Private Company vs. LLP - Which is Better for You?
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When starting an enterprise, one of the most fundamental and preliminary questions raised by an entrepreneur is which kind of entity, a private company incorporated under the Companies Act, 2013 (Companies Act) or a limited liability partnership established under the Limited Liability Partnership Act, 2008 (LLP Act), would be most suitable to the enterprise. This article discusses the options that an entrepreneur should consider while forming an enterprise.
Where lies the difference?
An LLP is an attractive entity to establish mainly due to tax reasons. Both a private company and an LLP are liable to pay an income tax at the rate of 30 per cent of its taxable income, in addition to surcharges depending on net or total income, respectively. However, the main difference comes for the dividend distribution tax, where a private company has to pay an additional tax at an effective rate of 20.36 per cent on any amount which is declared or distributed or paid by a private company to its shareholders.
Unlike a private company, an LLP is not required to pay any dividend distribution tax and profits distributed and they are not liable to tax in the hand of the partners. Incorporating an LLP requires lesser legal compliances, whereas a private company is required to file various forms and documents like a memorandum of association and articles of association at the time of incorporation. The LLP agreement, offers more operational flexibility in structuring and managing an LLP compared to a private company, bound by the memorandum of association and its articles of association. A company also has to undertake a number of statutory compliances such as holding general meetings, board meetings, maintaining registers and much more which are not required in the case of LLPs.
It is important to note that a private company can be converted into an LLP more expeditiously, in compliance with the LLP Act, 2008 and the extent foreign investment provisions but conversion of an LLP into a company would require compliance with detailed legal provisions, which may not be optimal from a tax and timing perspective. Further, since an LLP is a relatively newer concept in India, there are certain procedural hurdles that might delay the setting up of an LLP as compared to a private company. Further, in our experience, some laws and regulations are yet to be updated expanding their applicability to LLPs (along with companies).
The disadvantages of an LLP
The biggest disadvantage of an LLP is in terms of its liability. The Companies Act provides the manner for determining liability of directors and individuals qualifying as an “officer in default”. In an LLP, the designated partner has no shield or protection from the LLP and the liability for compliances with the LLP Act fall on the designated partner and there can be instances where the designated partners are also personally liable alongside the LLP. The company provides a corporate veil to its shareholders and there is a distinction between ownership and management.
In an LLP, there is no clear distinction between partners and management. This places a huge risk on the partners of an LLP when taking a loan, applying for licenses, or dealing with third parties. While operationally an LLP may seem easier, if you are planning for long term growth of your business, whether it is raising funds from the public, selling a business, merging, etc. but the private company is the preferred form of structure. However, it is always prudent to seek legal advice for your bespoke requirements.
(This article was first published in the May issue of Entrepreneur Magazine. To subscribe, click here)