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Pointers for structuring a new business - Functional Difference between Limited Liability Partnership and a company

Since the time that LLP has been introduced in India, it has become an additional option for entrepreneurs, business owners and investors starting new ventures to incorporate their business as an LLP, instead of a traditional private limited company (Pvt. Ltd.). In light of this, it is important to understand the advantages and drawbacks of each of these structures, the differences between them and consider carefully which one suits the need of the business best. This chapter explains the differences between an LLP and private limited company, and can be used as a handy guide for decision-making while planning how to structure a new business.
I. Process of formation of LLP and Private Limited Company
Incorporation of LLP Incorporation of a private limited company
For formation of an LLP, minimum of 2 Partners are required. There is no limit to the maximum number of Partners. A body corporate can be a member of an LLP. The minimum number of shareholders required for a company is 2 and there can be up to 200 shareholders, in case of a private limited company. Only public companies can have more shareholders.
Steps for Incorporation Steps for Incorporation
For the formation of LLP, firstly you need to apply for Director Identification Number (DIN) for the designated partners of LLP and obtain Digital Signature for one of the Partners of the Proposed LLP The first step for incorporation of a company is selection of name for the proposed company. Then apply for Directors Identification Number and Digital Signatures.
Application for Name Availability & Obtaining the Name for the proposed LLP. Drafting of Memorandum and Articles of Association.
Drafting of LLP Agreement for the LLP and filing of incorporation document consisting of Form 2, 3 and 4 available on llp.gov.in with the registrar of companies. Stamping, digitally signing and e-filing of-  MoA, AoA, E-Form INC-1, INC-7, INC-22 and DIR-8 under Companies Act, 2013, and other documents if any which has been stated in MoA with the Registrar.
Obtaining Certificate of Registration of LLP Obtaining Certificate of Incorporation.

Both LLP and private limited company are incorporated under Registrar of Companies and both the entities protect the partners/ members from the legal risk stemming from the activities of LLP or company.

The biggest difference that a business must understand and take into account is the difference in taxation and compliance requirement. 
II. Difference in Taxation
Unlike countries such as UK, in India LLPs are not pass through structures, but are taxed as separate entities. A Limited Liability Partnership is subjected just to income tax or minimum alternate tax (as applicable). A company on the other hand is liable to pay income tax or minimum alternate tax (as applicable) and dividend distribution tax. The profits shared by partners of an LLP and dividend earned by shareholders are not taxable any further when it reaches the hands of recipients.
1. Taxes levied on a Limited Liability Company
Firstly, a company is liable to pay tax on the income of the corporate. Income tax on a limited liability company is levied at the rate of 30%.

A company is subjected to dividend distribution tax when it pays dividend. Under the Income Tax Act, Dividend distribution tax is charged at the rate of 15% (plus applicable surcharge and cess).
Third kind of tax applicable on a company is Minimum Alternate Tax. Many companies charge depreciation in their books and take advantage of various benefits or relaxations provided under the Income Tax Act. Thus, the profits shown as per the accounts maintained for reporting to stakeholders is higher, on which they can declare dividend. However, for income tax purposes, they may show low profit or even loss. These companies are known as zero tax companies. These companies show higher ‘book’ profits, that is, profits as per their balance sheets.
To prevent such companies from taking advantage of the relaxations under the Income Tax Act, a company has to pay a Minimum Alternate Tax (MAT) on its book profit if the income tax payable on the total income as calculated under the Act is less than the minimum stipulated amount. From April 2011, MAT has been payable at the rate of 18.5% on book profits according to the latest Finance Act. Currently, if the tax payable under the regular provisions of the Income Tax Act is less than 18.5% of the book profit, then the company must pay a flat rate of 18.5%.
Please note that MAT rate has been subjected to frequent changes and it may change in future as well, just like any other taxation rate mentioned here. Therefore, it is worth doing a fresh check on the ongoing rate for any practical purposes.
2. Taxes levied on a Limited Liability Partnership
a) Tax on distribution of profits
Taxation structure for LLP is simpler. LLP is subjected only to income tax or MAT (if the income tax payable is lower than a minimum threshold). Tax on distribution of profits to partners is not applicable on LLP. Once profits are declared and tax is paid by the LLP, the distributed income is tax free in the hands of the partners. Tax is levied on the firm at the rate of 30%. This is why LLP is often a more tax efficient vehicle than a private limited company.
In spite being subjected to MAT, LLP offers lesser tax liability in comparison to a company. Hence, it may be more tax efficient for freelancers, lifestyle businesses or a start-up to structure their business as an LLP rather than a company.
Note: Applicability of MAT to LLPs

From the assessment year 2012-13, LLP will be subjected to MAT. The purpose behind implementation of this tax is to rationalize taxation of LLP’s with companies, as otherwise many companies could convert to LLPs in order to avail tax benefits. Hence, the current rules provide for MAT at the rate of 18.5% on the income of Limited Liability Partnerships. According to the new rule, when the regular income tax payable by a LLP for a particular financial year is less than 18.5% on its adjusted total income, the LLP will be liable to pay MAT at 18.5%.
b) Tax on withdrawals by shareholders
Under Income Tax Act, any loan or advance made by a private limited company to a shareholder who owns more than 10% shares of a company is taxable as dividend to the extent it is attributable to the profits of the company. During early stages of a business, founders typically own a substantial portion of the company (which is in excess of 10%). Therefore, any loans taken by them from the company taxable to the extent the company has accumulated profits. However, the same provision is not applicable to LLPs. Loans taken by partners of an LLP are not taxable as dividend.
3. Compliance requirements
The yearly cost of compliance in case of private company can be substantial. Under the Companies Act, 2013 and the rules made thereunder, a limited liability company is required to consider balance sheet, profit and loss account, hold meetings, prepare directors’ report, arrange for mandatory audit; make a declaration with regard to dividend and appoint auditors, while annual compliance in case of LLP consists of presentation of statement of account and solvency along with annual report under Section 34(2) and 35(1) respectively of LLP Act. Meetings can be held in a relatively more flexible manner. Practically, the effort and cost of compliance in case of LLPs is a fraction of what is required in case of a private limited company.
4. Private Limited Company is preferred by Venture Capitalists over Limited Liability Partnerships
In India, VCs are not yet comfortable with LLPs, and insist that the startups they will consider should be in the form of Private limited Company or that a private limited company should be formed to take their investment and henceforth business should be done in name of the company. VCs are risk averse and generally have proven to be slow adopters despite significant benefits of the LLP form in case of many business models as far as India is concerned. This is surprising given that several VC funds were quick in forming LLPs instead of private trusts in order to administer and manage their funds. If you are planning to raise venture capital in the near future, private limited company is the way to go.
5. Private limited companies have much better access to foreign investment and foreign loan markets as compared to LLPs
LLPs require regulatory approvals under the FEMA to receive foreign investment, although however most sectors are open to foreign investment under the automatic route if the investment is made into a company. Similarly, LLPs are prohibited from accessing foreign loans (which are significantly cheaper compared to domestic loans) as compared to private limited companies. You will read more about this under the chapters on foreign investment law and foreign loans.
6. Partner / director loans
Transactions between the founders and the business are very common, especially during the early stages of a business. For example, when the business faces a cash crunch, a founder may provide a loan. Similarly, when the business is cash-positive, a founder may need to draw money out from the business for his or her own needs, which can be structured as a loan (this is relatively easier so long as there is no venture capital investment in the business, as venture capitalists typically require their approval to be taken for such transactions). Loans to founders will be more expensive in case of companies than in case of LLPs. In such cases, although an LLP will not have to pay tax, in case of private companies such loans will be treated as dividend payouts and will be taxable in the hands of the company if the company is making profits.
If the objective is merely to reduce the impact of taxes, minimize compliance requirements and have maximum operational flexibility, an LLP is preferable. 

However, if the plan is to raise venture capital, approach foreign investors or raise cheaper loans by approaching foreign banks (which is the case for companies which intend to rapidly scale up their operations), structuring a business as a company is preferable.

Exhaustive comparison of a Private Limited Company with an LLP
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