By Rabindra Jhunjhunwala, Pranay Bagdi and Bidya Mohanty
In this context, the considerations of structuring investments through LLPs and the factors that provide LLPs an edge over other prevalent Indian corporate structures are imperative to be assessed – a snapshot of some key considerations and features are discussed below.
Tax efficiency of an LLP structure
While the tax treatment of income in both LLP and private company are similar, LLP triumphs over a private company for profit distribution. Unlike companies (where a dividend distribution tax @ 20.56% is payable), no tax is payable by an LLP on distribution of profits to its partners. Further, companies and LLPs are subject to Minimum Alternate Tax (MAT) and Alternate Minimum Tax (AMT), respectively, @18.5% (plus applicable surcharge and cess).
For a company, MAT is payable on its ‘book profits’ – the prescribed manner of computation of these ‘book profits’ makes this a higher tax liability for companies as compared to AMT on LLPs, for which ‘book profits’ are not required to be computed.
Loans and advances by a company to its shareholders are considered as deemed dividends liable to tax. However, in case of an LLP, such loans and advances to partners are not taxable. However, such loans by both LLPs and companies have to comply with applicable transfer pricing regulations.
LLP in the context of Indian exchange control regulations
The Foreign Direct Investment (FDI) regime was partially liberalised in November 2015 to permit FDI in LLPs under the automatic route in sectors where 100% FDI is permitted in automatic route and there are “no FDI linked performance conditions”. LLPs were also permitted to undertake downstream investment in Indian companies which complied with the abovementioned conditions. This policy liberalisation has made LLPs popular for greenfield ventures where foreign investment is unregulated such as the IT, ITeS sector.
However, some sectors such as construction development where 100% FDI is allowed under automatic route may not be eligible to use the LLP structure as certain conditions are prescribed under the FDI policy. It should also be noted that while domestic partners can contribute to the capital of the LLP in cash or otherwise, foreign partners can make contributions only through cash.
In terms of eligibility of foreign entities to invest in LLPs, investment by FVCIs and FPIs is not permitted while NRIs, including foreign companies, trusts and partnership firms owned and controlled by NRIs, can invest in LLPs, on non-repatriation basis, without any conditions or restrictions. Another limiting factor is that LLPs have not yet been categorised as “eligible borrowers” under the applicable guidelines on availing foreign loans.
Greater flexibility and separate legal personality – to the benefit of partners!
In LLPs, the mutual rights and obligations of the partners are as they choose to agree under the LLP agreement. Moreover, the incorporation process is comparatively simpler. For instance, there is no requirement of a minimum capital contribution (even in practice). Further, the partners are free to choose their profit-sharing ratio, i.e., unlike a company, it does not necessarily have to be linked to contribution to capital. With a distinct legal personality and limited liability of its members, the LLP itself is liable for debts that it may run up in the course of its business and not its partners.
Lack of onerous compliances
LLPs are not subject to rigorous secretarial compliances applicable to companies. For instance, LLP is not bound to have a minimum number of meetings in particular year or make routine filings – the manner in which business decisions are to be taken can be determined in the LLP agreement. There are no restrictions on partners entering into transactions with the LLP nor any with the LLP giving loans or guarantees to any person. Mandatory audit of accounts of an LLP are required only if certain thresholds in terms of turnover or contribution are met.
LLPs – a promising way ahead
Although the LLP structure has gained significant amount of traction in the last few years as its benefits are being duly recognised by investors, in comparison to other structures, the LLP regime is in a fairly nascent and at an evolving stage in India. Regulators and government authorities across India are yet to gain enough familiarity with the LLP structure, which may require additional efforts and lead to delays in an LLP getting its operations running. Further clarifications or reforms especially in the context of exchange control regulations would be welcome, as it would help India Inc truly leverage the strengths of the LLP structure.
About the authors
Rabindra Jhunjhunwala (Partner), Pranay Bagdi (Principal Associate) and Bidya Mohanty (Associate) are lawyers with the corporate and M&A practice at Khaitan &Co.
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