LLP-Excellent hybrid of partnership & company

LLP at a glance

Overview of LLP Act

Presently, two forms of business organisation are popular - partnership under Indian Partnership Act and company under Companies Act.

Partnership form of organisation provides flexibility of operations. However, its basic disadvantage is unlimited liability and the fact that partners are agents of partnership firm as well as other partners, since act of partner binds partnership firm which in turn binds other partners also.

Companies Act does remove defect of unlimited liability but over the years, lot of rigidity has entered the Companies Act. There are many restrictions on managerial remuneration, loans, investments, guarantees, selling agents, contracts where directors are related etc. Many procedural formalities like registration of charge, periodic meetings and filing of numerous documents with ROC is required. Many statutory registers and records are to be maintained.

This rigidity is acceptable and indeed  required when public money is involved i.e. in case of listed companies. However, in case of private companies and small public companies, these restrictions reduce flexibility in operations and increase administration costs.

Solution - The solution is provided in form of LLP, major portion of which has become effective from 1-4-2009.

LLP is ideal blend of partnership and company - You mix Companies Act and Indian Partnership Act, remove all defects of traditional partnership firm, remove all procedural hassles and rigidity in Companies Act, keep good points of both Indian Partnership Act and Companies Act and what you have is Limited Liability Partnership! This, in brief, is the description of Limited Liability Partnership Act, 2008.

LLP is excellent hybrid of Partnership Act and Companies Act. LLP is a very good substitute to formation of a private limited company.

LLP may not be a good substitute for small family owned partnerships, but will be excellent tool for professional partnerships.

Even in case of small partnerships, in certain situations, LLP may be a good option. If the proposed activity is of manufacture, service providers, import/export etc.; there can be a sudden huge tax liability. if some unexpected tax demand comes. In such cases, LLP gives protection.

LLP is also a good alternative for partnerships where some of the partners are willing to provide finance but do not want to be saddled with unlimited liability which can accrue in case of traditional partnership firm.

Higher cost compared to normal partnership – Costs of running LLP are high compared to traditional partnership under Indian Partnership Act. Various documents are to be filed periodically with Registrar of Companies (ROC) and accounts and records have to be maintained.

Much fewer procedures - Procedures are much fewer compared to Companies Act. However, there is scope for further reduction in procedures.

All portions of LLP Act have become effective

Major portion of LLP Act was made effective from 1-4-2009 vide notification No. SO 891(E) dated 31-3-2009. Following provisions of LLP Act were not made effective on 1-4-2009 but have been made effective w.e.f. 31-5-2009 –

Thus now all provisions of LLP Act are in full force.

Registration of LLP has commenced - Registration of LLP has commenced from 1-4-2009 and some LLPs have already been registered.

LLP Rules - ‘Limited Liability Partnership Rules, 2009’ are notified effective from 1-4-2009. These rules also contain provisions relating to conversion of firm or company to LLP [rules 32, 33, 38, 39 and 40]. These rules have also been made effective from 31-5-2009. The rules do not contain provisions relating to winding up and the provisions of winding up have not been made effective so far.

Basic features of LLP

Basic features of LLP are as follows -

Limited liability and perpetual succession - LLP is a body corporate having perpetual succession [Section 3(1) of LLP Act, 2008]. It is a legal entity separate from its partners [Section 3(2) of LLP Act, 2008].

Any change in the partners of a limited liability partnership shall not affect the existence, rights or liabilities of the limited liability partnership [Section 3(3) of LLP Act, 2008].

No partner is personally liable to liabilities of LLP except in case of fraud [Sections 27 and 28 of LLP Act, 2008]. Liability of LLP is not liability of individual partners.

Partner is agent of LLP but not of other partners - Every partner of LLP is agent of LLP but not of other partners. Thus, he can bind LLP by his acts but not other partners.

Flexibility in operations of LLP - The LLP Act provides great flexibility in management and operations of LLP. In many of the cases, provision as contained in LLP Agreement prevails.

Accounts and annual returns - Each LLP will have to maintain accounts. It will have to prepare Statement of Account and Solvency. This statement and Annual Return is required to be filed with Registrar of Companies. LLP having turnover/contribution beyond prescribed limits will have to get their accounts audited by Chartered Accountant.

Ministry of Corporate Affairs is administrating ministry - Ministry of Corporate Affairs, Government of India is the administrating ministry. Registrar of Companies (ROC) of respective State is the administrative authority where all documents are to be filed.

All thinking and concepts of company law have come in LLP since administrative ministry is same. Procedures regarding incorporation of LLP, e-filing of returns, inspection and investigation, reconstruction and amalgamation, compromise, winding up etc. are identical or similar to Companies Act.

Provisions of Companies Act can be made applicable - Central Government can make applicable any provision of Companies Act to LLP with suitable modifications by issuing a notification [Section 67 of LLP Act, 2008]. This provision is risky since rigidity under Companies Act can be brought in LLP Act through back door.

Indian Partnership Act does not apply - Provisions of Indian Partnership Act will not apply to LLP [Section 4 of LLP Act, 2008].

LLP can be constituted for profession as well as trade/manufacture - It was thought that LLP Act is necessary to form partnership among professionals only. However, LLP Act does not contain any such restriction. LLP can be constituted for any ‘business’ having profit motive.

Procedure for Incorporation of LLP at a glance

LLP Agreement

‘Limited liability partnership agreement’ means any written agreement between the partners of the limited liability partnership or between the limited liability partnership and its partners which determines the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership [Section 2(1)(o) of LLP Act].

After incorporation, LLP may have Limited Liability Partnership Agreement. This agreement will govern mutual rights and duties of partners of LLP and mutual rights and duties of LLP and its partners. The agreement can be changed and details should be filed with ROC [Section 23 of LLP Act, 2008].

The LLP Agreement is similar to Articles of Association of company. Such LLP Agreement is theoretically optional. If such agreement is not there, mutual rights and duties will be as specified in first schedule to LLP Act.

Many of the standard clauses in first schedule to LLP Act will not be acceptable in majority of the cases. Further, fees payable for filing a document depend on ‘contribution’ of partners. Hence, practically, each LLP will be required to have LLP Agreement.

The provision of rules are such that the agreement can be signed and executed either before incorporation or after incorporation of LLP. LLP Agreement is very vital for operation of LLP. The details are discussed in a later chapter.

Stamp duty payable on LLP agreement - Since LLP Agreement is a new instrument, obviously, it will not find place in any schedule of State Stamp Act. If the entry in schedule simply reads ‘Partnership Deed/Agreement’, then LLP Agreement can fall under that entry. However, if entry reads ‘Partnership deed/agreement under Indian Partnership Act’, then obviously LLP Agreement will not fall in that heading. In that case, it should fall under residual entry i.e. Any other agreement’ ,  ands stamp duty will be payable accordingly.

General comments on LLP Agreement - Just as a shirt cannot fit all persons, there cannot be a standard LLP agreement which will fit requirements of all types of LLPs.

LLP can be of different sizes and for different purposes. Some LLPs may have few partners while some may have huge number of partners. Some LLPs may be in form of family partnerships while some may be in form of Joint Ventures.

These aspects have to be kept in mind while drafting LLP agreement. The agreement should not be rigid and should provide as much flexibility as possible. More the rigidity, more the problems of operations.

Interests of all parties should be kept in mind. Chances of oppression and mismanagement by some partners cannot be ruled out. There can be oppression of majority. These factors should be considered and proper care should be taken.

Types of partners - As per section 18 of India Partnership Act, a partner is agent of firm. Section 19 of Indian Partnership Act states that act of partner in usual course of business binds the firm. Thus, any partner can bind the firm. Since firm is responsible for acts of a partner, acts of one partner binds all other partners. Thus, they are ‘mutual agents’.

However, under LLP, authority of a partner can be restricted by way of LLP agreement. Such restriction may not be required in caser of small family managed LLP but should be provided in large firms.

LLP Agreement can provide for different categories of partners. Some may be termed as Senior/Managing/Executive Partners, some may be termed as ‘Partner’ and some may be even ‘Junior Partner’.

Veto powers to one or more partners - If one or more partner/s intend to control LLP, the agreement can provide them veto power i.e. LLP agreement can provide that in any meeting of Partners or Senior/Managing/Executive Partners, there will be no quorum if they are not present and no resolution can be passed without their affirmative note.

Executive/Managing Committee in case of large LLP - In case of LLP with large number of partners, it is unworkable to give executive or operational powers to all partners. Hence, it may be advisable to form a committee of senior partners which may be termed as Executive/Managing Committee. In my opinion, the number should not exceed five or seven to make it manageable.

Main clauses of LLP agreement in form 3 - Columns 7 to 20 of Form 3 are in respect of information with regard to LLP agreement. It is highly advisable to draft LLP Agreement in same sequence as far as possible, so that filling form 3 and its checking by ROC will be easy.

Income tax of LLP

LLP incorporated in India will be assessed as if it is a partnership firm. Section 10(23) of Income Tax Act states that ‘firm’ shall include LLP, ‘partner’ shall include partner of LLP and ‘partnership’ shall include LLP.

LLPs incorporated outside India (foreign LLPs) shall be taxed as ‘company’.

Share of profit of LLP at the hands of partners will be exempt [section 10(2A) of Income Tax Act]..

Remuneration to partners – Remuneration paid to partners is deductible at the hands of LLP within limits prescribed under section 40(b) of Income Tax Act, if requirements of section 184 are satisfied. As per section 185 of Income Tax Act, if the requirements of section 184 are not satisfied, firm will be assessed as firm but shall not be eligible for deduction of remuneration or interest to partner.

As per section 40(b) of Income Tax Act, maximum amount deductible in respect of remuneration to partner of LLP is as follows – (a) If book profit is negative or les than Rs 1,66,667– Rs 1,50,000 (b) If book profit is Rs 1,66,667 or more – On first 3 lakhs 90% and on balance 60%.

The amount deductible from income of LLP will be the amount given above or amount actually debited to profit and loss account of LLP, whichever is lower.

Remuneration paid/credited to partner will be allowable as deduction to LLP and it will be taxed at the hands of partner of LLP.

Conditions for allowing deduction of remuneration – The conditions for allowing deduction of remuneration are as follows – (a) Remuneration should be paid only to working partner (b) Remuneration must be authorised by the partnership deed and should be in accordance with terms of partnership deed (c) Remuneration should not pertain to period prior to partnership deed and (d) Remuneration should not exceed the permissible limit.

Book profit means the net profit as shown in the profit and loss account for the relevant previous year, computed in accordance with chapter IV-D of Income Tax Act, as increased by the aggregate amount remuneration paid or payable to all partners of the firm, if such amount has been deducted while computing net profit of LLP [Explanation 3 to section 40(b) of Income Tax Act]

‘Working partner’ means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner [Explanation 4 to section 40(b) of Income Tax Act].

It should be noted that there is no requirement that he should provide full time for business of LLP. Thus, if a partner is engaged in establishing business policies of LLP, remuneration paid to him would be eligible even if does not participate in its implementation and other routine jobs.

Requirements of  LLP agreement for allowing deduction - Remuneration must be authorised by the LLP Agreement and should be in accordance with terms of LLP agreement. As per CBDT circular No. 739 dated 25-3-1996, the LLP agreement should specify either the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. A general clause that remuneration should be as per section 40(b)(v) of Income Tax Act or that remuneration will be as mutually agreed upon partners at the end of year will not be sufficient to allow deduction of remuneration of working partner of LLP.

Remuneration paid above limits of section 40(b) will be exempt at hands of partner of LLP – Remuneration paid to partner over and above limits of section 40(b) will be taxed at hands of LLP but will be exempt at hands of partner. For example, if remuneration paid was Rs 3 lakhs, but actual allowable as per section 40(b) was Rs 2 lakhs, the excess Rs one lakh will be taxed at hands of LLP. However, this amount will be treated as share of profit at hand of partner and will be exempt.

Interest to partners – Interest paid to partners is deductible at the hands of LLP within limits prescribed under section 40(b) of Income Tax Act if requirements of section 184 are satisfied. As per section 185 of Income Tax Act, if the requirements of section 184 are not satisfied, firm will be assessed as firm but shall not be eligible for deduction of remuneration or interest to partner.

Interest paid/credited to partner will be allowable as deduction to LLP and it will be taxed at the hands of partner of LLP.

The conditions for allowing deduction of interest are as follows – (a) Payment of interest  should be authorised by the partnership deed and should be in accordance with terms of partnership deed (b) Interest should not pertain to period prior to partnership agreement and (c) Interest should not exceed 12%.

Disallowance of interest and interest u/s 40A(2) – As per section 40A(2) of Income Tax Act, any expenditure incurred by an assessee in respect of which payment has been made to specified persons (relative, director of company, partner of firm, person having substantial interest in business of assessee etc.), is liable to be disallowed in computing business profit to the extent such expenditure is considered to be excessive or unreasonable, having regard to the fair market value of goods or services or facilities etc.

Thus, even if payment of remuneration or interest is allowable as per section 40(b) of Income Tax Act, it can be disallowed under section  40A(2) of Income Tax Act.

Signing of IT return – Income Tax return shall be signed by designated partner of LLP. If for an unavoidable reasons, the designated partner is unable to sign and verify the return, or where there is no designated partner, any partner of LLP can sign and verify income tax return [section 140(cd) of Income Tax Act].

Income tax rate for LLP – For the Assessment Year 2010-11 (Financial Year 2009-10), income of LLP will be taxable @ 30% plus 3% education cess (total 30.9%). There is no Dividend Distribution Tax (DDT).

Wealth tax on LLP - Indian LLP will not be liable to wealth tax. Foreign LLP will be liable to wealth tax.

NO MAT or DDT – Since LLP is not treated as company for income tax purposes, there will be no Dividend Distribution Tax [DDT] or Minimum Alternate tax [MAT}.

No presumptive taxation scheme – LLP cannot avail presumptive taxation scheme under sections 44AC or 44AD of Income Tax Act.

Liability of partner towards liability of income tax of LLP - All partners of LLP are jointly and severally liable for income tax liability, but a partner can escape the liability if he proves that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of any duty on his part [section 167C of Income Tax Act].

Conversion of partnership firm into LLP – Conversion of partnership firm to LLP will not have any tax implications if the rights and obligations of the partners remains the same and there is no transfer of any asset or liability after conversion. [Explanatory memorandum to Finance (No. 2) Bill, 2009. However, there is no specific amendment or provision to that effect in the main Income Tax Act. In any case, there should be no capital gains tax in view of decision of Bombay High Court in case of Texspin as discussed below]. If there is any violation of this provision, provisions of section 45 of Income Tax Act will apply.

Conversion of private or unlisted company to LLP – The LLP Act makes provision for conversion of private company or unlisted public company into LLP. There is no specific provision in Income Tax Act for treatment of income tax in such cases.

In CIT v. Texspin Engg (2003) 129 Taxman 1 = 44 SCL 239 = 180 CTR 497 = 263 ITR 345 (Bom HC DB), it was held that when a firm is converted into a limited company, it is not transfer by way of distribution u/s 45(4) of Income Tax Act. There is no transfer of asset as contemplated u/s 45(1) of Income Tax Act. Hence, question of capital gains tax does not arise. It was also held that depreciation for the year is allowable to the firm for the year. Section 34 of Income Tax Act does not apply as the assets are not ‘sold, discarded, demolished or destroyed’.

Thus, there should be no capital gains tax if the rights and obligations of the partners remains the same and there is no transfer of any asset or liability after conversion.

Liability of stamp duty – In case of amalgamation of companies, in Madhu Indra Ltd. v. ROC (2005) 58 SCL 160  = 130 Comp Cas 510 (Cal HC DB), it was held that transfer of assets and liabilities of transferor company take place by virtue of section 394(2) of Companies Act, without any further act or deed. Hence, no stamp duty would be payable on the Court order approving amalgamation – followed in Tata Tea Ltd. In re (2008) 88 SCL 170 (Cal HC).

Based on aforesaid decision and also decision of Bombay High Court in case of Texspin Engineering, it can be argued that there should be no liability of stamp duty in case of transfer of firm/company to LLP.

Returns and records required by LLP 

 Forms under LLP Rules/

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