06 January 2008
Three organization forms have dominated the Indian business scene ΓÇö Companies, Partnerships and Sole Proprietorships.
Partnerships/Sole Proprietorships are largely unregulated and are being used by entities ranging from small kirana stores to large international professional outfits. However, an unlimited liability poses a significant hindrance to growth, especially in the case of professional firms, considering a general increase in incidence of litigation against professionals.
In a Company, shareholders are not liable for corporate debts beyond their investment, but these advantages come at the price of a whopping 14.025% additional taxation ΓÇö commonly known as the Dividend Distribution tax.
Limited Liability Partnerships (ΓÇÿLLPsΓÇÖ) combine the characteristics of corporate and non-corporate entities; LLPs have the advantage of limited liability without any additional distribution tax. The advent of the LLPs, in addition to providing the Indian entrepreneur a new business form, will provide Indian professional organisations a level playing field with their international counter-parts.
Most western economies have provisions for hybrid entities like the LLPs. The United States legislation provides for six independent business forms, including the Limited Liability Partnership and also the Limited Liability Company (ΓÇÿLLCΓÇÖ). The LLP form in the US can be used only by professional outfits. The US LLP is governed by state laws, and in general, each partner in an LLP is fully liable for the debts of the partnership, but not for the acts of professional negligence of other partners. The LLC structure on the other hand is predominantly a corporate entity, which has the flexibility of choosing its tax classification (i.e., as a corporate or partnership) for the purpose of federal taxes, however, many states in the US levy an additional franchise tax or capital tax on LLCs.
Looking at international trends, the Ministry of Company Affairs has published the Concept paper on LLPs, based on the Reports of Naresh Chandra Committee and Dr. J. J. Irani Committee1.
A closer look at the LLP ΓÇö The Indian scenario:
The Concept Paper is divided into 16 chapters and 5 schedules provides the basic framework of guidelines applicable to the LLP.
The incorporation procedures of the LLP are similar to those of a Company. Each LLP is required to have a registered office in India and two persons are required to subscribe their names to the ΓÇÿincorporation documentΓÇÖ in the requisite format.
Further, each LLP is required to appoint a manager (not necessarily a partner of the LLP) who is responsible for ensuring statutory compliance by the LLP. The role of a manager in an LLP is comparable to that of a Director in a Company.
Even though an LLP is very similar to a Company in many respects, it is still in essence a partnership. The primary distinction between Partnerships governed by the Indian Partnership Act, 1932 (Partnership) and LLPs stems from the fact that in a Partnership, Partners act as agents as well as principals on behalf of each other, whereas in an LLP, Partners act as agents only on behalf of the LLP.
It is interesting to note that economic interests of a Partner, (that is to say the right to share in profits and shares of the LLP) are freely transferable; however the non-economic rights, such as the right to participate in management, shall not be transferred unless specified in the LLP Agreement. Hence, it is possible to segregate ownership from management in an LLP structure.
The Concept Paper issued still needs to evolve, however, some aspects which one should consider before adopting the LLP structure are:
Bending in favour of the LLP:
ΓÇó Limited liability :
The liabilities of the LLP are met out of the estate of the LLP. Stated differently, a partner will not be held personally liable, directly or indirectly, for an obligation of the LLP, solely by reason of being its partner. The liability of the partners may be unlimited where they act with the intent to defraud.
ΓÇó Pass-through entity for tax purposes :
Probably the most important advantage of the LLP is the avoidance of economic double taxation, coupled with the limited liability of the Partners. Business losses/profits of the LLP shall be regarded as the losses/profits of the Partners acting in partnership. Even capital gains on disposal of the assets of the LLP shall be taxed in the hands of the Partners as such. However, clarity would be needed in understanding whether or not the limited liability of the Partners in an LLP extends to outstanding income-tax dues.
ΓÇó Flexibility in inter-se Partner arrangements :
The rights, shares in profits/losses, duties of the Partners of the LLP to each other and to the LLP are governed by agreements between the Partners. This provides the LLP with complete flexibility to define the relationship between all Partners.
ΓÇó Perpetual Succession:
Unlike General Partnerships, LLPs are regarded as a body corporate having perpetual succession and a legal status separate from that of its partners.
ΓÇó No limit to maximum number of partners :
Any number of partners may be admitted to an LLP, however, if the number of partners in an LLP falls below two and the business is carried on for a period exceeding six months, the continuing partner shall be liable for the obligations of the LLP incurred during the period.
ΓÇó Limited compliance :
Companies are required to keep detailed minutes to record all proceedings and resolutions. The LLP business structure requires lower compliance and is easier to operate.
Bending away from the LLP :
ΓÇó Privacy :
Declaration of solvency made by the manager of the LLP is to be periodically filed with the Registrar. The Declaration of solvency may be required to be supported by financial information of the LLP. Hence, limited liability of the LLP comes at the cost of loss of privacy of information.
ΓÇó Getting listed :
It appears that the intent of the Government is only to give liberty to companies to get listed. Businessmen who wish to take their company public may hence refrain from using the LLP structure.
ΓÇó Legal uncertainty :
Like most new regulations, the guidelines of the LLP will also be subject to uncertainty and litigation, which may not go too well with the risk-averse businessman.
The advantages of the LLP make it a very tempting option for most professionals, venture capitalists and entrepreneurs who do not wish to leverage the company on the strength of the capital markets, however, many may still prefer tried- and-trusted business forms with high degree of legal certainty.
Whether or not the LLP becomes a mainstream business form in the long term, only time will tell.