In this blog post, Sanjna Vijh, a student of Bharati Vidyapeeth University, Pune, who is currently also pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the powers of the Compensation Committee of the Board of Directors of a company.

With great power comes great responsibility. The responsibility of running a business or company is on the shoulders of an important body called the Board of Directors. These members are the decision makers and ensure the successful running of the company.

Board of Directors (BoD) of a company are responsible for smooth management and functioning. There are four important committees of the board for delegation of various duties i.e. executive, audit, compensation and nominating, among others.

Compensation Committee is formed to devise compensation of the top executives, directors and senior management of the company. The committee ensures that executive employees are paid a fair compensation for their work and not an exorbitant executive pay.

In India, this committee is known as:

• Nomination and Remuneration Committee (NRP) under Section 178(1) of the Companies Act, 2013
• Compensation Committee under Regulation 5.2 of Securities and Exchange Board of India (Share-Based Employee Benefits) Regulations, 2014

As mentioned in the 2013 Act, all Listed Companies, and Public Companies having paid up capital of Rs.100 crores or more; or in the aggregate, outstanding loans or borrowings or debentures or deposits exceeding Rs.50 crores must constitute a Compensation Committee.

Since the committee is designated to formulate schemes of executive pay, the composition has been given in the Act as – 3 or more Non-Executive Directors out of which one-half shall be Independent Directors.

Responsibilities of the committee are not only limited to executive pay schemes, but the committee also plays a role in the identification of potential board members and their appointment by devising criteria for qualifications and attributes.

Powers

The committee holds, among other things, the following powers in their capacity:

• Formulation of a policy governing appointment and removal of board of directors and senior management
• Laying down criterion for evaluation of directors’ performance.
• Formulation of a policy to determine compensation of executive members such as CEO etc. and key managerial personnel
• Implementation and review of compensation guidelines devised
• Review and establish succession plans in senior management of the Company
• Review incentives to be given in addition to the existing payment plans

The role of compensation committee falls very much under the functions of human resources as they play an integral part in monitoring appointment, removal, and compensation of the most senior and coveted members of the organization. The policies devised shall be disclosed in the board’s report to communicate the guidelines to all.

In India, the ground reality of exercising the above-listed powers is different. It is observed that the committee is often exploited by the executives to demand more salaries and incentives. It practically becomes a servant to the CEO who approves the annual budget of the company and compensation guidelines. Excessive executive compensation is an emerging problem in Indian corporates which becomes oppressive and unfair to shareholders if the company has not been making increasing profits.

It is primarily important to ensure that a system of ‘check and balance’ is in place for the committee to effectively fulfill its duties in the capacity of the powers vested. Policies of the committee disclosed in board reports should also include the basis for compensation decisions and how the decisions were made. An independent compensation committee, without executive influence, will bring out demonstrable results in the growth of a company ensuring a fair mechanism for employment and compensation of the senior management of companies.

In this blog post, Siddhesh Talekar, a student of Institute of Law, Nirma University, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the important laws applicable to public charitable trusts in India.

Introduction

Charity is a practice of voluntary giving of help. The term can also be used with organizations, Section 8 companies (non-profit companies under the Companies Act, 2013), societies, trusts, etc. Not all non-profit organizations are charitable organizations. Some charitable organizations may be established as a part of tax planning strategies.

Trust is a form of organization which is formed by obligation annexed to the ownership of the property, and arising out of confidence reposed by owner. The author or will maker transfers the property to be used for a purpose. If the objective is to benefit few individuals, it becomes a private trust and if it uses ‘property’ for common public or for community at large, it is called a public trust.

Person, group, company, etc. on the receiving end of trusts are called beneficiaries. What distinguishes public trust from a private trust is their beneficiary. Private trust beneficiaries are usually a closed group, individuals, company but beneficiaries of public trust is always uncertain, that is public at large. Public trust is a form of organization that is formed with a strong motive of charity to public. Diaspora of beneficiaries actually differentiates public trust and private trust. Charitable trust can be formed by various means and is subject to various Acts or legislation. Under Article 19(1)(c) ‘Charities and charitable institutions, charitable and religious endowments’ are under the Concurrent list of the Seventh Schedule of The Indian Constitution. Here, both the centre and the state are allowed to legislate on Public Charitable Trust.

Definitions

Under Section 3 of The Indian Trusts Act, 1882, ‘A “trust” is an obligation annexed to the ownership of the property, and arising out of confidence reposed in and accepted by the owner, or declared and accepted by him, for the behalf of another, or of another and the owner.’

The person who reposes or declares the confidence is called the ‘author of the trust’. The person who accepts the confidence is called ‘trustee’. The person for whose benefit, the confidence is accepted is called the ‘beneficiary’. And the subject matter of the trust is called ‘trust property’ or ‘trust money’ and the ‘beneficial interest’ or ‘interest’ of the beneficiary is his right against the trustee as owner of the trust property and the instrument, if any, by which the trust is declared is called ‘instrument of trust’.

Trust created for the advancement of education, promotion of public health, relief of poverty, etc regarded as charitable in law is public charitable trust. Though it doesn’t have a definition of its own, public charitable trust must be created for the benefit of the public.

To look into what laws apply to public charitable trusts in India, we need to understand what charitable purpose means. Under Section 2(15) of The Income Tax, Act expression of, charitable purpose is in an inclusive manner. Charitable purpose under Section 2(15) of the Income Tax Act includes relief for the poor, education, medical relief and the advancement of any other object of general public utility. The aforesaid definition is not exhaustive and therefore, purpose similar to the purposes mentioned in the aforesaid definition will also constitute charitable purpose.

According to Section 9(1) of The Bombay Public Trust Act, 1950, “charitable purpose” includes relief from poverty, education, medical relief, the advancement of any other object of general public utility, but does not include a purpose which relates exclusively to religious teaching or worship.

However, there are also public cum private trusts in India. Here, a part of the income of the trust is applied for public charity whereas and the other part of the income is used for private business. The only income which is applied for charitable purposes under public charitable trust is eligible for exemption under Section 11 of the Income Tax Act. These type of trusts now seize to exist.

Laws applicable to public charitable trusts in India

Public charitable trust is governed by the public trust Act of that state and The Indian Trusts Act, 1882. As charity has been placed in the Concurrent list of the Constitution, both the centre and the state the right to legislate over public charitable trusts. A public charitable trust organization can be formed by registering as a trust by executing a trust deed or as a society under the Registrar of Societies. Also, a private non-profit company can be formed under Section 8 of The Companies Act, 2013. A Section 8 company is parallel to that of a Section 25 company under the old Companies Act, 1956.

Apart from the above, various laws are applicable to religious trusts such as The Hindu Religious Institutions and Charitable Endowments Act, 1997, Muslim Wakf Act, 1954. But not all religious charitable trusts enjoy income tax exemptions. Also, various state laws are applicable to charitable organizations, trusts, institutes. If a public charitable trust is in the state of Maharashtra, then it is regulated by the Bombay Public Trust Act, 1950, whereas a public charitable trust in Rajasthan is governed by The Rajasthan Public Trust Act. And in states where there is no public trust Act, public trust is legislated by The Indian Trust Act, 1882. In Delhi where there is no public trust Act of the state/UT, the Indian Trust Act comes into picture.

Public charitable trust and Income Tax Act

Public charitable trust is exempted from income tax. Section 11, Section 12, and Section 13 of The Income Tax Act talk about tax exemptions given to public charitable trusts. Section 80G deals with privileges given to donors of public charitable trusts.

1. Section 11 of the Income Tax Act states the means of exemption from income tax to the public charitable trusts.
2. Section 12 cites contribution of income of the trust
   • Income of trusts from contributions
   • Voluntary contribution received by a trust created wholly for charitable or religious purposes or by an institution established wholly for such purposes.

3. Section 13 of Income Tax Act deals with forfeiture of exemption of income tax by public charitable trust.

All trusts have to file annual reports. Annual returns of income should be filed with the authorities having jurisdiction of the state where it is registered. Income of the author of trust can be taxed as personal income under Section 60 to Section 63 of the Income Tax Act, 1961 if the trust deed has a provision for revocation of trust.

Under Section 80G, an individual is granted deduction if donations are made to such kind of public charitable trusts. To give this benefit to its donors, the public charitable trust is required to obtain a valid certificate. For this certificate, it is required to give application with form 10G along with the trust deed to the income tax office. The basic perquisite to obtain this certificate is that the income gained from the property of the trust should only be used in charitable purposes. The income tax has certain tax benefits for the donor. These are certain conditions to be fulfilled by the public charitable trusts to obtain certification:

1. The trust should not be private trust e. it should be a public charitable trust.
2. The public charitable trust should be registered under relevant laws and with the income tax department.
3. Any income or contribution of the trust should not be not applicable for exemption under Section 11, Section 12, Section12A and Section12AA of the Income tax Act. If so, it should maintain separate books of accounts and should not use donations for private business.
4. The byelaws and objectives should solely be for charitable purpose only.

East India Industries (Madras) Pvt Ltd vs. CIT (1967) 65 ITR 611 (SC) – The honorable court in this case held that property, as used includes business also and unless the business also is exempt, donation to such an institution will not be eligible for concession.

5. Regular maintenance of accounts and regular audit of the same.
6. Regular filing of income tax returns.

Summary

Public charitable trusts in India are mainly governed by The Indian Trust Act, 1882 and also by various relevant state Acts where the public charitable trust may be registered. Since charities comes under Schedule 7 of the Indian Constitution at entry number 10 in the Concurrent list, the centre and the state both have legislation over the public charitable trusts.

Other laws applicable to public charitable trust are

• Registration Act, 1908
• Indian Stamp Act, 1899
• Hindu Religious and Charitable Endowments Act, 1951
• Muslim Wakf Act, 1923
• The Income Tax Act
• The Companies Act (for non-profit company)
• Foreign Contribution regulation Act
• And other relevant state acts like Bombay Public Trust Act, 1950

In this blog post,  Tanvi Bhatnagar, a lawyer by profession, presently working with G.S Rijhwani & Co., an IPR firm dealing with National and International Trademark, Copyright and Patents, who is also pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the advantages of a Private Company over a One Person Company for a single founder.

Introduction

Under Section 2 (62) of the Companies Act, 2013, One Person Company (OPC) is defined as a company which has only one person as a member/shareholder.

Under Section 2 (68) of the Companies Act, 2013 a Private Company is defined as a company having a minimum paid-up share capital of one lakh rupees or such higher paid-up share capital as may be prescribed, and which by its articles,—

(i) restricts the right to transfer its shares;

(ii) except in case of One Person Company, limits the number of its members to two hundred:

Provided that where two or more persons hold one or more shares in a company jointly, they shall, for the purposes of this clause, be treated as a single member:

Provided further that—

(A) persons who are in the employment of the company; and

(B) persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased, shall not be included in the number of members; and

(iii) prohibits any invitation to the public to subscribe for any securities of the company.

Brief Overview

Well broadly considering, the basic requirements of both the companies are same, that they require a minimum of two members to incorporate a company, where a Private Company directly requires minimum two shareholders to incorporate a company, a One Person Company requires only one shareholder, along with a nominal shareholder, who shall become the shareholder and take care of the company in case of death or incapacity of the original shareholder. Also, both the companies require an initial share capital of Rs. 1 lakh and the other pre and post incorporation processes are also similar, except that One Person Company has been provided with certain exemptions in ROC filings and conduction of Annual or Extra General Meeting i.e., there is no requirement to hold an Annual General Meeting. If there is a transaction which requires special or general resolution, it’ll be considered passed by the One Person Company if the resolution is communicated by the members to the company.

Advantages

Even though the concept of One Person Company has been recently introduced under the Companies Act, 2013 keeping in mind the hardships that individuals have faced while incorporating a company, as the only option that was available as per the Companies Act, 1956 was forming a sole proprietorship which had its own pros and cons. The very idea of being given an option to incorporate a One Person Company by a single member, has been a sigh of relief for individuals who were more willing to work alone than to find another shareholder to match the basic requirement of incorporating a Private Company and availing the benefits of being a Company formed under the Companies Act. However, there are certain advantages that incorporation of a Private Company may have over the incorporation of a One Person Company for a single founder. When it comes to raising a share capital, a Private Company always has an upper hand, as it does not restrict the number of shareholders. A Private Company requires a minimum of two shareholders, which can extend up to 200 shareholders, which makes it easier for the Private Company to raise paid up share capital for its business as and how it requires. However, a One Person Company faces difficulty when it comes to raising share capital by adding more shareholders, as it cannot have more than one shareholder or else the basic concept of a One Person Company will change. There is another drawback that One Person Company faces is that it restricts the limit of paid up share capital it can raise i.e., if the threshold limit is increased beyond Rs. 50 lakhs or its average annual turnover during the relevant period exceeds Rs. 2 crores, then the One Person Company has to invariably file forms with the ROC for conversion into Private or Public Limited Company, within a period of six months on breaching the above threshold limit.

There are certain other advantages of having a Private Company over a One Person Company, i.e., in a Private Company, a shareholder has the freedom to sell or transfer its shares to another party or to any other shareholder with a condition that a shareholder cannot sell or transfer their shares without offering them first to other shareholders for purchase, whereas One Person Company cannot exercise such freedom to transfer its shares to another shareholder or any other person as whole or in parts as it ceases to be One Person Company if the shares are so transferred, as partly transferring the shares shall mean having another shareholder in the Company which is against the basic idea of a One Person Company. Also, when it comes to shareholders that are required to incorporate a Private Company, the criteria is a lot simpler as a Private Company can have a shareholder who is a natural person i.e., a Indian National or a Foreign National, or it can be a Company i.e., an Indian Company or a Foreign Company, whereas there is a strict rule as to the One Person Company that the shareholder of a One Person Company should be a natural person who is an Indian citizen and resident in India who shall be eligible to incorporate a One Person Company. In this case, “Resident in India” shall mean a person who has stayed in India for a period of not less than 182 days during the immediately preceding one calendar year. Also, when it comes to adding minors as shareholders, Private Company is a little flexible as a minor can become a shareholder in a Private Company when fully paid up shares are transferred or gifted to him or when the shares are passes on to him by way of transmission, but the same rule does not apply to a One Person Company, as a minor cannot become a shareholder as per the norms of One Person Company.

There is also a concept of an Employee Stock Option Plan (ESOP), which has gained significance in India and is more applicable in Private Company than in One Person Company. The Concept of ESOP or ESOS (Employee Stock Option Schemes) has been introduced to encourage the performance of the employees and give them the benefit of purchasing the shares of the Company at a future date at pre-determined prices. The very idea behind providing ESOP’s to employees is to align the interest of Employees with that of the shareholders of the Company. However, such benefits are not provided for in the concept of One Person Company.

Conclusion

In my view incorporating a One Person Company has its own perks, however when it comes to practically managing the company and raising funds for its expansion and managing other risks involved, incorporating a Private Company is always an advantage over incorporating a One Person Company for a single founder, as it provides flexibility in funds, expansion of business and raising share.

In this blog post, Tarun Gaur, a student of University School of Law & Legal Studies, GGSIPU, New Delhi, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, deliberates on whether partners are required to contribute a minimum capital in an LLP or not?

Introduction

The term “capital” connotes some form of asset of an organisation. It is usually linked or understood to be known as the initial monetary contributions made by the founders in their organisation.

Investopedia defines the term capital as “Capital” can mean many things. Its specific definition depends on the context in which it is used. In general, it refers to financial resources available for use. Companies and societies with more capital are better off than those with less capital. Capital may mean:

1. Financial assets or the financial value of assets, such as cash.
2. The factories, machinery and equipment owned by a business and used in production”.

In the context of present write up, capital shall be construed as financial assets including money and financial value of assets, contributed by partners before, during or after the formation of LLP. The statement “after the formation of LLP means and includes the situation where an individual becomes partner after the LLP has already been formed and makes contribution towards capital during his appointment as a partner.

The term “minimum capital” stipulates the minimum amount of capital contribution which is required from the founders during the time of incorporation of LLP or form individuals during their entry as a partner in an already existing LLP.

The basic pre-requisite for setting up of any commercial structure for trade is the requirement of capital and with the definition given above the importance of same can’t be denied or overlooked. Almost all the legislations governing different business vehicles mandates for certain level of initial capital contribution initially or during the incorporation or setting up of the stipulated business vehicles.

One such example is the Companies Act, both 1956 and 2013 stipulates that the minimum capital that is required to incorporate a private limited company is Rs. 1 lakh and Rs. 5 lakh for the incorporation of public company.

But with the onset of new Companies (Amendment) Act, 2015, such provision for minimum requirement of capital, even for companies, has been done away with.

In this write up, the focus is on the business vehicle i.e. LLP and to find out whether there is some mandatory need for the partners of LLP to contribute some sort of minimum capital, before, during or after the incorporation of an LLP. Therefore in order to get a clear picture of same, we need to evaluate the provisions mentioned regarding same in the LLP Act, 2008 and its rules thereon and find out if provisions are clear or ambiguous on this aspect and if ambiguous then what form of interpretation shall be applied in order to ascertain the Actual intent of the parliament.

The LLP Act, 2008

The LLP Act 2008 is great step taken by the legislature, towards the development of commercial space, by providing for a business structure which was highly awaited and is proving to be of immense importance for the service providers. Therefore, by keeping in mind the growing need of a business structure where benefit of partnership can be availed with the advantages of having the liability like corporations, the legislature enacted this Act. Now this Act is the sole legislation that governs the Limited Liability Partnerships and further enshrines all the requisite rules and regulations required for the proper working of the said business structure. The very first provision that we should examine is the definition of a partner as is given under Section 2(q) of the Act.

Section 2(q): “partner”, in relation to a limited liability partnership, means any person who becomes a partner in the limited liability partnership in accordance with the limited liability partnership agreement.

The definition portrays that a partner can be anyone, who becomes partner, in accordance with the LLP agreement. Therefore what becomes clear from the definition is that for any person to be included in the definition of the partner as is given under Act, the only requirement is to become the partner in accordance with the terms of LLP agreement and the Act does not specify any kind of capital requirement here.

Then we head to the provision which provides for the requisite essentials on the fulfilment of which, an individual shall be barred from making the partner and the said essentials are listed u/s 5 of the Act.

Section 5: Any individual or body corporate may be a partner in a limited liability partnership: Provided that an individual shall not be capable of becoming a partner of a limited liability partnership, if—

1. He has been found to be of unsound mind by a Court of competent jurisdiction and the finding is in force;
2. He is an undercharged insolvent; or
3. He has applied to be adjudicated as an insolvent and his application is pending.

From the above section the provisions that are relevant for this write up are those listed under part (b) and (c) above. The relevant provisions stipulates that an individual shall not be capable of becoming a partner of an LLP if he is an undischarged insolvent or he has applied to be adjudicated as an insolvent and his application is pending.

Therefore what we can gather form this is that for becoming partner in an LLP what is required is that the person must be a solvent. Now since these provisions makes it mandatory for an individual to be solvent, can it be said that these provisions in a way implies that the individual need to contribute mandatorily, some form of capital during his making of partner?

To answer this question, since the provisions are not entirely ambiguous, we need to construe them in a literal manner and after applying such rule of construction, what we gather is that the provisions, though provides for the person to be solvent, but that does not necessarily means that he have to contribute some form of capital. Therefore a person can be solvent and yet can be made partner without contributing anything in the LLP.

After construing the definition of partner, another somewhat related but important definition that need to be looked upon is that of Designated Partner. The same has been defined u/s 2(j) of the Act.

Section 2 (j): “designated partner” means any partner designated as such pursuant to section 7.

Since the definition simply provides that the designated partner shall be the partner pursuant to the provisions mentioned u/s 7, let’s have a look at same.

Section 7 (2): Subject to the provisions of sub-section (1),—
(i) if the incorporation document—

(a) specifies who are to be designated partners, such persons shall be designated partners on incorporation; or

(b) states that each of the partners from time to time of limited liability partnership is to be designated partner, every partner shall be a designated partner;

(ii) any partner may become a designated partner by and in accordance with the limited liability partnership agreement and a partner may cease to be a designated partner in accordance with limited liability partnership agreement.

The provisions of the Act provide that a designated partner shall be the partner who will control the functioning of entire LLP. Therefore in a way it can be said that the role of a designated partner is similar to that of a CEO and CFO in a corporation. But there exists a huge line of difference with respect to their roles in both the organisations. LLPs are more like partnerships and less like corporations and we all know that in partnerships, the managing partner is usually the one who contributes the most in the capital of the firm and sometimes in accordance with the agreement b/w the partners when all the partners contribute equally, then they may decide a method for appointing of a managing partner.

Here according to the provisions listed u/s 7 of the Act, designated partner shall be one who is specified as same in the incorporation document or if incorporation documents specifies that every partner shall be designated partner from time to time then in accordance with their terms or in accordance with the terms of the agreement. Moreover even in this provision, the principle of “higher contributor will be appointed as designated partner is absent” and on the contrary it provides that anyone and everyone of the partners can become a Designated Partner in accordance with the terms of incorporation document or terms of the agreement.

After going through the above mentioned provisions, we need to examine the incorporation requirements as is given u/s 11 of the Act.

Section 11: (1) For a limited liability partnership to be incorporated,—

1. two or more persons associated for carrying on a lawful business with a view to profit shall subscribe their names to an incorporation document;

(2) The incorporation document shall—

1. Be in a form as may be prescribed;
2. State the name of the limited liability partnership;
3. State the proposed business of the limited liability partnership;
4. State the address of the registered office of the limited liability partnership;
5. State the name and address of each of the persons who are to be partners of the limited liability partnership on incorporation;
6. State the name and address of the persons who are to be designated partners of the limited liability partnership on incorporation;
7. Contain such other information concerning the proposed limited liability partnership as may be prescribed.

According to the Section 11(1)(a), the Act provides for the existence of an LLP, two or more persons to be associated for carrying on of a lawful business with a view to earn profit, and they shall there by subscribe their names to the incorporation document.

After the subscription, sec. 11(2) lists out explicitly a number of things, which are required to be mentioned in the incorporation document and nowhere in the list the provision explicitly provides for the mentioning of amount of capital contribution by each and every partner.

But at the same time it does not excludes such requirement completely as in the end, it provides for such other info concerning the proposed LLP as may be prescribed i.e. prescribed in the LLP agreement.

Now we should move on to the provisions as are listed u/ss 22 & 23 of the Act, which provides for the appointment of partners and addition of new partners in later stages and govern the relationship between partners.

Section 22: On the incorporation of a limited liability partnership, the persons who subscribed their names to the incorporation document shall be its partners and any other person may become a partner of the limited liability partnership by and in accordance with the limited liability partnership agreement.

This section simply stipulates that whoever subscribes to the incorporation document will become the partner and any other person may also become partner but only in accordance with the LLP agreement. Moreover,here again there exists no requirement for any kind of mandatory capital contribution by any of the partner either while signing the incorporation document nor in the subsequent addition of some other partner.

Section 23. (1) Save as otherwise provided by this Act, the mutual rights and duties of the partners of a limited liability partnership, and the mutual rights and duties of a limited liability partnership and its partners, shall be governed by the limited liability partnership agreement between the partners, or between the limited liability partnership and its partners.

(4) In the absence of agreement as to any matter, the mutual rights and duties of the partners and the mutual rights and duties of the limited liability partnership and the partners shall be determined by the provisions relating to that matter as are set out in the First Schedule.

This provides that rights and duties be governed in accordance with the terms mentioned in the agreement and in absence of same, the rights or duties, will be governed by Schedule I of the Act.

Schedule I contains various provisions but the provisions which are relevant for this write up are produced below:

2. All the partners of LLP are entitled to share equally in capital, profits and losses of the LLP.

Now this provision stipulates that in the absence of any terms with respect to the profit sharing, all the partners shall be entitled to share equally in capital, profits and losses of the LLP. This provision nowhere provides that partners shall contribute equal in capital instead uses the term “entitled” which stipulates that all the partners irrespective of their share contribution, considering if any, will be eligible to take equal share in capital, profits and losses. Hence what can be concluded from here is that irrespective of the fact that who contributed to what extent, all the partners shall get equal share in profits and everything.

5. Every partner may take part in the management of the LLP.
6. No person be introduced as a partner without consent of all.
7. Any matter related to LLP shall be decided by majority vote and for this purpose, each partner shall have one vote. However no change in business without consent of all.

All these provisions provides for a common thing i.e. irrespective of the amount of capital contributed by any of the partner, all are entitled to equal rights and privileges in the matter of share in capital and profits, participate in management, and every partner gets on vote in the matters dealing with the affairs of LLP.

Hence the provisions does not provides for any special rights or privileges for the partner who has contributed the most in comparison to others.

Now let’s move on to the provisions dealing with the cessation of partnership as is given u/s 24 of the Act.

Section 24 (1): A person may cease to be a partner of a limited liability partnership in accordance with an agreement with the other partners or, in the absence of agreement with the other partners as to cessation of being a partner, by giving a notice in writing of not less than thirty days to the other partners of his intention to resign as partner.

(2) A person shall cease to be a partner of a limited liability partnership—

1. on his death or dissolution of the limited liability partnership; or
2. if he is declared to be of unsound mind by a competent court; or
3. if he has applied to be adjudged as an insolvent or declared as an insolvent.

(5) Where a partner of a limited liability partnership ceases to be a partner, unless otherwise provided in the limited liability partnership agreement, the former partner or a person entitled to his share in consequence of the death or insolvency of the former partner, shall be entitled to receive from the limited liability partnership—

1. an amount equal to the capital contribution of the former partner actually made to the limited liability partnership; and
2. His right to share in the accumulated profits of the limited liability partnership, after the deduction of accumulated losses of the limited liability partnership, determined as at the date the former partner ceased to be a partner.

Now, with respect to the provisions of this section, what is relevant for the present write up is sub section 5.

Section 24(5): provides that on cessation of partnership of a partner, the former partner or a person entitled to claim under him shall be entitled to receive form the LLP, an amount equal to the capital contribution made my former partner. Now this is an ambiguous provision as it nowhere provides that the capital contributed in accordance with the terms of agreement or anything of that sort, and in the entire discussion we have seen that if there exists some need of capital contribution by partner, then that exists only if the agreement provides for same as the Act, till now nowhere makes the capital contribution a mandatory thing. Therefore by applying the golden rule of interpretation and after reading the statute as a whole, what we can infer is that the intent of parliament under this sub head is to state the “contribution made by former partner in accordance with the terms of the agreement”.

Now let’s move to the express provisions which deals with the part of contributions by partner and the same are listed u/ss 32 and 33 of the Act.

Section 32 (1) A contribution of a partner may consist of tangible, movable or immovable or intangible property or other benefit to the limited liability partnership, including money, promissory notes, and other agreements to contribute cash or property, and contracts for services performed or to be performed.

(2) The monetary value of contribution of each partner shall be accounted for and disclosed in the accounts of the limited liability partnership in the manner as may be prescribed.

Now this section can result in two things i.e. it may come out as a clear provision which provides for mandatory capital contribution in the forms mentioned in the section towards the incorporation of LLP and other is, it may strike as an ambiguous provision where it is just not clear whether the Act tries to make such contribution a mandatory thing or simply a mere obligation which if not complied with will not lead to any noncompliance with the Act. The base of such ambiguity stems from the fact that the provision though provides as to in what form the contribution of a partner may be in, it nowhere provides whether such contribution is mandatory or not as the provision does not entail words like “a partner may contribute and such contribution may be in form… ” nor does it reads like “a partner must contribute and such contribution may be in form… ”.

In order to get a clear picture on such ambiguity, we should try reading this provision in conjunction with section 33 and the same is produced below.

Section 33 (1) The obligation of a partner to contribute money or other property or other benefit or to perform services for a limited liability partnership shall be as per the limited liability partnership agreement.

Now here when, we read both these sections in conjunction with each other, the resulting construction stipulates that the Act of contribution is an obligation which stems from the terms mentioned in the LLP agreement and in absence of any such terms, there exists no mandatoriness for the partners to contribute in capital during the incorporation of the LLP.

Rules 2009

After going through the provisions of the Act, let’s look at the rules which are made under the Act so as to get a much more clear and unambiguous picture with respect to the fact whether there exists any mandatory requirement under the LLP Act for the partners to contribute in some form in the capital during the incorporation of the LLP.

Rule 9 stipulates that a person shall not be appointed as a designated partner if (a) He has at any time within preceding 5 years been adjudged insolvent.

Now here again, what the legislature has provided is that for any partner to be appointed as designated partner, he need to be solvent and at any time during the preceding 5 years, he has not been adjudged as an insolvent. This rule nowhere provides that the designated partner shall be appointed on the basis of amount of capital contributed or anything of that sort and what it entails, clearly implies that any partner, irrespective of the fact as to how much of capital contribution he has made in the partnership, can be appointed as a designated partner and only requirement that need to be fulfilled is that he shouldn’t be adjudged as an insolvent in the preceding 5 years.

Then we come to the rule providing for the accountability and disclosure made with respect to the contribution made by the partners which is listed u/r 23.

Rule 23 (1) the contribution of each partner shall be accounted for and disclosed in the accounts of the LLP along with the nature of contribution and account.

(2) The contribution of a partner consisting of tangible, movable or immovable or intangible property or other benefits brought or contribution by way of an agreement or contract for services shall be valued by a practicing CA, cost accountant or by approved valuer from the panel maintained by central government.

These provisions simply provides that the contribution made by the partners in the capital during the incorporation of LLP shall be accounted for and disclosed in the accounts of the LLP along with the nature of contribution and account and the provision further provides that if any contribution is made in tangible form of property (movable or immovable) or intangible property or other benefits or contribution by way of an agreement or contract for services shall be valued by a practicing CA, Cost Accountant or by an approved valuer from the panel maintained by central government.

Conclusion

The above discussion elaborates the provisions listed under the LLP Act 2008 and the rules made there under to ascertain whether the partners need to contribute a minimum capital during the incorporation of an LLP. The discussion entails all the provisions and rules in an elaborate form with proper commentary with specific interpretation of all the provisions mentioned.

Hence the conclusion that can very well be derived is that there exists no need for the partners to contribute a minimum capital per se and everything relating to the aspect of capital contribution shall be governed solely in accordance with the terms of the LLP agreement and this is not shocking or amusing in any manner because in the entire Act, one thing that becomes very clear, is that, the intention of the parliament while enacting this Act was simply to give the LLP agreement entered into by the parties, utmost importance and hence the basic requirement which always prevails in all the business structures i.e. capital contribution, without which any business structure can’t work, has been left on the discretion of the partners and nothing has been imposed as minimum paid up capital or minimum requirement of capital, by the legislature, in the Act.

But all this in no way stipulates that in a real world scenario as well, partners don’t contribute any capital in the formation of LLP. In fact, the practical situation is very different than the theoretical one and is highly detailed, as every LLP actually stems from an LLP agreement entered into, by the partners and under same, partners include detailed provisions for everything and these provision specially includes the provisions for capital contribution and same is dealt under the head “capital contribution by the partners” in the agreement.

The agreement also entails the provision for various privileges that stems from the amount of capital contributed by the partners hence in actual scenario, partners do include special privileges for themselves in form of special treatment simply because of the fact that they have contributed the most in the capital. Another form of privilege which is very prevalent is the grant of veto power or grant of votes in proportion with the capital contributed and these privileges are added with the sole objective of retaining the control and the management of the business structure in few hands.

Hence it becomes clear that, the requirement of Minimum Capital Contribution in LLP, though a Practical Necessity, yet left Discretionary by the legislature.

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In this blog post, Nandish Shah, a student pursuing his BLS LLB from Rizvi Law College, Mumbai and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, gives a brief overview of regulations pertaining to small companies. 

Introduction

Small Companies are new forms of private companies under the Companies Act, 2013. A classification of private companies into small companies is based on its size, i.e., paid up capital and turnover. In other words, such companies are termed as small-sized private companies. The concept of small companies has been introduced in the Companies Act, 2013 as recommended by the Dr. JJ Irani Committee. The recommendation of the Irani Committee in this regard was as under:

“The Committee sees no reason why small companies should suffer the consequences of regulation that may be designed to ensure balancing of interests of stakeholders of large, widely held corporates. Company law should enable simplified decision-making procedures by relieving such companies from select statutory internal administrative procedures. Such companies should also be subjected to reduced financial reporting and audit requirements and simplified capital maintenance regimes. Essentially the regime for small companies should enable them to achieve transparency at a low-cost through simplified requirements. Such a framework may be applied to small companies through exemptions, consolidated in the form of a Schedule to the Act.”

The new Companies Act identifies some companies as small companies based on their capital and turnover for the purpose of providing relief/ exemption to these companies. Most of the exemptions provided to small companies are same as that of One Person Company.

As per Ss.2(85) of Companies Act,2013 “small companies” means a company, other than a public company—

1. Paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than five crore rupees; or
2. Turnover of which as per its last profit and loss account does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than twenty crore rupees:

Provided that nothing in this definition shall apply to:

1. a holding company or a subsidiary company;
2. a company registered under section 8; or
3. a company or body corporate governed by any special Act;

So, according to Ss.2(85) only a private company can be classified as a small company. Even a holding company, a subsidiary company, a charitable company and a company governed by Special Act cannot be classified as a small company. For a small company, both conditions have to be fulfilled, i.e., the paid up capital should not exceed Rs.50 Lakhs or the turnover as per the last statement of profit and loss should not exceed Rs. 2 Crore.

It is also a statutory rule that the status of a “small company” may change from year to year. Thus, the benefits which are available to a company during a particular year may stand withdrawn in the next year and become available again in the subsequent year. For qualifying as a small company, it is enough if both the capital and turnover are less than the prescribed limit. It is not sufficient if only one of the requirement is met without meeting the other requirement.

As per the recommendation of Dr. J.J. Irani Committee the concept of “Small Company” was introduced to give them certain privileges and compliance exemption under the new Companies Act.

Privileges And Exemption To Small Companies

The privileges and exemption enjoyed by a small company or its advantages over other companies are as follows:

1. According to Ss.2(40), small companies have the privilege that as part of their financial statement with regards to small companies they may not include the cash flow statement;
2. According to Ss. 67(2), small companies are given financial assistance for purchase of or subscribing to its own shares or shares in its holding company;
3. According to Ss. 92(1), the annual return of the small company shall be signed by the company secretary, or where there is no company secretary, by the director of the company. In other words, it need not be signed by the company secretary in practice;
4. According to Ss.121(1), a small company need not prepare a report on Annual general meeting;
5. According to Ss. 134(3)(p), a small company need not prepare a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors;
6. According to Ss. 149(1), a small company need not have two directors on its Board;
7. According to Ss. 149(4), the law provides that small companies need not appoint independent director on its board;
8. According to Ss. 152(6), the law provides that in a small company a proportion of directors need not retire every year;
9. According to Ss. 164(3), the law provides that additional grounds for disqualification for appointment as a director may be specified in the articles.
10. According to Ss. 165(1), the law provides for restrictive provisions regarding total number of directorships which a person may hold in a public company do not include directorships held in small company which are neither holding nor subsidiary company of a public company;
11. According to Ss. 167(4), the law states that additional grounds for vacation of office of a director may be provided in the Articles.
12. According to Ss. 173 (5), the law provides that a small company is required to hold at least one meeting of the Board of Directors in each half of a calendar year, and the gap between the two meetings should not be less than ninety days.
13. According to Ss. 190(4), the law provides that the provisions relating to the contract of employment with managing or whole-time directors do not apply to a Small Company
14. According to Ss. 197(1), the law states that the total managerial remuneration payable by a small company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year may exceed eleven per cent. of the net profits.

Laws Relating to Small Companies

The term “Small Companies” was introduced in Companies Act, 2013. According to the provisions of the Companies Act, small companies have to be a private company. Hence, laws pertaining to small companies is governed by Companies Act 2013.

Conclusion

Due to the introduction of the concept of small companies on the recommendation of the J.J. Irani Committee, there are many benefits given to a small company in terms of annual filings, board meetings, cash flow statement and rotation of auditors. So, since most of the startups will have a paid-up capital of less than Rs.50 lakhs and an annual sales turnover of less than Rs.200 lakhs, they will be classified as small companies. Thus, the benefits under the provision of Companies Act for small companies will help the startup to grow.

In this blog post, Mrinal Litoria, a student pursuing his BA LLB from Rajiv Gandhi National University of Law, Patiala and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, provides advice to a private Company who wants to induct a new co-founder. 

What is a Private Company?

A private company may be one whose shares are not offered to the public for sale and are privately held by the founder or co-founders. Also, a private corporation may work with legal requirements which are less strict that those of public limited companies.

Who is a Founder?

A person who is the brains behind the conception of an idea for business, which he might want to start alone or with the help of other co-founders, and also venture into the implementation of the concept, may be called a founder. The concept or idea may be for-profit or non-profit purpose but what is important is that the mere conception of the idea will not make him a founder, something has to be founded upon the idea, i.e., the idea must be materially executed to make him a founder.

Who is a Co-Founder?

A founder does not necessarily have to be working alone on his conception or that the idea might not always be entirely his. There may be situations where an idea may be conceptualized by two or three or more persons, or that after the conceptualization of an idea the founder may feel like he needs additional people or their particular skill-set at the very core of it and moreover goes on to find somebody who believes in his idea and wants to put in equal effort in transforming the idea into reality, is the person capable of being called a Co-Founder. This person is equally involved with others in materializing the idea into reality.

Inducting a New Co-Founder

In a scenario where a private company has been incorporated by a founder or a couple of co-founders, the existing set of founders might feel like adding to their strength at the core of the company by inducting or recruiting a new co-founder, who might be able to take the company’s operations ahead in a better or organized manner. The company might want to recruit this new co-founder because they want to incorporate in their company his particular professional expertise for the benefit of their company. There may also be a situation of there being a vacancy in the position of a co-founder of a company for various reasons. In all such circumstances a private company can go on to recruit a new co-founder by entering into an agreement with this person (whom they are looking to recruit) for the decision of percentage of share that he would own, or other details about control or management, which is called a Co-Founders Agreement.

But certain essentials are to be pondered upon before entering into a co-founders agreement, which may be –

• In the case of a registered company, the articles, and memorandum of association have to be looked into for deriving the power to induct a new co-founder, which, if is not present, an amendment to this effect has to be made.
• There also might be a co-founders recruitment clause in the original co-founders agreement, specifying the rights and duties and even the method of inducting a new co-founder.
• A private company may have another pre-decided procedure, criteria or panel for deciding upon the issue of recruiting a new co-founder as and when the need for such arises.

Co-Founder Agreement

A Co-founder Agreement is a contract between Co-Founders setting out the ownership, initial investments and responsibilities of each Co-Founder. This agreement also safeguards in the case of a dispute, as it can provide protection to show what the co-founder agreed too. A co-founders agreement may have provisions and clauses related to the following topics-

• Co-Founder details
• Project Description
• Equity breakdown
• Capital contributions
• Roles and responsibilities of each Co-Founder
• Management and approval rights
• Non-compete clause
• Confidentiality clause
• Provisions relating to intellectual property
• Provisions relating to Removal, Resignation, Dissolution and Termination, etc.

Steps Involved in Inducting a New Co-Founder Post Incorporation:

The mere signing of a co-founders agreement is not enough for inducting a new co-founder unless the agreement is comprehensive enough to cover all the issues involved in such induction like issuing of shares, IP assignment, etc. That is to say either for every issue a different legal document may be signed, which is usually the practice, or that such a set of documents which finally decide upon all the issues may be collectively referred to as a Co-Founders Agreement.

Upon incorporation the directors of the company are mandated to issue shares to the founders of the company, similarly, when there is a situation of inducting or recruiting a new co-founder, shares or stocks are to be issued to him in one way or the other. This can be done by some ways, i.e., by the existing founders selling some of their shares to the new founder or by having the company issue new shares and selling them to the new founder at fair market value etc. Therefore a restricted stock purchase agreement is to be signed by the new founder who in turn gives the company the right of first refusal in case of a proposed transfer or otherwise.

Then there might be issues of intellectual property assignment, and further documentation may need to be followed up with that. IP comes in many forms but make sure that whatever IP is being developed for your new enterprise belongs to the entity and not the individuals behind the development of the IP.  This concept extends to not only co-founders but to all employees, consultants, and contractors.

The basic idea around which the concept of adding a new co-founder revolves is the issuing of ‘Founders Stock’ to the new co-founder and the legal formalities to be followed about the same. This does not have to be a specific kind of stock which is to be issued distinctively, but any stock of shares which is issued to the new founder may be called as such.

Therefore, it is to be kept in mind that a strict co-founders agreement is to be formed for the protection of interests of the company with having all the necessary non-compete and confidentiality clauses. Inducting a new founder can be a very sensitive issue, and there should be unison in the minds of all the existing founders and directors of the company. The issuing of shares to the new co-founder is the central step involved in the procedure which should thereby be carried out by a strict share-purchase agreement between the new founder and the company or between the existing holders and the new founder.

The followingnserves as an example for a co-founder’s agreement:

[1] The Sample Co-Founder’s Agreement has been taken from: https://www.docracy.com/6348/founders-agreement-template

In this blog post, Shubham Soni, a student of Institute of Law, Nirma University, Ahmedabad, discusses if the beneficiary in a trust can transfer his or her beneficial ownership in the trust?

Trustee, Beneficiary & Ownership

A long time ago, when Knights used to go to war, they used to entrust their property to some ‘trusted’ friends, who would look after it for the benefit of their families. Such trusted people were referred as ‘trustee’ and the family members were the ‘beneficiaries’. This is how the English Trust Act developed from which the Indian Trust Act, 1882 took inspiration.

Under the English trust law, the trust property becomes the subject of dual ownership. The trustee is the legal owner and the beneficiary is the beneficial owner. The picture though, changes in the Indian Trust Act, which departed from the dual ownership concept to the concept of single ownership. The provisions of the Indian Trust Act, 1882 clearly makes the trustee the legal owner as well as the beneficial owner.  Beneficial ownership is not recognized in India. However, some rights that are very similar to ownership can be found in Chapter VI of the Act.

Does that mean I cannot transfer my beneficial ownership?

Beneficial Ownership is definitely a big no. But you sure can transfer your beneficial interest under the Indian Trust Act. Beneficial Interest is one of the rights of the beneficiary in the trust and reflects many elements of beneficial ownership. The Right to transfer beneficial interest is laid down in Sections 58 and 69 of the Indian Trust Act. Section 58 of the Trust Act clearly states the conditions as well as the caveat.

“58.  Right to transfer beneficial interest.—The beneficiary, if competent to contract may transfer his interest, but subject to the law for the time being in force as to the circumstances and extent in and to which he may dispose of such interest: Provided that when property is transferred or bequeathed for the benefit of a married woman, so that she shall not have power to deprive herself of her beneficial interest, nothing in this section shall authorise her to transfer such interest during her marriage.”[1]

Whoever receives the beneficial interest under this Section also acquires the rights and liabilities of the beneficiary at the date of the transfer. It is clear, that it is the right of the beneficiary. This became even clearer in the case of Canbank Financial Services Ltd. v. Custodian[2], when the Supreme Court held that when a trust is created by reason of express agreement between parties, the beneficial interest can be indisputably transferred.

Who cannot transfer?

The transfer can be made in most of situations without a glitch but there are certain restrictions as well. Such a transfer can be made by the beneficiary only if they are of the:

1. age of majority with
2. sound mind and
3. are not disqualified by any law for the time being in force in India.

In case the beneficiary is a married woman and the trust property has been bequeathed to her via the trust to ensure that she would not deprive herself of her beneficial interest, the trust property cannot be transferred at her instance as aforesaid.

It is clear therefore that though beneficial ownership is not recognized in India, a beneficiary can exercise his or her right under Section 58 of Indian Trust Act to transfer his beneficial interest in the trust.

Footnotes:

[1] Indian Trust Act, 1882

[2] (2004) 8 SCC 355

In this blog post, Seuj Bikash, an Advocate, presently practicing in the Gauhati High Court who is also currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, lays down, in details, the FDI Rules that need to be followed when investing in an LLP in India.

Introduction

Limited Liability Partnership (LLP) is a comparatively new and unconventional corporate business which provides for limited liabilities of the partners unlike the traditional partnership, along with operational flexibility. On the one hand, the partners of an LLP are allowed to arrange the terms and conditions of their partnership business in accordance with their mutual agreement but on the other hand, any partner of the LLP is not responsible or liable for misconduct or negligence of the other partner/partners. An LLP presents almost all benefits of a private limited company and is advantageous from the point of view of taxation. In India, the LLPs are introduced and governed by the Limited Liability Partnership Act, 2008. LLP business type has been introduced in India to accelerate the economic growth of the country facilitating the entrepreneurial initiatives.

Foreign Direct Investment (FDI) is investment by foreign individual or organisation in the economic sectors of a country, such as banking, insurance, electricity, roads, railway, aviation, defence etc. FDI makes it possible for a business enterprise based in one country to control the ownership of a business enterprise in another country. For the growth of the Indian economy, the role of foreign investors is considered indispensable since it accelerates economic growth by supplementing domestic capital, technology and skills. FDI in India was introduced by Foreign Exchange Management Act, 1991(FEMA). The Ministry of Commerce and Industry, Government of India has passed the Consolidated FDI Policy (with effect from October1, 2011) (herein after called the FDI Policy) allowing FDI in LLPs and the said policy has laid down specific rules/guidelines with regard to the FDI in LLPs. FDI in LLPs are allowed in order attract more foreign capital investment in various economic sectors which is at present considered as a need of present time for greater development of the Indian economy.

FDI rules regarding investing in Limited Liability Partnerships (LLPs)

Rule 3.2.5 of the Consolidated FDI Policy has laid down conditions under which FDI in LLP is permitted-

The Routes of investment in LLPs and restrictions therein

The Rule 3.2.5 (a) of the Consolidated FDI Policy states that FDI will be allowed through the Govt. approval route, only in LLPs operating in sectors/activities where 100% FDI is allowed, through the automatic route and there are no FDI-linked performance conditions (such as ‘Non Banking Finance Companies’ or Development of Townships, Housing, Built-up infrastructure and Construction-development projects, etc.).

The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (Notification No. FEMA.20/2000-RB, dated 3^rd May, 2000) passed by the Reserve Bank of India, as amended from time to time, in its Annexure-B to the Schedule-1, gives details of  those sectors where 100% FDI is allowed. These sectors are explained here under in light of the said Regulation.

(i)  As regards the manufacturing activities in the Telecommunication Sector, 100% FDI is allowed.

(ii) In the Housing and Real Estate Sectors, the 100% FDI is allowed in the following areas, provided that only NRIs/OCBs are allowed to invest in those areas( the areas listed below)-

1. a) Development of service plots and construction of residential premises,
2. b) Investment in the real estate covering construction of residential and commercial premises including business centres and offices
3. c) Development of townships
4. d) City and regional level urban infrastructure facilities, including both roads and bridges
5. e) Investment in manufacture of building materials
6. f) Investment in participatory ventures in the all above [ that is in (a) to (e)]
7. g) Investment in Housing Finance Institutions.

(iii) In the Mining Sector, 100% FDI is allowed in the Exploration and mining of gold and silver and minerals other than diamonds and precious stones, metallurgy and processing.

(iv) 100% FDI is allowed in the Film Industry (i.e. film financing production, distribution, exhibition, marketing and associated activities relating to the Film Industry subject to the following conditions-

1. a) Companies with an established track record in films, TV, music, finance and insurance.
2. b) The company should have a minimum paid up capital of US $ 10 million if it is the single largest equity shareholder and at least US $ 5 million in other cases.
3. c) Minimum level of foreign equity investment would be US $ 2.5 million for the single largest equity shareholder and US $ 1 million in other cases.
4. d) Debt equity ratio of not more than 1:1, i.e., domestic borrowing shall not exceed equity.
5. e) Provisions of dividend balancing would apply, etc.

Specific restrictions

The Rule 3.2.5 (b) of the consolidated FDI Policy prohibits the LLPs with FDI from operating in agricultural/plantation activity, print media or real estate business.

The economic activities, such as agricultural activities, plantation, print media, real estate etc. need observance of the standards of public health, safety and security. Such economic activities are of immense importance from social perspective also. Therefore, the law makers have rightly debarred the LLPs with FDI from operating in such sectors which generally act exclusively with profit motives.

Downstream investments

Downstream investment means investment by a company in another company/LLP. An Indian Company already having foreign investment may make investment in an Indian downstream company or LLP.  Rule 3.2.5 (c) of the consolidated FDI Policy states that an Indian company, having FDI, will be permitted to make downstream investment in an LLP only if both the company, as well as the LLP are operating in sectors where 100% FDI is allowed, through the automatic route and there are no FDI-linked performance conditions. However, the Rule 3.2.5(d) of the policy restricts the LLPs with FDI from making any downstream investment. Thus, only the companies (with FDI), not LLPs (with FDI) are permitted to make downstream investment.

Mode of making and receiving investment

Rule 3.2.5(e) of the consolidated FDI Policy states that Foreign Capital participation in LLPs will be allowed only by way of cash consideration, received by inward remittance, through normal banking channels or by debit to NRE [Non-Resident (External) Rupee account] or FCNR [Foreign Currency (Non- Resident ) account] of the person concerned, maintained with authorised dealer or authorized bank.

Rule 3.2.5(f) prohibits the investment in LLPs by Foreign Institutional Investors (FIIs) and Foreign Venture Capital Investors (FVCIs). Further, the LLPs are also not permitted to avail External Commercial Borrowings (ECBs).

Foreign Institutional Investors (FII), as per Rule 2.1.14 of the FDI Policy, means an entity established or incorporated outside India which proposes to make investment in India and which is registered as an FII in accordance with the SEBI (FII) Regulations 1995. Rule 2.1.15 of the FDI policy defines Foreign Venture Capital Investor (FVCI) to mean an investor incorporated and established outside India, which is registered under the Security and Exchange Board of India (Foreign Venture Capital Investor) Regulations, 2000 {SEBI (FVCI) Regulations} and proposes to make investment in accordance with these Regulations.

Other Rules

1) The Rule 3.2.5 (g) says, “In case the LLP with FDI has a body corporate that is a designated partner or nominates an individual to act as an designated partner in accordance with the provisions of Section 7 of the LLP Act, 2008, such a body corporate should only be a company registered in India under the Companies Act, 1956 and not any other body, such as an LLP or a trust.”

2) The Rule 3.2.5(h) states that for the LLPs with FDI, the designated partner “resident in India”, as defined under the ‘Explanation’ to Section 7(1) of the LLP Act, 2008, would also have to satisfy the definition of “person resident in India”, as prescribed under the Section 2 (V)(i) of the Foreign Exchange Management Act,1999.

3) The Rule 3.2.5(i) of the FDI Circular states that the designated partners will be responsible for compliance with all the conditions prescribed by the Rule 3.2.5 of the FDI Circular and also liable for penalties imposed on the LLP for their contravention, if any.

4) Conversion of a company with FDI, into an LLP, will be allowed only if the above stipulations are met and with the prior approval of FIPB/Government [Rule 3.2.5(J) of the FDI Policy].

Conclusion

India is considered as major FDI destination for multinational corporations. Allowing the foreign investors to invest in LLPs will definitely foster the economic growth of the country in days to come. Since the enforcement of the Limited Liability Partnership Act, 2008, the LLPs are increasing in number. In the forthcoming years it will be efficacious for the economic growth of the nation if the Government adopts some additional measures to promote the new LLPs with small entrepreneurial businesses and enterprises.

In this blog post, Naman Maheshwari, a Taxation Expert at C.P.Laddha & Co. and a student pursuing his Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, provides an overview of business structures suitable for a venture funded software business.

“Great advice once I heard was to structure your business so you respect your customers, because they will bring out the best in you and you will feel better yourself.” – Christopher Davis

Introduction

 Business can be any work or process which is started by a person or jointly by a group of two or more persons with a common objective to earn money in exchange of goods or services or both. So a business can be anything or work which is done on a regular basis with an aim to accomplish goals by a person or group of two or more persons who own it and control it with the help of several others. But running a business in the correct manner is not that simple. Acquiring future growth, achievements, success, etc., is not that simple.

Every good business needs proper business structuring. When starting a business, one needs to choose the best feasible business structure through which business could exist successfully for a longer period in the corporate world.

A Business structure is just like a legal skeleton to prop up the business in existing corporate world. It is important for every growing company. Remember the chosen business structure will have both legal and tax implications. The number of business structures, we hear in our daily life are as follows:

1. Sole Proprietorship
2. Partnership
3. One Person Company
4. Limited Liability Partnership (LLP)/LLC
5. Non-Profit Company
6. Trust
7. Joint Venture
8. Association

Types of

The four types of Business Structures found in India are:

Sole Proprietorship: This is the most common type of business structure. This type of structure runs on the principle of One Person One Owner. No second person exists in such a type of business structures. A person starts business, invests, works, and earns. 

Partnership: Two or more than two persons start a business in the form of a partnership. The best part of this form of structure is that the profit and losses are borne the partners’ individual tax returns on the basis of their sharing ratios, so the burden of paying taxes do not fall on the company.

One person Company: This is a mixed form of Sole Proprietorship and a company form of business with concessional and relaxed, or nominal requirements. This was introduced under the Companies Act, 2013.

LLP/LLC (Limited Liability Partnership/Limited Liability Company): These are two hybrid kinds of business structures. LLP is a mixed form of Partnership and Limited Liability.

What Is Venture Funding?

Venture funding is a type of funding or equity which is very much different from a loan. In such a type of private equity, financing is provided to early-stage growing firms or businesses that have high potentials in reference to many factors like the number of employees, revenue or future stability and growth.

It is different from other funding because, in this type of funding, venture capitalists are more interested in buying stakes rather than just providing finance on some loan basis. They buy a fixed percentage of stakes in the business they are investing.

Which Business Structure Is More Suitable For Venture Funded Software Business?

Some factors which are noticeable for choosing a business structure include:

1. Legal liability
2. Tax implications
3. Cost formation and ongoing administration
4. Flexibility
5. Future needs

So, if we take each and every factor, then the partnership is the best suitable business structure for a venture funded business structure. Under a partnership form of company, liability is divided between the numbers of available partners. This is not present in sole proprietorship which provides more flexibility and which also divides profit and losses of businesses in income tax returns of the number of partners rather than taking it whole as a gain of business which helps in showing lesser gains. The partnership provides more flexibility rather than other structures. Hence, a venture funded Software business will have potential future growth if the product research is done in a good area. However, this structure is suitable only in India. Concerns arise when this is shifted to an international level.

Two major business structures that come to mind when we think of one for a software business are LLC/LLP and C-corp. Since, we are looking at a venture-funded software business, C-corp. would definitely be the most suitable business structure.

C-corp. provides the company with a clean capital business structure that a venture capitalist would generally look for before investing. The C-corp. is an equity based capital structure, with the initial equity being owned by the founders, i.e., founder’s shares. At the time of incorporation, the share price is very nominal (e.g. – Rs. 0.0001 per share). Therefore, now the founders/owners of the company have ownership of the company in the form of shareholding. If the founders feel, they can give stock options to their employees and management, too.

Now to the outside investor this capital structure looks clean for investment. Firstly, there are a manageable number of shareholders. Second, the stock option plan gives key employees the incentive to continue working with the business and build on their shareholder value. Finally, there are no obstacles when the company issues shares to new investors in exchange for capital investment.

The only disadvantage of a C-corp. compared to an LLC/LLP is, in a C-corp. we are taxed twice. Taxed on the company’s net profits and taxed on our personal income. Whereas in an LLC/LLP, the net profits the company makes is seen as personal income. Thus, the company gets taxed only once. An alternative to overcome this issue is S-Corp. It has a capital structure similar to that of a C-corp. and tax benefits similar to that of an LLC/LLP.

The issue with S-corp. is that number of shareholders is limited. Transforming the company’s business structure from an S-corp. to a C-corp. can be an expensive affair. Therefore, I believe C-corp. is the most suitable business structure for a venture funded software business.