Selecting and registering a new business under any of the suitable business structures is a vital prerequisite for the business to operate. There are a number of business entities to choose from, and these business entities provide a separate existence to the enterprise in order to structure to the organisation and also for the purpose of taxation.
Out of the types of business entities, a Company and its various types such as a Private Limited Company and Public Limited Company are more suitable for a large business with considerable returns, while a sole proprietorship and One Person Company are for a single entrepreneur. A partnership is a good choice for a business structure, but it has a few negatives, such as unlimited liability on the partners, limited resources, and unreliability of its future, all of which make it a less favoured choice. Thus out of all the options available, the entity which is most optimum and suitable for the majority of the business types is a Limited Liability Partnership or LLP.
A Limited Liability Partnership is a business entity that combines the features of a Partnership as well as a Company or a corporation. The members within an LLP have limited liabilities, which means that they are not completely responsible or liable for the misconduct of the other partners and also in the case of negligence. Also, unlike the formal setting and compliances within a Company, LLP has the informality seen in a partnership that has not been incorporated.
Reason For Choosing A Limited Liability Partnership
The benefits of incorporating a business as a Limited Liability Partnership is that it combines the positive features of both a partnership and a corporation and is thus the reason why a rising number of entrepreneurs are looking to register and sign a Limited Liability Partnership Agreement for their start-ups. Some of the reasons why LLP has gained popularity include-
Number Of Business Owners
An LLP does not have a limit on the maximum number of members that can be incorporated, while the minimum requirement is of 2 members. A private limited company has an upper limit of not more than 200 members while an LLP has no such restriction.
Minimum Contribution By Members
An LLP does not have any minimum requirement on the contribution made by each member or on the capital invested and contributed. Additionally, the contribution made by the partners need not just be capital or funds but can be movable or immovable or tangible or intangible property or any other contribution that is of benefit to the limited liability partnership.
Audit Requirement
Unlike other companies which need a compulsory audit of their accounts, irrespective of the share capital, an LLP does not need a mandatory audit. The conditions which warrant an account audit for an LLP are when the overall contributions exceed Rs 25 lakhs and when the annual turnover of the business exceeds Rs 40 lakhs.
Registration Cost
The cost of registering a Limited Liability Partnership is lower than the cost of incorporating and registering a Private Limited Company or a Public Limited Company.
Taxation Structure Applicable
As far as the taxation aspect is concerned, LLPs have almost the same tax structure applicable as those applied to a partnership. This means that LLPs are liable to pay income tax but its members are not liable to pay tax for their share in the enterprise. This means that LLPs do not need to pay dividend distribution tax and the provision of “deemed dividend” which falls under the laws of income tax is not applicable to a Limited Liability Partnership.
Essentials Of An LLP Agreement
After going through the benefits it is quite clear why most entrepreneurs opt for an LLP agreement. Thus, getting to know the LLP registration procedure is vital and one of the first steps in the procedure is to draw an Agreement. This Agreement has some essential elements that need to be considered and adhered to before registering the business under an LLP agreement.
Before registering itself, an LLP needs to have a minimum of 2 partners, who could be individuals or even two corporations functioning as partners.
An LLP must have a registered office in India where communication can be sent and received.
The document of Incorporation of an LLP needs to be completed and submitted in the manner prescribed, electronically, with the Registrar.
The LLP must have a name, which is unique and distinct. The name cannot be the same as that already being used by another Company, or an LLP or a Partnership firm.
A minimum of two individuals needs to be appointed as designated partners to carry out all the matters, acts and things required to be done as the responsibilities of an LLP.
The designated partners must be residents of India since the LLP is registered in India and carrying out business from the country.
Additionally, each of the designated partners must hold a DPIN, which stands for Designated Partner Identification Number, which is allotted by the Ministry of Corporate Affairs or MCA.
A written agreement must be executed between the partners or even between the LLP and the partners of the LLP. In case of an absence of agreement, the provisions specified in the First Schedule of the LLP Act, 2008 are applied to the business.
The LLP agreement must include necessary information, especially regarding the partners and the LLP, such as the capital contributed by each of the partners, the board meetings, the ratio of profit sharing among the partners, the method or mechanism decided upon to resolve disputes, the method decided when deciding to wind up the firm, etc. These clauses in detail which are essential and need to be included in the Agreement are –
Definition Clause
This is, in brief, the essence of the entire agreement and includes the definitions of the Agreement drawn, such as the designated partners, name and business of the LLP, the address of the registered office of the LLP, the address of the partners and the accounting period of the LLP, etc.
Capital Contribution
This includes the exact amount of capital that is contributed by each of the partners in order to constitute the LLP, must be mentioned in the Agreement by the partners. The capital contribution is the amount invested by each of the partners and can be either in cash, or in terms of assets or also in kind (such as in terms of skills of the partner, or reputation or connections)
Business Of LLP
The Agreement must specify the exact nature of the business that is going to be carried out by the LLP and its members and also specify the areas that will be dealt with while conducting the business. The place of the business along with the date of commencement of the LLP business must also be mentioned in the Agreement.
Rights And Duties
The rights and duties applicable to the partners and mutually agreed upon to be carried out by the individual partners must be specified in the LLP. If the absence of such an agreement between the partners, the provisions of Schedule I of the Limited Liability Act, 2008 will be applied to the business as given in Section 23(4) of the said Act, as specified previously.
Profit Sharing Ratio
The Agreement can also specify the exact ratio in which the partners will share the profits as well as the losses of the LLP business. This means that the amount of profit received by each partner or the amount of loss that they will be liable for must be mentioned in the Agreement. Additionally, the Agreement can also specify the part of the profits that is to be paid as interest calculated on the members’ capital contributions.
Indemnities
The Agreement must also specify a provision made in case of indemnities. This indemnity clause must state that the LLP is required to protect its members from any kind of liability or claim incurred by them while carrying out the business of the LLP. The members should also agree to indemnify the LLP for the loss caused by it due to any breach committed by them.
Dispute Resolution Mechanism
The LLP Agreement must also contain provisions that are made to resolve any disputes that take place between the partners or members. Most of the time LLPs opt for Arbitration as a mode of resolving disputes, thus making the LLP be governed by the Arbitration and Conciliation Act, 1996. The LLP Agreement must thus incorporate a clause providing for a dispute resolution mechanism in order to avoid disputes that result in lengthy and expensive litigation.
Restrictive Covenants
The Agreement must specify the various restrictions that are incorporated by the LLP on its members and such a clause is termed as Restrictive Covenants. These restrictive covenants are important as they protect the legitimate interests of the LLP and the business, for instance, any member of the LLP upon leaving the business or firm must be prohibited from carrying out a business that is competitive to the nature of business of the said LLP firm. This is the type of restrictive covenants which can be applied to protect the business.
Winding Up The Business
The Agreement must also specify the term of validity of the LLP Agreement as decided upon by the partners, that is if the Agreement is perpetual or whether it stands valid for a fixed period of time. Additionally, the situations where the partners decide to wind up the affairs of the LLP must also be mentioned in the LLP Agreement and also whether the decision to wind up is taken voluntarily or stipulated by an order of Tribunal for the specific violations as mentioned in Section 64 of the Act.
Miscellaneous Provisions
The Agreement must even provide for specifications related to miscellaneous provisions such as terms regarding the admission of new members, the retirement of an existing member or in case of death of a member or partner, guidelines decided upon for expulsion of partners and the terms for renewal of the LLP Agreement itself and any such similar clauses as decided upon by the partners of the LLP.
These are the essentials that need to be included in an LLP Agreement. In case business owners feel the need to seek assistance while stipulating the conditions for the LLP Agreement, they can contact deAsra who are suited to provide guidance for every stage in the journey of the business.