In the US, the Limited Liability Partnership (“LLP”) is a popular vehicle used by organizations to provide professional services, and hence architects, lawyers and accountants frequently incorporate their business as an LLP to provide services. In India, the Limited Liability Partnerships Act (“LLP Act”) does not contain any limitation on who may organize into an LLP (except for the obvious fact that it should not be constituted to promote illegal activities) and hence one is likely to come across any businesses in almost any sector adopting this kind of a business vehicle. In fact, LLP structure was envisaged by the government for all sorts of SMEs.
The question then is, if a foreigner or foreign entity intends to set up a business which engages in an industrial or manufacturing activity, that is, in the real sector and not in the professional services sector, should he consider incorporating the venture as an LLP or a company?
We have previously covered the new notification which has allowed foreign investment in LLPs, but this post shall focus on whether LLPs should be the preferred vehicle for a business which is in the manufacturing or industrial sector, that is, not in the services sector.
Time taken / number of steps required to start business
Note that foreign investment in LLPs has recently been permitted, but it is only under the approval route (even in sectors where investment into a company is possible under the automatic route), and the approval from Foreign Investment Promotion Board (FIPB) is therefore an extra step a foreigner will have to take while setting up his business. You may not be refused approval as the purpose of FIPB is simply to monitor foreign investment under this new route, and not to actively regulate them. Nevertheless, it does add to the time a foreigner will take in getting his business operational.
If the sector is a regulated sector where foreign investment is not up to 100% and under the automatic route, then the foreigner has no option at all, as FDI in LLPs operating in such sectors is not permitted. The foreigner must incorporate a company.
Structuring Shareholding within group / affiliate / subsidiary companies
Second, a business which is in the industrial or manufacturing sector is likely to have investments in other related or group companies. Unfortunately, Limited Liability Partnerships with foreign investment (FDI) are not permitted to have downstream investments at all.
Ability to control management
Thirdly, a foreign company which has incorporated a Limited Liability Partnership venture in India would like to be involved in the active governance. Ordinarily, a company can be nominated as a Designated Partner. However, if a foreign company intends to nominate a body corporate as a designated partner, the body corporate must be a company registered under the Companies Act, 1956. It cannot nominate other Indian entities or a foreign body corporate as a Designated Partner.
Ability to look for Indian partners
A foreign entity is likely to look for Indian business partners. While an LLP can enter into joint venture and agency agreements, some partners are likely to demand equity in the venture. The ability of an LLP to look for business partners who hold equity stake in it is severely limited. Any company which has FDI can only invest into an LLP if both are in the 100% automatic route sector.
Therefore, if a company operating in the aviation sector or in broadcasting has 24% foreign investment, it cannot invest in an LLP (FDI in the automatic route is permitted only upto 49% in aviation and broadcasting).
Therefore, it becomes extremely difficult for an LLP to choose Indian partners as equity holders in the business, as their options are severely restricted.
Further, the LLP has an increased burden of doing significant legal due diligence to find out the detailed shareholding pattern and ownership structure of the company that is investing into it, before it can involve the company as an equity holder in its business.
Ability to borrow: Cost of capital and access to capital
The freedom to borrow money is restricted in case of an LLP. A foreigner is typically not used to the high interest rates charged in India (access to foreign capital is much cheaper than capital from India, as interest rates abroad are much lower), and he may have the added advantage of having dealt with and convinced foreign financial institutions to lend money to his venture. Indian businesses also prefer taking loans and debt from abroad, which is done through the External Commercial Borrowings (ECB) route under Exchange Control Regulations. However, LLPs are placed at a great disadvantage with respect as they cannot avail of ECBs.
Which foreigner interested in business should opt for LLPs?
The LLP route is ideal for foreigner who plans to setup a professional services venture. He may not be interested in creating a large corporate group with interconnected companies or roping in Indian corporates as equity partners. Also, if the foreign promoter does not plan to take on any external debt in the short or medium term for the business, he could consider incorporating an LLP, as the structure has a tax advantage, and much less periodic compliances as compared to a company.
In case of an LLP, note that the impact of taxation is lower, as it is only at the level of the LLP and partner’s income is received free of tax. In case of a company, apart from corporate income tax, it must also pay a tax on distribution of divided, which comes to about 17 percent of the total amount distributed. For a foreigner in the real / physical sector, investment through a company is the ideal route.