Understanding Pros and Cons for setting up a LLP

Introduction

A Limited Liability Partnership (“LLP”) is an alternative business form that gives the benefits of limited liability of a company and the flexibility of a partnership. It has a separate legal entity distinct from that of its partners. It is capable of entering into contracts and holding property in its own name. Further, no partner is liable on account of the independent or un-authorized actions of other partners, thus individual partners are shielded from joint liability created by another partner’s wrongful business decisions or misconduct.

Mutual rights and duties of the partners within a LLP are governed by an agreement between the partners or between the partners and the LLP as the case may be. The LLP, however, is not relieved of the liability for its other obligations as a separate entity.

Since LLP contains elements of both ‘a corporate structure’ as well as ‘a partnership firm structure’ LLP is called a hybrid between a company and a partnership.

All LLP’s are governed by the Limited Liability Partnership Act, 2008 (“LLP Act”).

Features of LLP

• It has a separate legal entity.
• Each partner’s liability is limited to the contribution made such partner.
• Less compliance and regulations.
• No requirement of minimum capital contribution.

The minimum number of partners to incorporate an LLP is 2. There is no upper limit on the maximum number of partners of LLP. Among 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.

The rights and duties of designated partners are governed by the LLP agreement. They are directly responsible for the compliance of all the provisions of the LLP Act 2008 and provisions specified in the LLP agreement.

Advantages

Separate legal entity:

An LLP is a separate legal entity. This means that it has assets in its own name and can sue and be sued in its own capacity. No partner is responsible or liable for any other partner’s misconduct or negligence.

No owner/manager distinction:

An LLP has partners, who own and manage the business. Just like a private limited company, whose directors may be different from shareholders. Primarily for this particular reason, venture capital funds do not invest in the LLP structure.

Flexible agreement:

The partners are free to draft the LLP agreement with respect to their rights and duties.

Limited liability:

The liability of the partners is limited to the extent of their contribution made to the LLP. At the time of winding up, only the LLP’s assets are used for the clearing of debts. The partners have no personal liabilities and hence are free to conduct the business in the best manner possible without the fear of attachment of their property.

Fewer compliance requirements:

An LLP is much easier and cheaper to run than a private limited company as there are only a few compliances per year. On the contrary a private limited company has a lot of compliances to fulfil along with conducting an audit or other such compliance requirements. The LLP is required to get an audit done when turnover  exceeds, in any financial year, forty lakh rupees, or when contribution exceeds twenty five lakh rupees. Other Compliances which are not required in LLP Vis-à-vis a private limited company are having no requirement of minimum number of board meetings in the financial year, no requirement to distribute dividend and no payment of dividend distribution tax. However the tax compliances for both a private limited company and a LLP is similar. A LLP is charged a flat rate of 30% on its total income. The amount of income-tax shall be further increased by a surcharge at the rate of 10% of such tax, where total income exceeds one crore rupees.

Easy to wind-up:

Not only is it easy to start, it’s also easier to wind-up an LLP, as compared to a private limited company.

No requirement of minimum capital contribution: 

The LLP can be formed without any minimum capital. There is no requirement of having a minimum contribution before preparing an agreement. It can be formed with any amount of capital contributed by the partners.

Disadvantages

Difficulty in raising capital and funding:

The LLP does not have the concept of equity or shareholders like a company. Angel investors and venture capitalists can only invest in the form of partners in a LLP if they would want to. This would entail them to take up all the responsibilities of a partner. Thus, angel investors and venture capitalists prefer to invest in a company rather than an LLP making it difficult for the LLPs to raise capital. Also, Foreign Direct Investment (FDI) in LLP is more restrictive as compared to companies.

Public disclosure:

The documents filed through the MCA portal are public documents. Any person can pay a small fee and can access the copy of LLP’s incorporation documents other than the LLP agreement and financial statements. These documents are not accessible in the case of sole proprietorship or traditional partnership firm are not available for public viewership.

Non-Compliance is Expensive:

Even though the compliance requirements for an LLP are relatively low, it is essential to adhere to them, else it can lead to heavy penalties. In case of non-compliance, penalty of ten thousand rupees shall be levied and in case of continuing contravention, with a further penalty of one hundred rupees for each day after the first during which such contravention continues, subject to a maximum of one lakh rupees for the LLP and fifty thousand rupees for every partner of such LLP.

In the case of a proprietorship or traditional partnership firm, there is no such requirement to bear non-compliance expenses.

Who should prefer a LLP?

From the business perspective it is essential to understand the advantages and disadvantages of setting up a LLP in general, however it is also essential to understand if it is the best structure for your business.

To understand if setting up a LLP is the right start to your business journey it is also essential to view the below mentioned points from the point of view of taxation and the operations. Let us also look at these additional points.

• If the business is engaged in manufacturing/ production and the dividend pay-out ratio will be relatively low: Incorporating a private company shall be beneficial as manufacturing companies can opt for lower taxation @ 20% as per section 115BAB of the Income-tax Act, 1961 and no deduction or allowance in respect of any expenditure or allowance shall be allowed in computing such income.
• If the business is going to be engaged in trading a partnership firm / sole proprietorship would be a better choice as the benefit of presumptive taxation under section 44AD of the Income-tax Act can be taken. The total turnover or gross receipts can be charged to 6% or 8% tax, provided that total turnover doesn’t exceed INR 2 crores. Also the requirements to maintain formal books of accounts is not there in case of presumptive taxation.