Published in SME WORLD Dec 2012 Issue
Informally FORMAL
In India, a large population of enterprises falls under the micro and small category. These are commonly in the unorganized form and are thus unaccounted in statistical data. Owing to the minefield of statutory compliances and legal tangles, many entrepreneurs prefer uncomplicated form of business identity such as a proprietorship or partnership firm. These forms are useful to get a small venture off the ground and gradually scale up when especially resources are limited and (or) ideas are new. They are also efficient in terms of operational ease and work well as far as routine operation is concerned.
But there is also a downside to it. What happens if one person falls sick or disabled in either forms of business and is unable to discharge duties? What happens if one of the partner's commits fraud then who all are liable? If a property has to be bought in a partnership it will be registered in the name of a partner or partners and never in the name of the firm itself. In such a scenario, how does one safeguard investments and regulate the business properly? Filing of accounts, annual returns or solvency statements are not required under the partnership act. Further, in a partnership registration of the firm is not mandatory. What is your liability as a non-active partner who does not interact on a day to day basis? All partners are liable for compliance under a given partnership. There are issues of credit rating and business performance too which impacts availability of loans and All these point at only one course – the need for compulsorily ingraining some degree of formality while leaving the flexibility to operate in a slightly informal setup. Earlier there was the next possible solution to incorporate a private limited company but that was again bursting with complicated rules, regulations and need for conformance.
In 2009, a new form of business entity formation was introduced in India called Limited Liability Partnership (LLP). This is guided by the Limited Liability Partnership Act 2008 of Government of India. LLP allows for ease of operation with limited legal compliance while enforcing certain degrees of formalization (through a LLP agreement) and professionalism in running a firm.
This article is aimed to create awareness about this form of business incorporation for the benefit of entrepreneurs and existing proprietorship and partnership firms stating the benefits and a basic guideline to implement the same.
Getting your ACT together with LLP
LLP is a relatively new business structure in India but it has been in existence in US, UK and Singapore since the past two decades. Indian LLP act draws from the UK and Singaporean framework.
The most common feature is separate legal entity of the firm from that of the partners and perpetual succession which is not the case with our proprietorship and partnership firms. Owing to the fact that most of these structures are pertaining to entrepreneurs and small businesses, succession is a crucial matter. The separation of entity is vital to safeguard against unlimited liability which is integral in proprietorship and partnership firms.
What LLP essentially addresses are three critical factors for running a successful business.
Accountability – LLP protects each partner from any misdemeanor of other partners. This ensures that partners take accountability of their act and not mismanage the firm according to their whims and wishes. The liability of each partner is limited to their contribution which protects against excessive exposure to personal assets. It makes the firms function in more professional and ethical manner with careful consideration to its operation. The entire agreement is documented and registered compulsorily which is not necessary in partnership firms. In LLP, the separate entity of the firm from that of the partners means property etc can be held in the name of the firm and not inidual partners. This also protects firms from gross interest of any specific partner or partners. In an informal partnership, there is adequate ground for dispute due to excessive flexibility. LLP helps create a more corporate-like structure for operation while retaining a large part of the flexibility.
Compliance - LLP requires that Designated Partners be declared who run the business on a day to day basis. They are responsible for all statutory compliance as required by various laws. LLP's have to compulsorily file annual statement of accounts, solvency and annual returns as per the directive of the law with the Registrar of LLP every year. Though taxation is less than companies, it requires clear accounting and record keeping monitoring performance and ethics. LLP's are meant to be “for profit” firms and not businesses created to channel losses in a larger structure.
Transparency – The biggest advantage which LLP's enjoy is creditworthiness due to mandatory disclosures and compliance. Companies and suppliers who deal with LLP's are more assured of their transactions. If required they can inspect the firm's documents like incorporation and names of partners, statement of account and solvency etc from the office of the Registrar at a nominal fee. This is also a positive factor when the firm needs loans for business expansion. Banks are more comfortable to lending to LLP's as compared to regular partnership and proprietorship firms. (In a proprietorship the owner is same as the business and thus has lesser borrowing capacity. They are also not enforced any mandatory compliance apart from filing of tax returns or VAT payment. They can wind up the business very easily and have full control.)
How to INCORPORATE a LLP
Entrepreneurs can incorporate a LLP either from the beginning or convert their existing proprietorship, partnership firm or private limited company into a LLP.
The standard procedure for incorporation is:
Business Longevity
We put in our best efforts to setup and run a business. Bursting with ideas and a zeal to succeed, we end up paying too much attention to setting up the business and getting it off the ground tying funds from various sources. However, due to our eagerness, lack of financial and legal insight or competence or sheer procrastination, we do not give sufficient thought to how the firm should be incorporated with a long term view of sustainability and performance. We might reason that proprietorship will free ourselves from lot of complications and we can start the business immediately from our house but what happens if we default? Will my house remain with me or it will be put on the block? How will my family's interests be protected from the negative effects of my business venture in case there is a calamity? Often two friends would setup a partnership firm and sign a token document of partnership deed. As the firm starts growing there is a possibility of vested interests interfering and causing upheavals. How should the firm be protected form it? How will our legal heirs take over from us twenty five years down the line if they wish to? These are questions we need to ask ourselves and plan accordingly.
LLP is a good development in the area of a favorable hybrid business structure between the ultra flexible partnership firm and the compliance intensive company structure. It is worth looking at the benefits of this form of business incorporation from various angles like creditworthiness, succession, protection of inidual assets, management of business assets as part of the firm and liability of partners not involved in day to day activities.
Footnote. Read more details about LLP and the Act itself. Please visit http://www.mca.gov.in/LLP/ or www.llp.gov.in or http://www.mca.gov.in/MinistryWebsite/dca/actsbills/pdf/LLP_Act_2008_15jan2009.pdf
Disclaimer. This is only an informative article on LLP. SME WORLD does not assume any responsibility for incorrect use of this information. Please consult your CA for suitability and applicability of the same for your business.
About the LLP Act
Published in Gazette of India on 9 January, 2009, the Limited Liability Partnership Act 2008 was notified on 31st March 2009.
An LLP shall be under the obligation to maintain annual accounts clearly stating the true status and performance of the business. A “Statement of Accounts and Solvency” as per format should be filed by every LLP with the Registrar every year. Annual Return should be filed through Form 11 with ROC within 60 days of closer of financial year. These annual return will be public documents open for inspection at the Registrars for a fee.
Audit of all LLPs (except exempted ones as per notification by Central Government) is mandatory.
The LLP Act contains provisions to convert partnership firms and private company or unlisted public company into LLPs.
The LLP Rules, 2009 contains administrative provisions for formation, management, reconstruction and winding up of LLPs. The firm is a separate legal entity and can own assets.
Source: http://www.mca.gov.in/LLP
Informally FORMAL
In India, a large population of enterprises falls under the micro and small category. These are commonly in the unorganized form and are thus unaccounted in statistical data. Owing to the minefield of statutory compliances and legal tangles, many entrepreneurs prefer uncomplicated form of business identity such as a proprietorship or partnership firm. These forms are useful to get a small venture off the ground and gradually scale up when especially resources are limited and (or) ideas are new. They are also efficient in terms of operational ease and work well as far as routine operation is concerned.
But there is also a downside to it. What happens if one person falls sick or disabled in either forms of business and is unable to discharge duties? What happens if one of the partner's commits fraud then who all are liable? If a property has to be bought in a partnership it will be registered in the name of a partner or partners and never in the name of the firm itself. In such a scenario, how does one safeguard investments and regulate the business properly? Filing of accounts, annual returns or solvency statements are not required under the partnership act. Further, in a partnership registration of the firm is not mandatory. What is your liability as a non-active partner who does not interact on a day to day basis? All partners are liable for compliance under a given partnership. There are issues of credit rating and business performance too which impacts availability of loans and All these point at only one course – the need for compulsorily ingraining some degree of formality while leaving the flexibility to operate in a slightly informal setup. Earlier there was the next possible solution to incorporate a private limited company but that was again bursting with complicated rules, regulations and need for conformance.
In 2009, a new form of business entity formation was introduced in India called Limited Liability Partnership (LLP). This is guided by the Limited Liability Partnership Act 2008 of Government of India. LLP allows for ease of operation with limited legal compliance while enforcing certain degrees of formalization (through a LLP agreement) and professionalism in running a firm.
This article is aimed to create awareness about this form of business incorporation for the benefit of entrepreneurs and existing proprietorship and partnership firms stating the benefits and a basic guideline to implement the same.
Getting your ACT together with LLP
LLP is a relatively new business structure in India but it has been in existence in US, UK and Singapore since the past two decades. Indian LLP act draws from the UK and Singaporean framework.
The most common feature is separate legal entity of the firm from that of the partners and perpetual succession which is not the case with our proprietorship and partnership firms. Owing to the fact that most of these structures are pertaining to entrepreneurs and small businesses, succession is a crucial matter. The separation of entity is vital to safeguard against unlimited liability which is integral in proprietorship and partnership firms.
What LLP essentially addresses are three critical factors for running a successful business.
Accountability – LLP protects each partner from any misdemeanor of other partners. This ensures that partners take accountability of their act and not mismanage the firm according to their whims and wishes. The liability of each partner is limited to their contribution which protects against excessive exposure to personal assets. It makes the firms function in more professional and ethical manner with careful consideration to its operation. The entire agreement is documented and registered compulsorily which is not necessary in partnership firms. In LLP, the separate entity of the firm from that of the partners means property etc can be held in the name of the firm and not inidual partners. This also protects firms from gross interest of any specific partner or partners. In an informal partnership, there is adequate ground for dispute due to excessive flexibility. LLP helps create a more corporate-like structure for operation while retaining a large part of the flexibility.
Compliance - LLP requires that Designated Partners be declared who run the business on a day to day basis. They are responsible for all statutory compliance as required by various laws. LLP's have to compulsorily file annual statement of accounts, solvency and annual returns as per the directive of the law with the Registrar of LLP every year. Though taxation is less than companies, it requires clear accounting and record keeping monitoring performance and ethics. LLP's are meant to be “for profit” firms and not businesses created to channel losses in a larger structure.
Transparency – The biggest advantage which LLP's enjoy is creditworthiness due to mandatory disclosures and compliance. Companies and suppliers who deal with LLP's are more assured of their transactions. If required they can inspect the firm's documents like incorporation and names of partners, statement of account and solvency etc from the office of the Registrar at a nominal fee. This is also a positive factor when the firm needs loans for business expansion. Banks are more comfortable to lending to LLP's as compared to regular partnership and proprietorship firms. (In a proprietorship the owner is same as the business and thus has lesser borrowing capacity. They are also not enforced any mandatory compliance apart from filing of tax returns or VAT payment. They can wind up the business very easily and have full control.)
How to INCORPORATE a LLP
Entrepreneurs can incorporate a LLP either from the beginning or convert their existing proprietorship, partnership firm or private limited company into a LLP.
The standard procedure for incorporation is:
- Identification and Finalization of Partners
- Deciding on the Designated Partners
- Obtain Designated Partner Identification Number (DPIN) and a digital signature certificate. Your CA can get it done.
- Register with Ministry of Corporate Affairs' website on LLP (www.llp.gov.in) with all mandatory details and upload the digital signature certificate.
- Choosing a name of the LLP (in case of a new one) and confirming its availability
- Getting the Draft of the LLP agreement prepared by your CA. There are sample resources also available on good finance-related websites. It can be fine tuned to the needs of the specific firm.
- Filing the LLP Agreement, incorporation documents and obtaining the Certificate of Incorporation.
Business Longevity
We put in our best efforts to setup and run a business. Bursting with ideas and a zeal to succeed, we end up paying too much attention to setting up the business and getting it off the ground tying funds from various sources. However, due to our eagerness, lack of financial and legal insight or competence or sheer procrastination, we do not give sufficient thought to how the firm should be incorporated with a long term view of sustainability and performance. We might reason that proprietorship will free ourselves from lot of complications and we can start the business immediately from our house but what happens if we default? Will my house remain with me or it will be put on the block? How will my family's interests be protected from the negative effects of my business venture in case there is a calamity? Often two friends would setup a partnership firm and sign a token document of partnership deed. As the firm starts growing there is a possibility of vested interests interfering and causing upheavals. How should the firm be protected form it? How will our legal heirs take over from us twenty five years down the line if they wish to? These are questions we need to ask ourselves and plan accordingly.
LLP is a good development in the area of a favorable hybrid business structure between the ultra flexible partnership firm and the compliance intensive company structure. It is worth looking at the benefits of this form of business incorporation from various angles like creditworthiness, succession, protection of inidual assets, management of business assets as part of the firm and liability of partners not involved in day to day activities.
Footnote. Read more details about LLP and the Act itself. Please visit http://www.mca.gov.in/LLP/ or www.llp.gov.in or http://www.mca.gov.in/MinistryWebsite/dca/actsbills/pdf/LLP_Act_2008_15jan2009.pdf
Disclaimer. This is only an informative article on LLP. SME WORLD does not assume any responsibility for incorrect use of this information. Please consult your CA for suitability and applicability of the same for your business.
About the LLP Act
Published in Gazette of India on 9 January, 2009, the Limited Liability Partnership Act 2008 was notified on 31st March 2009.
An LLP shall be under the obligation to maintain annual accounts clearly stating the true status and performance of the business. A “Statement of Accounts and Solvency” as per format should be filed by every LLP with the Registrar every year. Annual Return should be filed through Form 11 with ROC within 60 days of closer of financial year. These annual return will be public documents open for inspection at the Registrars for a fee.
Audit of all LLPs (except exempted ones as per notification by Central Government) is mandatory.
The LLP Act contains provisions to convert partnership firms and private company or unlisted public company into LLPs.
The LLP Rules, 2009 contains administrative provisions for formation, management, reconstruction and winding up of LLPs. The firm is a separate legal entity and can own assets.
Source: http://www.mca.gov.in/LLP
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