“Great wealth and limited liability are circumstances that are rarely seen together.”
— Napoleon Hill
Limited liability partnership (LLP) is a breath of fresh air in world of company law. The LLP is viewed as an “alternate corporate vehicle”[1] which seeks to attain the principal benefits of both forms of business organisation — partnerships and companies. This is achieved by granting to the members of the LLP, the flexibility of organising their internal managerial structure as a partnership based on mutual agreement, while limiting the liability of the partners to the extent of their interests in the partnership, which is akin to the spate legal personality of a company.[2]
History
The concept of limited liability partnership originated in Texas in 1991 in unincorporated form, inspired by government litigation against law and accounting firms that had done work for failed savings and loan associations. The claims were against all partners including many who had nothing to do with the failed associations, highlighting the joint and several liability of partners for each other’s conduct. The prospect that all the members in a partnership of attorneys or accountants may be exposed to hundreds of millions of dollars in liability was a strong incentive for the development of mechanisms to limit the vicarious liability of partners. The LLP is the device developed to accomplish that objective. It has proved very popular.[3]
History of LLP in India
Back in 1932, a concrete suggestion was made by Iron, Steel and Hardware Merchant’s Chamber of India that partnership with limited liability should be recognised in India either by a special enactment or as a part of the Partnership Act, 1932:
Considering the recent amendment in the Indian Companies Act, we feel that a provision should be made in the Indian Partnership Act, 1932 by which Limited Liability Partnerships Act. The Indian Companies Act has become so cumbersome that for a small business it is impossible to comply with all the provisions unless a full-time secretary is engaged. Before the amendment was introduced in the Indian Companies Act, two or three partners used to find it convenient to register a private limited company and carry on the work. Now there are so many restrictions on taking loans by the directors or shareholders even in private limited companies that people will prefer to enter into a partnership instead of forming a limited liability company. The risk can only be minimised by introducing limited liability partnership.[4]
The suggestion was rejected having regard to the conditions prevailing in India, it was contended neither necessary nor expedient to make provision for limited liability partnerships in India.[5]
But this scenario changed rapidly and various committees made recommendations for legislations on LLPs in India:
(i) The Bhatt Committee in 1972;
(ii) Naik Committee in 1992;
(iii) Expert Committee on Development of Small Sector Enterprises headed by Sh. Abid Hussain in 1997;
(iv) Study Group on Development of Small Sector Enterprises (SSEs) headed by Dr S.P. Gupta in 2001;
(v) Naresh Chandra Committee Report in 2003 highlighted the grave need to introduce LLPs in the service industry, which finally succeeded in launching the concepts of LLPs in India;
(vi) J.J. Irani Expert Committee on Company Law in 2005 recommended to enact a separate legislation for LLPs in India, and also to extend the scope of LLPs to the small enterprises.[6]
In 7-1-2009, the LLP Bill received the assent of the President and was thereafter notified in the Official Gazette and the LLP Act was put into force by the Central Government on 31-3-2009.
The need for the LLP was realised by the Ministry of Corporate Affairs in the following words:
With the growth of the Indian economy, the role played by its entrepreneurs as well as its technical and professional manpower has been acknowledged internationally. It is felt opportune that entrepreneurship, knowledge and risk capital combine to provide a further impetus to India’s economic growth. In this background, a need has been felt for a new corporate form that would provide an alternative to the traditional partnership, with unlimited personal liability on the one hand, and, the statute-based governance structure of the limited liability company on the other, in order to enable professional expertise and entrepreneurial initiative to combine, organise and operate in flexible, innovative and efficient manner.[7]
One of the objectives behind the implementation of Limited Liability Partnership Act, 2008 was to give push to the small/medium enterprises (SMEs) and startups. Few facets of LLP are discussed below to give a clear view that how startups and SMEs can benefit from LLP and use it for their own advantage.
Capital contribution
LLP does not require any minimum capital contribution as opposed to the private limited companies requirement of Rs 1 lakh. Moreover, the contribution can be made through the means of instalments which also helps the startups and SMEs to avail these benefits and further shape their structure or policies.[8]
Eligibility
Any two or more persons can form a LLP for the purpose of carrying on any business, trade, profession, service or occupation.[9] Even a limited company, a foreign company, a LLP, a foreign LLP or a non-resident can be a partner in LLP. As per the recent clarification,[10] a Hindu Undivided Family (HUF) represented by its karta can be a partner of LLP.
Limited liability of partners
By virtue of Section 26 of the LLP Act, 2008[11] every partner becomes an agent of the LLP but not of the other partners. This provision is perhaps the most striking feature of the Indian law on LLP, distinguishing it from a partnership, wherein a partner is an agent of the firm and also other partners for the purpose of the business of the firm.[12]
In limited liability partnership a partner is not personally liable for any obligation arising in contract, torts, or otherwise, solely by reason of being a partner of the LLP.[13] Further, a partner shall not be personally liable for the wrongful act or commission of any other partner of the LLP.[14] Only liability arising from the misconduct of other partners is covered by this law. In Edlinger v. United States[15], the liability of a partner to the extent of their interest in the partnership or act or omission was upheld. Limited Liability Partnership Act, 2008 makes sure that the personal assets of a partner would not be attached to the negligent or wrongful act of his co-partners and thus widens the horizon for the people interested in startups and frees them from this fear as opposed to the sole proprietorship or the traditional partnership firm where the personal assets of the proprietor or partners could be at risk in the event of a failure of the business. Unlike proprietorship and partnership,[16] if an LLP becomes insolvent and is wound up, only the assets of the LLP are used to clear its debts. Thus this mode helps the partners to be free from personal liabilities or becoming bankrupt.[17] It enables them to use their professional expertise and encourages them take the initiative to combine with financial risk taking capacity in an innovative and efficient manner. Thus a partner of LLP is not personally liable, directly or indirectly, for any debts or obligations of LLP.[18]
Although the holy grail of limited liability has been achieved, its applicability to individual partners who are themselves negligent remains a conundrum. It is assumed that that the shield of liability will not be available to such member and lastly its importance depends on the scope of the LLP’s professional indemnity policy.[19] However, there is no shield at all where a member has to personally undertake a particular office or appointment in the course of the LLP’s business or where a third party e.g. a bank, demands personal guarantees. This has led to much discussion of what arrangements should be put in place to protect such members without creating unlimited liability for all.[20]
Further in Hosking v. Marathon Asset Management LLP[21] it was held that the profit share of a partner or a LLP member can potentially be subject to forfeiture where the partner or member has breached their fiduciary duties to the partnership.
Tax benefits
There are two popular models for taxation of LLPs which are used in various foreign jurisdiction viz. the French model and the other being UK and Singapore LLP model. In the French model, the LLP is treated as a fiscally transparent entity and merely the income of the partners are taxed and not the transparent entity.[22] Whereas in the United Kingdom and Singapore LLP models, the practice is to be accorded similar treatment to an LLP as a partnership.[23]
India has opted for the UK and Singapore LLP model practice i.e. to treat an LLP at par with a general partnership, so far as the tax treatment is concerned. Section 2(23)(i) of the Income Tax Act, 1961[24] implies that LLP shall be treated separate taxable entity. All the provisions concerning taxation of general partnership firms would apply mutatis mutandis to LLPs. The individual members of the LLP are treated as self-employed for tax purposes and are taxed on the profits of the LLP in accordance with their profit share entitlements.[25]
The income tax would be levied on the profits of the LLP and such profits would be taxable in the hands of the LLP itself. Partners would not be includible in computing the total income of the partners liable to tax under the provisions of Section 10 of the Income Tax Act, 1961.[26]
Remuneration to partners will be taxed as “Income from Business and Profession” which is within the scope of a “deduction” for computing income. In the event of failure to comply with Section 184 of the LLP Act, 2008[27] the remuneration paid to the partners will not be allowed as deductions on their personal income.[28] Substantially reduced National Industrial Contributions (NICs) arise on remuneration (profit shares) of individual members compared to salaries of employees. Provided they have self-employed status, no employer?s NIC liabilities arise on their remuneration.[29]
Some other tax advantages available to the LLPs, are like exemptions from some of corporate taxes, such as presumptive tax, dividend distribution tax or minimum alternate tax.[30] Since the LLPs have been treated at par with the general partnership, they would not be liable to dividend distribution tax and minimum alternate tax.[31] Further, the Budget 2009-2010 has also scrapped the surcharge on tax for firms. Also, if the LLP is a non-resident under the Information Technology Act, 2000 (its control management is wholly situated outside India), it would continue to be taxed at 30% plus applicable cess.[32]
Ease in loans
Another incentive to form an LLP for SMEs and startups is the ease in getting loans as security creation gets easier. This is because a LLP, upon incorporation, will be treated as a body corporate and will be considered as a legal entity separate from that of its partners. Thus banks or other financial institutions will be able to enforce securities while granting the loans specifically as the LLP can be sued being a separate legal entity.[33]
No requirement for compulsory audit
Unlike limited companies, whether private or public, where irrespective of their share capital they are required to get their accounts audited, in LLP, there is no such mandatory requirement. Only the LLP whose turnover exceed Rs 40 lakhs or whose contribution exceed Rs 25 lakhs are required to annually get their accounts audited by any Chartered Accountant in practice.[34] This is a significant compliance benefit for the startups as well as SMEs.
The LLP system combines the advantage of the traditional corporate structure and the entrepreneur-centric proprietary/partnership structure and will help more “marriages between brains and bank balances” take place within the small enterprise/business sector, just as is supposed to happen every time a company in the organised corporate sector issues capital to the public in the form of equity shares or debentures.[35]
FDI investments
Vide RBI/201314/566 A.P. (DIR Series) Circular No. 123 dated 16-4-2014 Indian Government has allowed foreign direct investment (FDI) in LLP. This allows the formation as well as registration of LLP under the LLP Act, 2008 to receive FDI subject to certain conditions as detailed under the abovementioned Circular.[36]
Dissolution
In Magi Capital Partners LLP, In re[37] in matters of dissolution, it was held that an LLP is more akin to a company than a partnership since this involves the winding up of a separate legal entity, incorporated under a statute. The Court held that:
In a limited liability partnership, it is accepted that it is a different entity, which is a creature of statute, and that it is not possible to exclude the statutory right to apply to have the statutory entity wound up by the court.
But despite the said advantages, recent statistics suggests that startups still do not prefer LLP and that there has been almost a 26% rise in private limited company formation. This may be due to various intrinsic problems which the individuals fare due to certain provisions of LLP in India. Some of the problems are:
Operational finance: Most startups are self/family funded with limited workforce which makes it difficult to maintain records both financial and operational. LLP has to maintain such books of account as provided in Rule 24 of LLP Rules.[38] Need for financial declaration has been accepted as non-discriminatory for the limited liability defence provided by the LLP. But Section 36[39] provides that the incorporation document filed with the Registrar, including the account of solvency, will be open to inspection by any person. This implies that the financial whereabouts or information of the LLP is open to complete public dissection which is advantageous for startups and SMEs especially when they are facing financial issues. Therefore, it would be preferable if the word “any person” is removed from Section 36 and selected set of authority should be allowed to have ingress to it.
Funding/capital deficiencies: Capital and access to capital has been a perennial problem for startups. LLPs cannot raise capital from the public as opposed to a company. Startups and small and middle enterprises anyways face the problem of capital deficiencies and the abovementioned norms simply add on to the problem instead of solving it.
Less business credibility: In addition to the Indian culture which has conditioned people to look down upon failure, it is a prominent fact that other business and many consumers or client do not see LLP as a credible business. Corporations tend to gain more credibility and respect. People need to start accepting failures and allow second chances and get accustomed to changes and growth in the sphere of company law.[40]
FDI restrictions: There are many restrictions on FDI investments in LLP as opposed to a private limited company. As per FDI norms, FDI in LLP is allowed only through government route and not under automatic route. Moreover FDI in LLP is allowed to only those sectors where 100% FDI is allowed under automatic route under the FDI policy.[41]
Restrictions on growth: There are certain provisions in LLP which hinders their long time growth. For example, one can go public by converting private limited into public limited company, but in the other case, LLP Act does not permit the conversion of LLP into private limited or into public limited.[42] This discourages the startups to opt for the option of LLP on the touchstone that it hinders their interests in the long run.
There are several other issues related to LLP which must be resolved by the Central and State Governments to make LLP more feasible to individuals. Some of these issues can be listed as under:
A. Loopholes/ambiguity regarding conversion of firm/company to LLP under Section 56 of the LLP Act, 2008[43]:
(i) Whether carried forward capital losses, business losses and unabsorbed depreciation in the hands of the firm/company will be allowed to be adjusted against capital gains, business income, etc. of the LLP on such conversion.
(ii) Whether any stamp duty will be payable when assets/liabilities of firm/company are transferred to and vest in the LLP on such conversion.
(iii) Position of transfer of patents, copyrights, licences, etc., on such conversion requires clarification.
(iv) Position of transfer of tenancy rights from the firm/company to LLP on such conversion.
(v) Position of transfer of Provident Fund/Employees’ State Insurance Corporation, etc. registration on such conversion.[44]
B. Whether minor can be admitted to the benefits of LLP or whether minor can become a member in LLP as allowed in partnership.[45]
C. Section 33 of the LLP Act, 2008[46] provides that the responsibility of partners to contribute money for other property shall be in conformity with the LLP agreement. But the Act fails to provide for any corresponding provision which can administer the situation in the absence of agreement.[47]
D. Section 23(2) of the LLP Act, 2008 provides that the LLP agreement should also be filed with the registrar. This is not essential as the agreement is for the internal affairs and the same should not be made public. Even in UK the LLP agreement is not required to be filed with the authorities or any registrar and hence is not public.[48]
Conclusion
As recommended by J.J. Irani Committee that: In view of the potential for growth of the service sector, requirement of providing flexibility to small enterprises to participate in joint ventures and agreements that enable them to access technology and bring together business synergies and to face the increasing global competition enabled through World Trade Organisation, etc., the formation of limited liability partnerships (LLPs) should be encouraged.[49]
LLP will prove to be a boon to the startups as well as SMEs once the loopholes will be deduced and rectified by the Government. LLP is the need of the hour which will take our corporate sector to new heights in the global level.
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* Student BA LLB (Hons.), National University of Study and Research in Law, Ranchi.
[1] Ministry of Corporate Affairs, Government of India, Need for the New Corporate Form – LLP, <http://www.llp.gov.in/aboutllp.htm>.
[2] Amit M. Sachdeva and Sachin Sachdeva, The Indian LLP Law: Some Concerns for Lawyers and Chartered Accountants.
[3] Limited partnerships and limited liability limited partnerships, by Professor Johan Henning, Amicus Curiae Issue 31, October 2000, Centre for Corporate Law and Practice, Institute of Advanced Legal Studies, University of London.
[4] Law Commission of India, Seventh Report on Partnership Act, 1932 at 8.
[5] Ibid.
[6] Ministry of Corporate Affairs, Government of India, FAQs on Applicability of the LLP Act, <www.mca.gov.in/MinistryV2/applicabilityofthellpact.html>.
[7] Ministry of Corporate Affairs, Government of India, LLP Act, <http://www .mca.gov.in/ Ministry/pdf/LLP.pdf>.
[8] Advantages of a Limited Liability Partnership, Lawyered, 1-5-2017, <https://www.lawyered.in/legal-disrupt/articles/advantages-limited-liability-partnership/>.
[9] FAQs on Limited Liability Partnership, The Institute of Company Secretaries of India, November 2017.
[10] Ministry of Corporate Affairs, Clarification, F.No. 1/13/2012 CL-V, 27-5-2016.
[11] Limited Liability Partnership Act, 2008, S. 26.
[12] Partnership Act, 1932, S. 18.
[13] LLP Act (n 11) S. 8.
[14] Ibid. S. 8 (3).
[15] No: 3:10-cv-148, 2010 WL 1485951 (NDNY 14-4-2010).
[16] Income Tax Officer v. Arunagiri Chettiar, (1996) 9 SCC 33; Ashutosh v. State of Rajasthan, (2005) 7 SCC 308.
[17] Utsav Gandhi and Ravi Thakur, A Study on Limited Liability Partnership as an Emerging Business Form for Entrepreneurs, Institute of Law, Nirma University (hereinafter “Utsav Gandhi”).
[18] Vohra v. Cadigan Arbor Park, No. G040387, 2010 WL 1102428 (Cal. App. 4 Dist. 25-3-2010).
[19] Gandhi and Thakur (n 17).
[20] Von Roderick I’Anson Banks, The UK Limited Liability Partnership — The Hidden Dangers, <rciab@partnershipcounsel.co.uk>.
[22] Sen, Nivedita et al. (2011), “Decoding The New Business Vehicle of India: The Limited Liability Partnership” NUJS Law Review, Vol. 4 (Oct-Dec) at 683.
[23] LLP Online, International Scenario, <http://www.llponline.in/>.
[24] The Income Tax Act, 1961, S. 2(23)(i).
[25] Structuring a Business as a Limited Liability Partnership (LLP), Macfarlanes LLP.
[26] IT Act, (n 24), S. 10.
[27] LLP Act, (n 11), S. 184.
[28] IT Act, (n 24), S. 184, as amended by Finance Act, 2010.
[29] Macfarlanes LLP.
[30] IT Act, (n 24) S. 10(2-A) and S. 28(v).
[31] LLP Online, Tax on LLP, <http://www.llponline.in/tax_llp.php>.
[32] Chaudhry, Sharmendra, “Limited Liability Partnership in India” at 17-18, <http://ssrn.com/abstract=1708215>.
[33] Behura, Monica, “LLP will help SMEs attract capital”, The Economic Times, 9-1-2009, available at <http://articles.economictimes.indiatimes.com/2009-01-09/news/28436003_1_llp-bill-llp-structure-limited-liability>.
[34] Alok Patnai, Audit Requirements for LLP in India, Taxmantra, 11-5-2017, <https://taxmantra.com/audit-requirements-for-llp-in-india/>.
[35] Behura Monica, (n 33) (last visited on 26-8-2013).
[36] Indian Government amends FEMA for permitting FDI in LLPs, India Juris, 25-4-2014.
[37] 2003 EWHC 2790 (Ch).
[38] R. 24 of LLP Rules, 2008.
[39] LLP Act, (n 11), S. 36.
[40] S.J. Prashant, Limited Liability Partnership in India — A Critical Analysis of the Naresh Chandra Committee Report on “Regulation of Small Companies and Partnership”, <www.indlaw.com/display.aspx?41-CA374-E-CC62-4453- A14-E>.
[41] Abhyudaya, Difference between Limited Liability Partnerships & Private Limited Company (LLP and LLC), 12-8-2011, <https://blog.ipleaders.in/difference-between-llp-and-llc/>.
[42] Agam Gupta, Why Startups Choose Private Limited Over LLP?, iamwire, <http://www.iamwire.com/2015/03/startups-choose-private-limited-llp/112577>.
[43] LLP Act, (n 11), S. 56.
[44] Shri P.N. Shah, Taxation of Limited Liability Partnerships (LLP) in India, Taxguru <https://taxguru.in/corporate-law/taxation-of-limited-liability-partnerships-llp-in-india.html>.
[45] R. Gopalakrishnan, SSIs: Why not ask for limited liability partnership? <http://www.hinduonnet.com./thehindu/features/ssi/stories/2004082800280123.html>.
[46] LLP Act, (n 11), S. 33.
[47] Ravi Sharma, Limited Liability Partnership — Evaluation of the new business vehicle, Corporate Law Adviser, Vol. 90/3, 15-6-2009.
[48] Shivani Maurya, Limited Liability Partnership: A Critical Analysis, Perennial Publications LLP, 20-8-2017.
[49] LLP Online, J. J. Irani Committee, <http://www.llponline.in/jj_irani_committee.php>.