partners and limited partners representing two-thirds of the limited partnership contributions. Importantly, the company's accounting matters must be properly completed: under the Accounting Act, the converting company's books should close on the day before KRS registration, and the new books should open on registration.
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Tax optimisation
Besides managing the process, ensure the conversion is tax-efficient. Taxpayers usually convert for optimisation reasons, though whether a limited liability company is worthwhile depends on individual circumstances. Remember that the conversion itself may be taxed. For the company, civil law transactions tax of 0.5% applies if the converted company's share capital exceeds that of the converting company (Article 1(3)(2) of the PCC Act).
Also consider tax from the partners' perspective. For individual partners, the condition is similar to PCC: if conversion increases share capital relative to the value of contributions to the limited partnership, the individual partners earn income from participation in a legal person's profits under Article 24(5)(4) of the PIT Act, subject to capital income tax. In practice, higher share capital increases a partner's share of company profits. If there is no such increase, no tax obligation arises, as confirmed by the Director of National Tax Information:
Under the Director's tax ruling of 11 January 2023, 0114-KDIP3-1.4011.1060.2022.4.MK1, if converting a limited partnership into a limited liability company does not increase the latter's share capital relative to the former's basic capital before conversion or transfer funds from the company's reserve capital to the limited liability company's share capital, the partners do not earn conversion income. In that case, there is no obligation to withhold flat-rate PIT.
We increased share capital through conversion: what should we do?
Under Article 42 of the PIT Act, the company must account for tax by the twentieth of the month after conversion (tax should be calculated on the conversion date). This flat-rate tax is 19% of the increase.
The general partner deduction mechanism is available. When paying profits, the partner's share of tax paid by the limited partnership is deducted from the 19% tax that would otherwise be withheld. For example:
A general partner that is a limited liability company, under Article 7b(1)(1)(f), may reduce its tax by its profit share multiplied by tax paid by the limited partnership. Suppose the partnership earns PLN 10,000 and the general partner's share is 0.5%. Its CIT relief is (0.5% * 10,000 * 9% CIT).
A limited partner may obtain a capital income tax exemption for 50% of revenue up to PLN 60,000 under Article 21(51a). Usually, however, this is unavailable if any condition in Article 21(40) is met, namely:
- Directly or indirectly holds at least 5% of shares in a legal-person company or capital company being formed that is a general partner of the limited partnership.
- Is a management board member of:
- a) A legal-person company or capital company being formed that is a general partner of the limited partnership.
- b) A company directly or indirectly holding at least 5% of shares in a legal-person company or capital company being formed that is a general partner of the limited partnership.
- Is related, within the meaning of Article 23m(1)(4), to a board member or partner of a company directly or indirectly holding at least 5% of shares in a legal-person company or capital company being formed that is a general partner of the partnership.
Simply put, if a limited partner has a significant holding in another company or sits on its board and that company is linked to the partnership, the partner loses the 50% tax reduction on revenue.
If this article interested you, explore our company conversion services and see how we can help:
Summary
Converting a limited partnership into a limited liability company may help optimise taxes but requires careful analysis and preparation of documents. The conversion may trigger tax both for the company and the partners, including civil law transactions tax and income tax on profits. The general partner deduction on profit distributions is important, while limited partners may qualify for a capital income tax exemption up to a certain amount if they do not meet specific disqualifying conditions. It is worth using an accounting firm such as TaxCoach to help through the process and optimise conversion taxation.
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