Limited Liability Partnership Bill

Limited Liability Partnership (“LLP”) as proposed in the Limited Liability Partnership Bill, 2008 (‘the 2008 Bill’), is expected

to be a path breaking legislation in India and will change the landscape of how professional services firms are structured, run and taxed in this country. LLP aims at creating a new corporate form that enables professional expertise and entrepreneurial initiative to combine, organize and operate in an innovative and efficient manner.

The significance of this Bill lies in the fact that flexibility in the laws relating to conducting business in India will encourage foreign investment in the country. This article, thus analyses the concept of LLP; its importance in the present scenario; different aspects of the Bill; the changes as incorporated by the 2008 Bill; its implications and the issues relating thereto.

Need for a Alternative Business Structure

The concept of joint and several liabilities inherent in a partnership implies that the personal property of the partners is also liable for attachment for the satisfaction of the company’s debts in addition to the capital contributed by the partners in the firm. This unlimited liability attached to a partnership firm thus makes partnership a risky affair. Moreover, law does not permit incorporated companies to practice as companies’ secretaries, chartered accountants, lawyers or related professionals. Thus, the only option available with such professionals is to either work in a conventional partnership firm set up or as a sole proprietor.

Furthermore, as per Section 11 of the Companies Act, 1956, the traditional form of partnerships cannot expand beyond 20 partners without being incorporated as a company. This acts as a deterrent for the growth and expansion of service based organizations and has a depressing effect on the economy and the development prospects of the firm. Thus, the present legal framework regarding setting up business is incompatible with the policy of globalisation and liberalisation India adopted during 1990s and has a detrimental impact on the foreign direct investment in India.

Limited Liability Partnership – The Concept

LLP is a body corporate of unlimited capacity having a legal entity separate from that of its partners, where no member or partner are liable on account of the independent or unauthorized actions of one’s partner, and whose liability is limited to the respective stake of each in the LLP.

It is based on three broad principles:

·         Limited liability

·         Corporate personality

·         Partnership flexibility

The concept of ‘limited liability partnership’ is thus a combination of the organizational flexibility and tax status inherent in partnership form of business along with the advantage of limited liability for its partner. In essence, LLP strives to merge the advantages of a partnership firm with those of a company, while trying to mitigate their disadvantages to the maximum extent possible.

Comparison between Partnerships, LLPs and Private Limited Companies

Point of Comparison

LLPs

Partnerships

Private Limited Companies Governing Act

The Limited Liability Partnership Bill, 2008.

The Indian Partnership Act, 1932.

The Companies Act, 1956.

 

Composition

Minimum 2 Partners.

2 to 20 Partners.

2 to 50 shareholders.

Body Corporate

It is a body corporate having a separate legal entity capable of sueing and being sued in its own name.

It does not have a separate legal entity and it is not a body corporate.

It is a body corporate having a separate legal entity capable of sueing and being sued in its own name.

Incorporation

Name;

MOA equivalent Incorporation Document;

AOA equivalent LLP Agreement; Declaration by CA/CS/Advocate/ plus 1 subscriber to the Incorporation Document.

Application to Registrar of Firms for Registration of Partnership Firm

Name Availability; MOA; AOA; Declaration by CA/CS/Advocate/or person named as 1st Director

Registration

Registration with RoC required.

Registration with RoC optional.

Registration with RoC required.

Name

Name to end with LLP or Limited Liability Partnership

The firm, which is registered, shall use the brackets and word (Registered) immediately after its name.

Name can end with Private Limited

Common Seal

Yes

None

Yes

Minimum number of Directors/ Designated Partners

Designated

Partners: Atleast 2. One must be an Indian. DP’s must have PIN.

Designated Partners: There is no concept of DP’s/

Directors.

Designated Partners: Atleast 2 Directors. Citizenship need not be Indian. Director must have DIN.

Limitation of

Liability

Liability of a Partner is limited to the extent of his capital contribution or as agreed as per the LLP Agreement. But no partner is liable on account of an independent action on part of any other partner.

Every Partner is liable jointly (with all the other partners) and severally, for all acts of the Firm done while he is a Partner.

Liability of shareholder is limited to the extent of total amount due on shares subscribed.

Dissolution

By agreement or by order of National Company Law Tribunal.

By agreement, mutual consent, insolvency, certain contingencies, and by court order.

By court order once the affairs of the company have been wound up or court’s discretion.

Transfer / Inheritance of share

Transferable, but transferee may not have management rights.

Not transferable. In case of death the legal heir receives the financial value of share.

Transferable (with the consent of Board of Directors).

Taxation

Unspecified.

Income of partners taxed, not of partnership.

Income of company is taxed; income distributed to shareholders is also taxed.

Annual Return to be filed with

Registrar

Yes

No

Yes

Regulation

Would be Regulated by Registrar of Companies

Regulated by Registrar appointed by the respective

State Government under the Partnership Act.

Regulated by Registrar of Companies

Conversion

The Bill lays down provision for the conversion of some business model to the LLP structure.

The Indian Partnership Act does not have any specific provisions for conversion of Partnership into any other form of business

Conversion to an LLP is allowed

Management

By Partners / Designated

Partners

By Board of

Directors

By Partners

Growth of LLP in India

The issue of Limited Liability Partnership (LLP) has been a matter of debate for many years and various committees and expert groups have time and again recommended introduction of LLP legislation in India. While the Abid Hussain Committee recommended legislation on LLP in 1997 in the context of Small Scale Industries (SSIs), the Naresh Chandra Committee on Regulation of Private Companies and Partnerships (2003) and Dr. Irani Committee on New Company Law (2005) have also made recommendations for a separate LLP Legislation.

Limited Liability Partnership Bill, 2006

The ministry of Company Affairs after initiating a wide based consultative process on the proposals for a LLP Law and after analysing the international experiences of the countries like UK and USA, and considering the recommendations of the various corporate law reforms committee (Naresh Chandra Committee 2003, JJ Irani Expert Committee on Company Law 2005) introduced a Concept Paper on LLP Law along with explanatory notes on chapters on 15th December 2006 in the Rajya Sabha.

Limited Liability Partnership Bill, 2008

Limited Liability Partnership Bill 2006 was subsequently referred to the Department related Parliamentary Standing Committee on Finance under the Chairmanship of Mr. Ananth Kumar for examination and report. The Committee submitted its recommendations in its report to both Houses of Parliament on 27th November, 2007 and the present Bill was introduced in the Rajya Sabha on 21.10.2008. The Bill attempts to improvise the 2006 Bill and has taken in view the recommendations made by the Standing Committee and other relevant inputs. With the passing of the Limited Liability Partnership Bill, 2008 by the Rajya Sabha & the Lok Sabha the earlier Bill stands withdrawn.

Salient Features of the 2008 Bill

The salient features of the 2008 bill are as follows:

Nature of LLP - A LLP as envisaged in the Bill is a body corporate and a legal entity separate from its partners. It has perpetual succession and any change in the partners of a LLP will not affect the existence, rights or liabilities of the LLP. The Indian Partnership Act, 1932 will not be applicable to LLPs. It is proposed by the Bill that that the relevant provisions of the Companies Act, 1956, may be made applicable to LLPs by a notification by the Union government, if required.

The Bill provides that any individual or body corporate may be a partner in a LLP subject to certain disqualifications which have been introduced by the Bill. The Bill requires that every LLP will have at least two partners out of which at least two individuals should be designated partners; it shall have a registered office and shall have either the words “limited liability partnership” or the acronym “LLP” as the last words of its name.

Incorporation - Two or more professionals, who wish to associate for the purpose of providing an identified professional service, may subscribe their names in an incorporation document which shall be filed with the Registrar along with the prescribed fee. Further, a statement made by an advocate or company secretary or chartered accountant engaged in the formation of the LLP must also be delivered to the Registrar stating that there has been compliance with all the requirement of the enactment.

Effect of Incorporation - On incorporation, the LLP shall have the power of suing and being sued; acquiring, owning, holding and developing or disposing of property, both movable and immovable; having a common seal; and doing and suffering such other acts and things as bodies corporate may lawfully do and suffer.

The mutual rights and duties of the partners of an LLP inter se and those of the LLP and its partners shall be governed by a registered agreement between partners or between the LLP and the partners. Also, the obligation of a partner to contribute money or other property or other benefit or to perform services for a LLP shall be as per the LLP Agreement. In the absence of any such agreement, the mutual rights and duties shall be governed by the provisions of proposed legislation.

Extent and Limitation of Liability of LLP and Partners - The LLP will be a separate legal entity, liable to the full extent of its assets, where the liability of the partners would be limited to their agreed contribution in the LLP. Further, no partner would be liable on account of the independent or un-authorized actions of other partners or their misconduct. The liabilities of the LLP and partners who are found to have acted with intend to defraud creditors or for any other fraudulent purpose shall be unlimited for all or any of the debts or other liabilities of the LLP. The Bill has also introduced the concept of ‘holding out’ which is similar to that of ‘promissory estoppel’.

The Bill has brought in corporate governance by including the concept of ‘whistle blowing’. Any applicable penalties against the partner or an employee who provides useful information may be reduced or waived. The whistle blower may not be penalised by the LLP for providing such information.

Financial Disclosures - The LLP shall be under obligation to maintain annual accounts reflecting true and fair view of its state of affairs on cash or accrual basis and according to double entry system of accounting and shall maintain the same at its registered office for such period as may be prescribed. A statement of accounts and solvency shall be filed by every LLP with the Registrar within a period of six months from the end of financial year. Every LLP shall be required to get its accounts audited as per the rules prescribed subject to any exemption granted in this regard from this requirement by the Central Government. Every LLP shall be required to file an annual return with the Registrar within 60 days of closure of the financial year as per the rules prescribed.

Taxation - The taxation of LLPs shall be addressed in the Income Tax Act, 1961.

Assignment and Transfer of Partnership Rights - A partner’s economic rights, which include the rights of the partner to a share of the profits and losses of the partnership and to receive distribution in accordance with the limited liability partnership agreements, are freely transferable. However, a transfer in whole or in part of the transferable interest does not imply the partner’s disassociations or dissolution and winding up of the LLP’s activities. Further, they do not entitle the assignee to participate in the management or conduct of the LLPs activities or access information concerning the LLPs transactions. Moreover, the non-economic right will not be transferable unless specified by the LLP agreement.

Investigation - The Central Government shall have powers to investigate the affairs of an LLP, if required, by appointment of competent inspector for the purpose.

Conversion to LLP - A firm, private company or an unlisted public company would be allowed to be converted into LLP in accordance with the provisions specified.

Foreign Limited Liability Partnership - The Bill recognises a Foreign LLP as a LLP formed, incorporated or registered outside India which establishes a place of business within India. The Bill requires that the provisions of the Companies Act, 1956 will apply with such modifications as appear appropriate in relation to establishment of place of business by foreign LLP within India and carrying on their business therein in accordance with the rules made by the Central Government in this behalf. In all other respects the provisions of the Bill will apply.

Compromise, arrangement or reconstruction of LLP - Provisions have been made in the Bill for corporate actions like mergers, amalgamations etc.

Winding up and dissolution - The winding up of the LLP may be either voluntary or by the Tribunal to be established under the Companies Act, 1956.

Advantages of a Limited Liability Partnership

The advantages of the LLP agreement are as follows:

The personal liability of a partner in a LLP arises only in case of his own wrongful acts or omissions and not for such acts or omissions by other partners. Thus, all the partners in the LLP have limited liability protection.

The requirements as to board meetings, resolutions, annual meetings, formation of a partnership agreement etc. are not mandatory for a LLP. The Bill also provides for default provisions regulating the mutual rights and duties of partners and LLP and LLP and its partners in absence of an LLP agreement under Schedule I. Thus, less paper work and filing requirements makes LLP as a viable option as compared to other forms of business structure.

As in general partnership, the internal structure of LLP can be organized as per mutual agreement. Thus, the management structure of an LLP is more streamlined than in a limited company.

This arrangement allows for general partners to use their expertise, make key decisions and manage the business.

Partners in the LLP are able to allocate profits, losses and gains as they see fit, regardless of the equity interest of a specific partner, subject to compliance with tax laws.

There is no limit as to the maximum number of members in a Limited Liability Partnership.

Since LLP is a separate legal entity, its existence is not affected by the entry or exit of partners.

Before the introduction of this concept, professionals like accountants, lawyers and others could form either a sole proprietorship or partnership; both requiring unlimited liability of the owners. LLP thus brings a sense of relief to these professionals and gives them a more convenient option to form an organization.

Implications of the LLP Bill, 2008 to the Hedge Fund Industry

A hedge fund is a private investment fund, usually incorporated as a LLP, with the fund manager being the general partner and the investors in the fund being the limited liability partners.

Though the current SEBI guidelines does not allow an asset manager to run a short-bias fund, leveraged fund etc., the introduction of LLP structure will allow asset managers to start offering sophisticated portfolio strategies to individuals/corporate/institutions who desire them while limiting liability from losses and from SEBIs interference. The LLP structure will enable fund managers to float a LLP for each strategy in which the clients will become partners and the fund manager can be paid his fees directly by the LLP depending on the scheme’s performance. This will benefit the investment profession as well as investors.

Thus, the LLP structure attempts to benefit hedge fund industry, but it may not be feasible for a large number of clients and for small investors.

Implications to the Law Firm Industry

Lawyers have always viewed the prospect of being a member of a partnership firm with unlimited personal liability as a risky one. Despite the nature of the risks involved, lawyers in India have organised around the partnership model because the Bar Council of India Rules did not permit lawyers to operate as Executive Directors of companies, or even draw salaries. However, LLP as a business organisation seems to be a feasible option for the legal community as it accommodates size, diverse specialisation, management talent, and limited liability, along with the flexibility of internal management.

The LLP model will allow law firms to grow larger in a more aggressive fashion encouraging the growth of existing as well as new law firms.

The Bill also covers amalgamations between LLPs and affords law firms a long overdue opportunity to divorce ownership from management. The division of ownership and management provides opportunities to the present law firms to invite investments into their corpus which benefits the investors as well, as they would not be held responsible for the acts or omissions of the partners responsible for management/governance of the law firm.

However, there are certain key questions that have been left unanswered by the LLP Bill which needs to be considered by the law firms before considering LLP as an alternative business model. Some of them have been enumerated below:

1.      The Central Government has been empowered to exempt classes of LLPs from the requirement to maintain accounts. However, as of now, there are no indications if legal profession will be exempted.

2.      The Bill does not reveal any taxation policy towards the LLPs. Thus, while the LLP structure will certainly offer much better opportunities to the Indian law firms in terms of their size, enhancement in competence level, limitation of liabilities, better management etc., it will be premature to offer any comment as to whether migration to such structure will be tax efficient.

3.      The Bill is also silent on both the crucial aspects of conversion to a LLP model i.e. stamp duty and capital gains. It is also imperative that the Income Tax Act, 1961 should be specifically amended and provisions similar to Section 47 (xiii) be introduced in the IT Act, so as to afford the same benefits to any transfer of capital assets from a firm to an LLP. Thus, the LLP law will have to be supported by amendments to the Income Tax Act. The impediment of stamp duty should also be removed to encourage the LLP model. Thus, the Indian law firm partners will have to await conversion to LLP depending upon the shape this legislation will take on formulation.

4.      The Advocates Act, 1961 allows law firms to exist only in the form of sole proprietorships and partnerships. Therefore suitable amendments are also required to be made under the Advocates Act on the passing of the LLP Bill which will allow law firms to organise themselves in the LLP model.

Though the text of the 2008 Bill highlights various loopholes, the accompanying Statement of Objectives and Reasons displays a clear intention to incorporate in LLP the characteristic flexibility of a partnership with the limited liability of a corporation thus enabling professional services to operate in an efficient and flexible manner.

Shortcomings of the 2008 Bill

Position of a Minor

The LLP Bill 2008 has indicated the various disqualifications that will prevent an individual from becoming a member. However, the Bill fails to clarify the position of a minor and does not clearly specify if the minor will be admitted as a member of the LLP or to the benefits of partnership as in the case of the Partnership Act, 1930.

Designated Partners

The Bill provides that every LLP shall have at least two designated partners who are individuals and at least one of them shall be a resident in India. A designated partner is an individual who shall be answerable for the doing of all acts, matter or things as are required to be done by the LLP in respect of compliance of the provisions of this Bill; and liable to all the penalties imposed on LLP for any contravention of such provisions.

The First Schedule to the Bill which lays down the provisions regarding mutual rights and duties of partners and LLP and its partners applicable in the absence of any LLP agreement provides that “no partner shall be entitled to remuneration for acting in the business or management of the LLP”. It follows from this that the designated partners like other partners are also not entitled to any remuneration for their services. One fails to understand that when the whole idea of entering into a LLP is that to limit liability, why would a person give his consent to become a ‘designated partner’ if he is not entitled to any benefits or incentives.

Compulsory Insurance

To protect the interests of persons claiming against the LLP and to ensure that creditors do not suffer loss, LLP laws all over the world require all LLPs to compulsorily take out an insurance policy that would cover its liabilities as an LLP to a reasonable extent. Liability insurance is generally designed to cover different kind of omissions, negligence, wrongful acts, malpractices and misconduct for which liability is otherwise limited. The state of Virginia is an excellent example of compulsory insurance where LLP are required to carry liability insurance of at least one million dollars.

The Federation of Indian Chambers of Commerce and Industry (FICCI) in its 13 Points Agenda to Ministry of Company Affairs on Concept Paper on Limited Liability Partnership (LLP) have also recommended the employment of this project.

The Naresh Chandra Committee also observed that people who might have claims against an LLP might not get any real relief, since there will be no access to the assets of partners of the LLP except to the extent of his/her liability in the LLP. This would deter the creation of shell LLPs or asset-thin LLPs. The committee has thus made the following recommendations in this regard:

Compulsorily taking out of insurance cover and/or or funds in specially designated, segregated accounts by the LLP for the satisfaction of judgments and decrees against the LLP in respect of issues for which liability may be limited under law.

The extent of insurance should be filed with the RoC and made be available for inspection by interested parties upon request.

However, the 2008 Bill does not contain any provision in this regard. It is thus recommended that the Indian law should also contain similar provisions relating to compulsory insurance to safeguard the interest of the outsiders.

Impediment for conversion to LLP model: Payment of stamp duty and capital gain tax

Another major lacuna in the LLP Bill concerns the Stamp Duty Liability. The Bill fails to address whether the assets transferred by a partnership or private limited company or an unlisted company at the time of their conversion into LLP or in the event of their merger or amalgamation will suffer the Stamp Duty on the book value of assets. Further, the rates of stamp duty and any concessional rates provided by the government and the mode for the valuation of assets are questions left unanswered by the Bill.

In the UK LLP Act, 2000, stamp duty is waived on any property that is transferred in the process of a partnership being converted to an LLP during a period of twelve months after its incorporation.

In tune with the UK LLP Act and the recommendations of the FICCI it is suggested that a provision granting stamp duty relaxation on conversion of existing partnerships/ private and unlisted public companies to LLP should be incorporated in the LLP Bill in India.

Similarly, it is not clear from the Bill whether the partners contributing assets towards the Capital at the time of formation of LLP or receiving their share of capital and accumulated profits on transfer of their share will be liable for payment of capital gain tax. It is suggested that appropriate exemption must be granted under section 47 of the Income Tax Act, 1961 whereby on conversion of a firm into LLP the transfer of property must not be regarded as a taxable transfer for the purpose of levy of Capital Gain Tax. In the absence of such provisions, the partners of the firm have to pay huge sums as capital gain tax at the time of transfer which will act as a detriment for those firms willing to convert itself into LLP.

Application of the Companies Act, 1956 to LLP

According to the Bill the Central Government may at any time direct the application of the provisions of the Companies Act, 1956 to LLPs. This proposition, however, may not be easily acceptable to those who wish to convert from a company or a partnership firm to an LLP for the simple reason that procedures required under the Companies Act are cumbersome and highly technical and the primary object of LLP is to avoid such technical procedures.

Secondly, the bill does not provide any basis on which the Central Government can issue such directions. This uncontrolled discretion vested with the government is likely to be misused in the absence of proper guidelines. Suitable provisions in this regard in the LLP Act itself will thus help in reducing this freehand discretion of the government.

Tax Treatment of a LLP

Taxation is a key element in any business structure, and a clear tax policy is crucial to ensure that the LLP model achieves its objectives of facilitating growth and competition in the service sector in India. Though the press release issued after the passing of the Bill in the Rajya Sabha suggests that the taxation of LLPs will be addressed under the Income Tax Act, 1961, the LLP Bill 2008, is still unclear on this aspect.

S. 10 of the UK LLP Act lays down that a trade, profession or business carried on by an LLP, will be treated as carried on in partnership by its members and not by the LLP itself. Thus, any asset held by an LLP, or any tax chargeable on gains made will be treated as held by the partners, or gains made by the partners, and not by the LLP itself. In other words, an LLP in UK enjoys a pass-through status and is not taxable as such; the taxation liability falls on the partners in their individual capacity. In USA, as in a partnership or LLC, the profits of an LLP are distributed among the partners for tax purposes, avoiding the problem of ‘double taxation’ often found in corporation. In other countries also, such as Netherlands, Switzerland, Russia, Germany, Finland, and Singapore, LLPs are tax transparent which allows partners to withdraw their money and assets at the time of exiting the LLP without disturbing the business structure.

Moreover, it is essential to note that if the LLP itself is taxed, the foreign partner in a cross-border partnership may end up paying tax in his country for his income from the partnership registered in India even if the LLP’s entire income has already been taxed in India. Further, if the LLP generates income in India as well as abroad, the entity will have to pay tax here even for the income that is generated abroad.

The Naresh Chandra Committee Report and the Concept Paper on LLPs which was released by the Ministry of Company Affairs in November 2005 also aims for tax transparency for an LLP by imposition of tax on partners rather than taxing the LLP itself.

From the above discussion it follows that it is desirable to have a “pass through” treatment for an LLP and thus suitable amendment are required to be made in the Income-tax Act.

Consent of all the partners is required for admitting a new member to the LLP

The Bill provides that in absence of a LLP agreement the mutual rights and duties of partners and LLP will be governed as provided in the First Schedule. The Schedule requires that consent of all the partners is required before a new partner is inducted in the LLP. However, this unanimity could be impossible and difficult to secure, especially if the LLP is very large. Moreover, the First Schedule itself provides that any matter or issue (except a decision for change in business of company) relating to the LLP shall be decided by a resolution passed by a majority in number of the partners.

Thus, there appears to be a contradiction in the Bill as to requisite majority for taking such decisions. It is suggested a norm of three-fourth majority for taking major decisions be followed so that the working of the LLP may be stagnated by an intransigent minority of one or two.

Conclusion

The LLP model, if properly implemented is expected to act as an engine of growth for the economic development of the country and is likely to foster the growth of professional services in the country. LLP as an alternate business model will encourage joint ventures and make Indian service sectors globally competitive. It thus becomes imperative to give effect to these suggestions so as to make the proposed law more comprehensive and in tune with requirement of the modern business environment.

By Yash Jain & Aarushi Jain