1. Brief Overview
What is a Limited Liability Partnership (LLP)?
An LLP is a form of business organization that has become popular among entrepreneurs as it gives the benefits of a private limited company (such as limited liability and separate legal entity) along with flexibility offered by a traditional partnership firm. Thus, it combines the benefits of both partnership firm and company into a single form of organization.
Governing Act & Rules:
An LLP is governed by the provisions of the Limited Liability Partnership Act, 2008 (“LLP Act”) along with the Limited Liability Partnership Rules, 2009.
Minimum & Maximum Number of Partners:
Like a traditional partnership firm, minimum two partners are required to incorporate an LLP. However, there is no upper limit on the maximum number of partners of an LLP.
Who can be a Partner in LLP?
However, if the individual is found to be of unsound mind by a Court/ is an undischarged insolvent/ has applied to be adjudicated as an insolvent and his application is pending; then such an individual shall not be capable of becoming a partner
The document which specifies mutual rights and duties of partners among themselves and in relation to the LLP is called the LLP Agreement. An LLP Agreement will contain clauses like the objectives of the LLP, its functioning, place of business, profit share between partners, salary and remuneration to be paid to partners, interest on loans given or taken from partners and conflict resolution among other things.
The LLP Act specifies that among all the partners, there should be a minimum of two Designated Partners who shall be individuals, and at least one of them should be resident in India.
Designated Partners (DPs) are those partners who are responsible for compliance of the LLP with provisions of the LLP Act. In case of any non-compliance, DPs are liable for penalties.
There are three important aspects to be considered:
I. All DPs should be INDIVIDUALS (a natural person). If a Body Corporate (which is a partner in an LLP) wants to be a DP of the LLP, it must nominate an individual as its Nominee and that individual shall fulfill the responsibilities of DP.
II. There should be MINIMUM 2 DPs. If due to circumstances such as death/retirement of a DP or change in designation of DPs, if the number of DPs reduces below 2, ensure that the DP is appointed within 6 months otherwise the LLP shall not be allowed to file any form on the LLP portal, and it would be a violation of provisions of the LLP Act.
III. Minimum 1 DP should be RESIDENT OF INDIA. An Individual is called Resident of India if he has stayed in India for not less than 182 days during immediately preceding 1 year.
2. Taxation of LLP
An LLP is taxed in the same way as a traditional partnership firm subject to certain exceptions like the benefit of presumptive taxation under section 44AD or section 44ADA of Income-tax Act, 1961 (“Income-tax Act”) is not applicable for LLP but applies to a partnership firm.
Tax Rate: For the Financial Year 2021-22 (i.e., Assessment Year 2022-23), the tax rate applicable to LLP is 30%.
Surcharge: If the total taxable income of the LLP is more than INR 1 crore, surcharge @ 12% is applicable.
Health and Education Cess (HEC): The amount of income-tax and the applicable surcharge, shall be further increased by HEC @ 4%
Thus, Effective Tax Rate for LLPs would be:
A.Taxable Income is up to INR 1 crore = 30*1.04 = 31.2%
B. Taxable Income is more than INR 1 crore = 30*1.12*1.04 = 34.944%
3. Advantages of LLP
i) Separate Legal Entity: It means that in the eyes of law, LLP is separate from its partners just like a company is separate from its shareholders. The LLP is distinct from its partners. An LLP can sue and be sued in its own name. This allows the business to contract with other entities, own assets and borrow funds in the name of an LLP itself which is not possible in the case of a traditional partnership firm.
Also, the LLP need not be wound up, if the number of partners falls below 2 temporarily. The LLP can continue to exist, and the surviving partner has a period of 6 months to introduce a new partner.
ii) Limited Liability: The liability of the partners is limited to the contributions made by them and they are not personally liable for any loss in the business. This means that if an LLP becomes insolvent, at the time of winding up, only the LLP assets are liable for clearing its debts and the personal assets of the partners cannot be attached.
This is entirely different from proprietorship and traditional partnership where the personal assets of proprietor/ partners are not protected if the business becomes bankrupt. This is one of the main reasons why people prefer LLP as their preferred form of business organization compared to sole proprietorship and traditional partnership.
iii) Low cost of incorporation and compliance: The cost of forming an LLP and the cost of compliances is low compared to the cost for a public or private limited company. The LLP needs to file only 2 statements annually, i.e., Annual Return (Form 11; the due date is 30th May) and a Statement of Accounts and Solvency (Form 8; the due date is 30th October).
Statutory audit is required for Limited Liability Partnership only if the contribution has exceeded INR 25 lakhs or turnover is more than INR 40 lakhs. If contribution/ turnover is below the specified limits, audit is optional. Unlike companies, compliances related to board meetings, annual general meetings, preparation and maintenance of minutes, board resolutions etc. do not apply to LLPs. This makes it cost-effective to maintain an LLP.
iv) Simple structure for withdrawing profits: The share of profits of LLP is not taxed again in the hands of partners. Let us take an example to understand this.
Eg: The Partners of RQS LLP are A and B and their profit-sharing ratio is 60:40. RQS LLP’s taxable income for FY 2021-22 is INR 10,00,000. The effective tax rate would be 31.2% (as taxable income is less than INR 1 crore)
Accordingly, A’s share of profit would be INR 4,12,800 whereas B’s share would be INR 275,200. When the partners withdraw their share of profits from LLP to their personal account, they need not pay tax on that amount as it is tax-exempt according to section 10(2A) of the Income-tax Act. Also, no formalities/compliances are required to withdraw profits.
However, in the case of a company, it is not that simple to withdraw the profits. The Company either needs to declare a dividend or buy back shares to distribute profits. Also, there is a limitation on the maximum amount that can be distributed in a year by way of buy-back. Dividends are taxed in the hands of shareholders at the rate applicable to them (Dividend is considered part of “Income from Other Sources”). In case of a buy-back, the company first needs to pay buy-back tax @ rate of 20% + 12% surcharge + cess as per section 115QA of the Income-tax Act. Paying shareholders by way of dividend or buy-back involves additional compliances as well.
One word answer: DEPENDS!
Whether a company or an LLP is the most tax-efficient structure will depend on the facts of each case. The calculation involves various assumptions such as business activity (manufacturing/non-manufacturing), taxable income of business, long-term proposed dividend payout ratio, income levels of shareholders/partners. Few deductions such as weighted deduction on in-house R&D applies only to companies.
Hence, there is a lot of subjectivity involved. It is important to take a few assumptions and evaluate scenarios to determine which entity will be lucrative from tax perspective.
v) No Valuation Norms for transferring the ownership: Transferring the ownership of LLP is simple as compared to a Private Limited Company. The sale of company’s share is subject to valuation under Income Tax and will lead to unfavourable tax consequences in case the valuation norms are not met. This is generally in case the company is in a distressed state and the actual valuation is much lower than its asset valuation. There are no such valuation norms in the case of an LLP.
4. Disadvantages of LLP
i) Public Disclosure: Public disclosure is the main disadvantage of an LLP. The documents filed through the MCA portal are public documents. Any person can pay a small fee of INR 50 and can get a copy of LLP’s incorporation documents (but not LLP agreement), financial statements etc. This is not an issue in the case of sole proprietorship or traditional partnership firm, where documents and financials are not available for public inspection.
ii) Limited Funding Alternatives: LLPs have limited alternatives when it comes to raising funds. LLPs can either borrow debt from financial institutions or via a loan from partners. Venture Capitalists (VCs), Angel Investors and Private Equity (PE) firms would be unwilling to invest in an LLP structure. This is because all ‘shareholders’ (having ownership stake) in an LLP must be partners, who have certain responsibilities toward the LLP and there is no separation between ownership and management. No VC/Angel Investor/ PE firm wants any of these responsibilities and would, therefore, only invest in a private limited company.
Also, Foreign Direct Investment (FDI) in LLP is more restrictive as compared to companies. Neither an LLP can issue Employee Stock Options (ESOP).
For these reasons, LLP is not the most ideal choice for startups who want to hyper-grow, seek seed or venture capital funding, or issue shares to their employees.
iii) Non-Compliance is Expensive: Though the compliance requirements for an LLP would be minimal, it is essential to adhere to them, else it can lead to heavy penalties. Even if an LLP does not have any activity, Form 8 and Form 11 are required to be filed annually. In case of non-compliance, an additional fee of INR 100 per day, per form is applicable. There is no cap on the additional fee, and it could run into lakhs if an LLP has not filed them for a few years. Also, the LLP and its DPs would be liable for a fine that can extend up to INR 5 Lakhs!
In the case of a proprietorship or traditional partnership firm, there is no requirement for filing annual forms and business need not bear non-compliance expenses.
5. Who should prefer LLP and who should not?
I have already mentioned the pros and cons of LLP that will help in deciding whether LLP is the right form of organization structure for your business. From taxation perspective and based on business to be conducted, I have the below additional observations:
6. How to incorporate an LLP
Step 1 – Obtain Digital Signature Certificate (DSC): DSC is required for digitally signing various forms such as incorporation forms (eg: Form FiLLiP and obtaining DIN/DPIN), compliance-related forms (Form 3/ Form 8/ Form 11), Income-tax Returns and GST Returns. It is advisable to obtain DSC for all Designated Partners. Currently, only class 3 DSCs are issued and the cost of a class 3 DSC with 2-year validity ranges from INR 1500 – INR 2000.
Step 2 – Obtain Director Identification Number (DIN)/ Designated Partner Identification Number (DPIN): DIN & DPIN are used interchangeably. DIN is a unique 8 digit numeric allotted to identify a particular partner/director. Up to 2 partners can obtain DIN by using the incorporation form (Form FiLLiP). Additional DINs can be obtained by filing Form DIR-3.
Step 3 – Create an account on the MCA website: To access RUN-LLP online form or for uploading e-forms, you need to have an account on the MCA website. You can create an account by visiting https://www.mca.gov.in/mcafoportal/login.do
Step 4 – Apply for Name Approval: Reserve Unique Name – LLP (RUN-LLP) is an online application form for reserving a name for the LLP. You can mention two proposed names for the LLP in the form. While selecting the LLP name, you should ensure that you consider LLP Name guidelines. The name should neither be undesirable in the opinion of the Central Government nor does it resemble any existing partnership firm or an LLP or a body corporate or a trademark. You can do a free name search by visiting https://www.mca.gov.in/mcafoportal/showCheckCompanyName.do
Additional information on LLP name guidelines can be accessed on https://www.mca.gov.in/Ministry/pdf/RUNLLP_Help.pdf.If the name resembles an existing company or LLP, you would be required to obtain a No-Objection Certificate (NOC) from them and add it as an attachment to the form.
In the comments box, you need to mention the objects of LLP (i.e. what business will be carried out through the LLP) in 500 characters. Be precise in writing the objects as your proposed name should have a connection with objects of LLP. Also, the objective of LLP will be auto-populated in Form FiLLiP. Professionals such as Chartered Accountants, Company Secretaries, Advocates shall also need to attach NOC from their sectoral regulator.
Fees for RUN-LLP is INR 200. If the name is rejected or any clarifications are required, re-submission of the form is allowed to be made within 15 days for rectifying the defects. Once a name is approved, you can apply for incorporation of the LLP by filing Form FiLLiP, before the expiry of the validity of the approved name i.e. 3 months from the date of approval.
Step 5 – Filing Incorporation Form: FiLLiP is the incorporation form for an LLP. You can also apply for name approval using this form. But it is advisable to have the name first approved using RUN-LLP and then use FiLLiP form for incorporation. Information such as the address of LLP, details of partners and designated partners, the business activity of LLP, contribution by partners, consent of partners etc. is required to be given in FiLLiP form. Subscribers’ sheet along with other supporting documents are to be added as attachments. Even if the owner of the proposed registered address of LLP is one of the partners, NOC from him is required to be attached.
Fees to be paid along with FiLLiP form depends on the amount of total contribution by all partners. For contribution up to INR 1 Lakh, the fee is INR 500; while for a contribution of more than INR 10 Lakhs, the fee is INR 5,000.
Step 6 – Drafting LLP Agreement and Filing Form 3: Upon scrutiny of information and documents provided in FiLLiP form by the Registrar, the LLP is incorporated. Certificate of Incorporation is issued containing LLP Identification Number (LLPIN). The next step is to finalize the drafting of the LLP Agreement. The LLP Agreement is required to be printed on Stamp Paper. The amount of Stamp Duty will differ according to the Stamp Act of the state in which the LLP is incorporated and the contribution amount of partners. LLP agreement must be filed in Form 3 online on the MCA Portal. Form 3 has to be filed within 30 days of the date of incorporation.
You should note that, unlike company registration where PAN & TAN are allotted along with company incorporation, LLP needs to apply for PAN & TAN once it receives a certificate of incorporation. Other registrations such as Professional Tax registration (PTEC & PTRC) and GST registration could be required and can be done post-incorporation.
Documents required for LLP Incorporation:
Note: In the case of NRI or Foreign National, documents of the partner must be notarized or apostilled. If the documents are in other than the English language, a notarized or apostilled translation copy is also required to be attached.
I wish you luck for new business adventure! If you have any queries or suggestions, drop a comment or you can reach me at [email protected]