This article is written by Akshita Rohatgi, from GGSIP University, New Delhi. It covers the adequacy of the Indian framework concerning limited liability partnerships as an alternative to traditional partnerships.

Introduction

The Indian Partnership Act was enacted in 1932 by the colonial government, to lay the basic framework for business partnerships in India. The principal feature of this form of partnership (“traditional partnership”) is that each partner is treated as the principal as well as the agent of every other partner. Thus, the liability of every partner to the acts done by the other partners during the course of employment is unlimited.

As the Indian economy progressed towards liberalization, privatization and globalization, more and more foreign firms started setting up branches and expanding to India. Smaller-scale industries and the entrepreneurial environment in India needed to be made more conducive to this investment.

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Around the world, the business model of traditional partnerships lost its appeal. Due to LPG, this dissatisfaction with traditional partnerships started growing in India too. This was primarily because of the unlimited liability binding all the partners to the acts of the other. Researchers all around the world examined their partnership laws and most of them advocated in favour of the concept of ‘Limited Liability Partnerships’ (LLP) to fix this problem. Jurisdictions all around the world started adopting this form, which was widely accepted by the people.

Need for introducing LLP

7th report of the Law Commission of India

The 7th report of the Law Commission of India contained a suggestion by the merchants of iron, steel and hardware industries for introducing a framework for Limited Liability Partnerships. This was due to the cumbersome incorporation procedure, high personal risks and restrictions associated with traditional partnerships. These were major obstacles for small businesses that did not possess the resources to incorporate themselves into a full-fledged company. However, the Law Commission rejected this idea.

Bhatt Committee, 1972 and Abid Hussain Committee, 1997

The Bhatt Committee in 1972 and the Abid Hussain Committee in 1997 gave similar recommendations to introduce a framework for incorporation of LLPs in India. This recommendation was primarily in response to the concerns of small scale industries and enterprises.

Naresh Chandra Committee, 2003

The Naresh Chandra Committee in 2003 advocated for a different approach. It highlighted the need to introduce LLPs to create a more favourable environment for the service industry. LLPs were expected to allow better pooling of technical expertise from professionals across fields.

J. J. Irani Committee, 2005

The J. J. Irani Committee in 2005 further recommended that the government enact a separate law to lay down the framework for LLPs in India. Additionally, it recommended that the government extend its scope to small businesses.

Limited Liability Partnership Act, 2008

Eventually, it became only a matter of time before India adopted the LLP model. The Limited Liability Partnership Act (“LLP Act”) was enacted in 2008. Touted as a hybrid between company and partnerships, this business model creates a healthy environment for the growth of small enterprises and venture capital. The Statement of Objects and Reasons of the LLP Act acknowledged this reason, declaring the purpose of the Act to be to enable entrepreneurship and professional expertise to combine ‘in a flexible, innovative and efficient manner’. 

The LLP-based business model was wholeheartedly accepted by India. This is evident by how within 4 years of the enactment of the LLP Act, more than seven thousand LLPs registered themselves in India.

Major differences between LLP and traditional partnership

LLPTraditional partnership
An LLP is a body corporate and has a separate existence as a legal entity. It is not legally categorized in terms of its partners.A traditional partnership has no existence as a separate legal entity. It is simply the sum of its partners in the eyes of the law.
Incorporation is compulsory.Registration of the partnership is not compulsory but may offer certain benefits.
Change in partners does not affect its separate existence or liability.Change in partners can affect the firm’s existence, rights and liabilities.
Perpetual succession, i.e., a change in partners, is allowed i.e. death or resignation of one partner does not lead to the dissolution of the LLP.Any change in partners may affect its overall existence unless otherwise agreed.
Minors can be partners.Minors can only be admitted to the benefits of the partnership i.e., the profits and are not personally liable for any losses.
Even though the minimum number of partners is two, the LLP is still valid if the business is carried on only by one partner, for a period of a maximum of 6 months.A traditional partnership cannot exist with only one partner.
The ‘designated partner(s)’ is/are the only one(s) who would be liable for statutory compliances.All partners are liable for statutory compliances.
Partners hold no personal liability for acts done by other partners, but only for the acts done by themselves.All of the partners are personally liable for the acts of other partners.
Every partner is an agent of the LLP, but not an agent of the other partners.Every partner is an agent of other partners.
The LLP shall include “LLP” in its name. There also exist certain other restrictions on its name.There are no specific restrictions on the name of the partnership.
An unlisted public company or a private one can convert itself into an LLP, following the procedure prescribed by law.No such conversion is possible in a traditional partnership.
Section 14 of the LLP Act mandates disputes to be referred to alternative dispute resolution (ADR).There is no such mandatory provision in a traditional partnership.

Advantages of LLP over traditional partnerships

  • LLPs combine the favourable features of a partnership firm, as well as of a company. The liability of each partner is limited to their contribution to it. This helps in minimizing personal risks and protects partners from the mistakes or misconduct of other partners.
  • LLPs are more flexible than companies. Companies have stricter compliance requirements and are more rigidly regulated than traditional partnerships. There is no requirement for minimum capital to start a business as required in public companies, and LLPs have lower registration costs than companies.
  • Additionally, LLPs are treated on par with partnership firms for taxation benefits and exempted from paying Dividend Distribution Tax. Further, an LLP is also exempted from the audit of its accounts, which further decreases compliance costs. This makes opting for LLPs over traditional partnerships more favourable.

A sum of these provisions makes LLPs suitable for technical and professional businesses since it helps experts from diverse fields come together to pool their knowledge. As examined, LLPs are also suitable for small-scale businesses. Thus, it creates a positive environment for venture capital in India.

Disadvantages of LLPs over other business forms

  • An LLP is not in a position to receive equity investment or any shareholding, as companies do. So, it can not receive any private equity funds or venture capital as shareholders. It is forced to fall back on debt and funding from promoters.
  • Under Indian law, LLPs are taxed at a rate of 30% for income tax, irrespective of their turnover. This is more than the income tax rate for companies with turnover over Rs. 250 crores, taxed at a mere 25%.
  • LLPs are to file annual income tax returns as well as MCA (Ministry of Corporate Affairs) returns, even in a case where the LLP is inactive. In certain cases, the penalty goes up to Rs. 100 per day. In contrast to this, a partnership firm has no such requirement.
  • There is a lack of clarity regarding the right to practice in courts by LLPs. Since LLP has a separate legal personality, there is a question of whether LLPs are allowed to represent in courts, or in other words, ‘practice’ law. According to Rule number 2 in chapter 3 of the Bar Council of India Rules, an advocate is barred from partnering or entering into any arrangement for sharing remuneration with a ‘non- advocate’. However, the rule does not prohibit partnerships between two advocates. Thus, the position of the law here is unclear.
  • According to Section 7 of the LLP Act, an LLP cannot be owned solely by foreign residents. In other words, at least one of the partners needs to be a resident of India, and the LLP cannot have only Non- Resident Indians (NRIs) as partners. One of them needs to have been residing in India for at least one hundred and eighty-two days in the immediately preceding year. This provision has attracted criticism especially since one of the objectives of the act is the admission of foreign partners.
  • Additionally, there is a question of law that arises on the liability of foreign partners, in case the partnership is related to the profession of law. There is no clarity on the extent of liability incurred by foreign partners, due to “wrongful” acts committed by them. Indian courts may decline to enforce any claim against the personal assets of the aforementioned partner.
  • Additionally, with respect to foreign investors, there is the issue of double taxation of income arising from the LLP. Income from the LLP would be taxed in India as well as the jurisdiction where the investor resides. This makes the environment for foreign investment unfavourable.
  • The LLP framework introduces a concept of a ‘designated partner’. This partner is held liable for all statutory compliances of the LLP, including filing returns, various documents, insolvency petitions as well as other reports and legally mandated documents. If they fail to do the same, they would be held personally liable for the penalty imposed on the LLP, as well as for any contravention of the law. This places an undue burden on some of the partners.
  • There is no provision that allows LLPs to convert back into companies.
  • LLPs need to be registered under Indian law, while partnerships do not face this compulsion.
  • Further, partners to the LLP have unequal rights, due to the lack of a one-vote-per-share system. This causes friction within the business.

Recommendations

  • The problem of double taxation of LLPs needs to be addressed. Here, the US framework for the taxation of LLPs being adopted merits consideration. The US allows the partners to decide whether tax should be levied on the LLP or its partners. This would solve the problem of double taxation in India.
  • The position of LLPs concerning the right to practice in courts must be addressed, and ambiguity should be removed.
  • A provision should be made in the LLP Act to allow the conversion of an LLP into a traditional partnership.
  • The rate of penalty on the LLP in cases of non-compliance with statutory requirements must be reduced.

Other disadvantages to the LLP framework require better and wider deliberations. This is vital to decide on how to rectify these problems, in case they need to be rectified at all.

It is pertinent to note here, that this business structure is merely over a decade old in India. Thus, as more and more businesses adopt it and it expands further, cracks in the framework and other shortcomings may begin to show. 

Conclusion

The introduction of LLPs in India gave a significant impetus to the development of Micro, Small and Medium-scale Enterprises (MSME). It successfully carves a middle path and offers a favourable alternative to traditional partnerships as well as the inconveniences posed by registration as a company. In doing so, this framework is forced to forgo some of the advantages provided by each form.

This is often the subject of criticism. However, doing away with all the unfavourable elements would inevitably put some of the favourable ones at risk too. Additionally, arguments for excessive de-regulation, undue reduction in taxes as well as unwarranted limitations to not hold the businesses liable for wrongdoing would harm the interests of justice and equity. Additionally, lower taxes would hit the government’s coffers and would mean diverting fewer resources to public works and welfare schemes. There is a need to attain a favourable balance between the two.

There are certain issues and obscurity with respect to the law that would do well if addressed. However, by and large, the framework of LLPs provides an effective alternative to the risks and inconveniences posed by traditional partnerships in the present scenario.

References

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