Sunday, August 11, 2013

Starting Trouble for LLP business model source business line

Starting trouble for LLP business model


The lack of clarity on foreign direct investment has left entrepreneurs unsure about forming Limited Liability Partnership firms.
To encourage small and medium enterprises, in 2009 the Government notified the Limited Liability Partnership Act, 2008. An LLP embodies the characteristics of a company. The legislation has been received well by the business community at large, primarily on account of nil tax on distribution of profits, perpetual succession, separate legal identity, low cost of compliance, limited liability of partners and an LLP being akin to company.
To promote it further, the Income Tax Act was amended to exempt from capital gains tax the conversion of existing partnership firms, private companies or unlisted public companies into LLPs, subject to conditions. For instance, exemption is restricted to entities whose sales, turnover or gross receipt from business does not exceed Rs 60 lakh in the preceding three financial years. This could be a dampener for those interested in turning into an LLP. Further, the I-T Act offers companies various incentives such as tax holiday for specified industries, tax breaks on certain investments and so on. If these benefits are extended to LLPs, more small/ medium entrepreneurs would opt for that structure. Similarly, amendments to permit tax neutrality on merger/ demerger between LLPs would also serve as incentive.
Realising the significance of LLP as a business vehicle, the Cabinet Committee on Economic Affairs approved foreign direct investment (FDI) in LLPs, with need for Government approval in sectors where 100 per cent investment is otherwise automatically permitted to companies. However, the Reserve Bank of India is yet to notify detailed regulations. The lack of clarity on FDI norms has caused entrepreneurs to rethink their LLP plans. Typically, the seed capital requirements of a growing business are met by private equity/ strategic investors, and any overseas investor may be deterred by the absence of clear norms.
Moreover, private equity/ strategic investors typically invest with pre-decided exit options after a stipulated period of time, either by offloading their stake to promoters or at the time of an initial public offer. As an LLP currently cannot raise money through an IPO, private equity/strategic investors may be reluctant to invest in the absence of exit options. This issue could have been resolved by allowing LLPs to convert into companies, and/ or enabling the merger of the LLP with an existing company. However, there is no clarity both under the LLP Act and Companies Act. An amendment in this regard could further boost LLPs as a favourable business model.
In India, overseas borrowings are governed by the Foreign Exchange Management Act. FEMA is not clear on whether LLPs can borrow money from foreign markets.
This could adversely impact entrepreneurs seeking to borrow money from global markets at lower interest. Further, to extend their footprint beyond India, many businessmen often consider acquiring an existing overseas entity. FEMA regulations on investment by Indians in foreign entities do not specifically include LLPs, nor clarify whether they can invest in overseas entities.
Thus, Indian entrepreneurs want more clarity on an issue that has potential to turn into a win-win for them and the Government.
The author is Head of Tax, KPMG in India
(This article was published on July 28, 2013)

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