The Company v. LLP Conundrum!
Updated: May 28, 2020
One of the most crucial decisions to be taken at the time of setting up a new business in India is finalizing the best suitable vehicle for the nature of business to be carried out. The entity most suitable for the business depends on a case to case basis. While making this decision, two of the most debated between vehicles are company and limited liability partnership (“LLP”). Herein below is a brief analysis of the factors that enable resolving the conundrum between a Company and LLP along with a review of the preferred vehicle from the view point of investments.
Formation of a Company and LLP
A company is governed by the Companies Act, 2013 and rules framed thereunder, collectively referred to as “Companies Act”. According to the Companies Act, there is an option of setting up a public company, private company, a one person company and a non-profit company. The Companies Act governs the formation, management, operation and regulation of companies in India. From the perspective of starting a new business in India, the most explored entity is a Private Limited Company (“Company”) and we have restriced the present note to a Private Limited Company and LLP. A Company is required to be registered with the Registrar of Companies (“ROC”) andis goverened by its Memorandum of Association and the Articles of Association.
The Liability Partnership Act 2008 and rules framed thereunder, collectively referred to as the “LLP Act”, provides for formation of an LLP. According to the LLP Act, the LLP is set up by way of a contract known as the limited liability partnership agreement (“LLP Agreement”) executed between the partners intending to set it up. LLP is registered with the registrar of companies and all compliances are required to be completed as stipulated under the LLP Act before the ROC. For the formation of an LLP, the rights and obligations of the partners along with all details pertaining to the management and operation of an LLP are captured in the LLP Agreement executed between the partners.
A Company and an LLP are both separate legal entities having perpetual succession, having a common seal and capable of owning assets. The registration process is convenient for a Company as well as for a LLP. The restriction on the number of directors/partners and members of each entity differs that is for the purposes of a Company minimum of 2 and a maximum of 200 members are permissible and a minimum requirement of 2 directors is mandatory (with one director being a resident of India). Similarly, for an LLP, the minimum requirement is that of 2 partners (with no maximum limit). The LLP shall have 2 designated partners as individuals (with one of the designated partners being a resident of India). A body corporate can also be a partner in an LLP. An LLP shall have 2 designated partners who shall be responsible for the legal and regulatory compliances of the LLP. In the event all partners of an LLP are body corporates, then nominees of such body corporates shall act as designated partners.
Compliances and Functioning
The Articles of Association read along with the Companies Act govern the functioning of the Company. The functioning and compliances of a Company are more complex and strict as compared to the LLP. The Companies Act provides for statutory meetings and associated filings which need to be complied in accordance with the prescribed procedures and timelines. Additionally, there are several secretarial and regulatory compliances that need to be complied with. In a Company, the directors in charge of day to day affairs can be separate from the shareholders of the Company. Resignation from directorship need not result in a director-cum-shareholder ceasing to have shareholder rights. The nature of rights available to a shareholder, the nature of power and duties of the directors, restrictions on transfer of shares, payment of dividends, employee stock options etc. along with the entire structure and functioning is governed by the Articles of Association and the Companies Act.
The internal functioning of an LLP is governed by the LLP Agreement. Each partner’s contribution consisting of both tangible and/or intangible property and any other benefit, rights of a partner to share of the profits and losses of the LLP and to receive distribution shall be detailed in the LLP Agreement. Further, monetary value of such contribution shall be accounted for and disclosed in the accounts of the LLP. The change in partners, addition or removal or retirement, is governed by the terms of the LLP Agreement and the same needs to be accordingly amended along with intimating such change to the ROC as prescribed. In the event the LLP Agreement does not cover a particular matter, then Schedule I of the LLP Act shall be applicable for such case, unless expressly excluded by the parties.
The LLP Act provides for the compliances and filing required for an LLP. Contrary to the requirement for Companies, there are no statutory meetings required in case of a LLP. An LLP is required to comply with provisions pertaining to maintaining annual accounts reflecting true and fair view of state of affairs and annual filings, audit of accounts and filing annual returns with the ROC. The details of penalties and fines applicable to an LLP are provided under the LLP Act.
In addition to the same, there are compliances which are common for both, i.e., Company and LLP which may be as per the state or central legislations and applicable to all businesses, for instance, compliances under the Shops and Establishment Act, trade licenses, factories act, industrial disputes act, labour welfare legislations etc.
Rights and liabilities of the shareholders and directors are governed by the Articles of Association and the Companies Act. The liability of the shareholders is limited by shares or limited by guarantee based, however, the shareholders are required to comply with all restrictions as imposed as per the Articles of Association and the Companies Act. The directors are primarily responsible for the legal and regulatory compliances of the Company. The nature of directorship including but not limited to non-exectuive director and independent director and rights associated with such directors is also provided under the Companies Act. On account of statutory non-compliances, there are several provisions where penalty provisions get attracted and in such cases, the directors being in charge may be held liable. Directors can be personally held liable on account of illegal and unlawful acts being committed on behalf of the Company or individually on account of being a director of the Company.
The rights and duties of the partners are governed by the LLP Agreement and the LLP Act. The designated partners in a LLP are responsible for the regulatory and legal compliances. The liabilities of the partners are limited to the contribution to the LLP and a partner shall not be liable for the wrongful acts and/or omission of another partner. However, the liability is unlimited in cases of intentional fraud or wrongful act of omission or commission.
The tax implications on a Company and LLP are different. For a Company, the applicable taxes are higher, including but not limited to corporate tax on profits, dividend distribution tax, surcharge and educational cess, and minimum alternate tax. For a LLP, the tax implications are relaxed and simple, i.e., income tax (plus surcharge, cess) at a fixed rate and alternate minimum tax. Additionally, distribution of profits to the partners of the LLP is exempt from tax.
Foreign Direct Investment (FDI)
FDI is allowed for majority of the sectors in a Company and LLP. There are entry routes, i.e., automatic route and government approval route. Foreign investment up to 100 percent is permitted by way of investment in the share capital of a Company or by way of contribution to the capital of an LLP operating in sectors/ activities under automatic route where there are no FDI linked performance conditions to a person resident outside India barring exceptions under law. However, under the said route, the requisite compliances as per RBI and the Companies Act/LLP Act need to be complied with. In the government approval route, prior approval is required from the government.
Company or LLP – Preferred vehicle
The structure of entity has to be decided upon after a careful consideration of the nature of business being set up, the plan of growth of the business, aim with regard to expansion and obtaining future investments, whether foreign or domestic. While traditionally, Company has been the preferred choice for all kinds of businesses due to the manner in which it is structured, however, with the relaxations in foreign investment, and the fact that LLP provides flexibility has started becoming a common choice for certain businesses as it provides the flexibility of a partnership firm along with protection of liability as applicable to companies without the rigid compliances. According to the information available on the website of Ministry of Corporate Affairs, mostly, LLPs are being desired by persons providing services, enterprises in new knowledge and technology based fields where corporate form is not suited, for professionals rendering services like chartered accountants, company secretaries etc., funds, enterprises engaged in scientific, technical or artistic discipline, for any activity relating to research production, design and provision of services, small sector enterprises, and producer companies in handloom, handicrafts sector.
Company or LLP – Investor preference
One important factor while deciding on the nature and structure of entity is obtaining foreign investment for growth of the business. The investment made by investors into businesses depends upon various factors apart from the nature of business, i.e., the type of investor and investment that is being brought into the entity. In a majority of cases, several aspects available in a Company make it a preferred option for investment by investors. Company is preferred for reasons including inter alia(i) shares – there are no shares in the LLP and all rights and liabilities are governed by the LLP Agreement. In a LLP, there is no convenience and flexibility provided by holding shares and transfer of shares as available in the case of a Company; (ii) ESOPs – in the absence of shares, there are no employee stock options which are incentives and usually form a part of long-term strategy; (iii) Company provides an option to differentiate between shareholding, directorship which enables a person to own shares and control the board and functioning of the Company with minimum impact of liability and responsibility, which is not an option in a LLP; (iv) Voting rights based on shareholding make a Company more systematic; (v) Exit options including an IPO or acquisitions are available in a Company and no such option is available in a LLP.
Kindly treat this as an information update and the same shall not constitute as an advisory by the firm.
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