This article is written by Sanjana Jain, from the Guru Gobind Singh Indraprastha University, Delhi. This article talks about the Limited Partnership (LP) and Limited Liability Partnership (LLP) and also the difference between them.
Many business people prefer partnerships because of its flexibility and simplicity however, many are concerned by the fact that partners are personally responsible for the liabilities of the partnership. In order to ease this concern, business structures like Limited Partnership and Limited Liability Partnership are designed. In both Limited Partnership and Limited Liability Partnership, partners while still enjoying the pass-through taxation and flexibility of a general partnership can be protected from personal liabilities. Limited Partnership and Limited Liability Partnership are almost the same things, these types of partnerships are more suitable for persons who are engaged in the same type of profession, like a law firm or an accounting firm.
A partnership is a formal agreement between two or more partners, in which they agree to be co-owners, distribute responsibilities among themselves for running a business and share the profit and losses that are generated by the business. Income generated by partners in a partnership is considered as their personal income, which means it is taxed only once, on the other hand, owners of corporations face double-taxation, as the first corporation’s income is taxed and then the owner’s personal income is taxed again.
In India, a partnership is governed by the Indian Partnership Act,1932. Section 4 of the Indian Partnership Act, 1932 defines partnership as an “agreement between partners in which they have agreed to share the business profits carried on by all or any one of them acting for all”.
According to this definition, a partnership requires partners who share business profits with each other. Further, either all of them together shall carry on the business or it should be carried on by one of them acting on behalf of others, the members of such a business are individually called partners and collectively, a firm.
Features of Partnership
The characteristics of a partnership are mentioned below:
Contract or formation
There must be a legal agreement between partners if a firm has multiple owners. So, in order to establish a partnership firm, it is compulsory to have a partnership contract.
The motive of the partnership should be one of profit, and its business activity must be lawful, so if the alliance is formed between two people to carry out charity or social work it will not constitute a partnership. Similarly, a partnership will be void if it carries out any illegal work such as smuggling.
All the partners have unlimited liability in the firm and all of them will be equally liable for the payment of the debts, even if they have to liquidate their personal assets.
A partner can sue the other partners for their share of the debt as per the contract of the partnership if the money is recovered from him only.
The partnership will be dissolved in case of death, bankruptcy, and retirement of any partner, the remaining partners who are willing to continue the partnership have to make a fresh partnership agreement amongst each other. Similarly, a father’s partnership cannot be inherited by a son, with the agreement of other partner members, he can be added as a new partner.
Number of members
A partnership firm can have any number of members, there is no specific number as to the maximum number of members a partnership firm can have. However, for banking only ten (10) members are allowed, and for companies, the maximum number of members should not exceed more than twenty (20) according to the Companies Act, 2013.
This means that for a company’s operation all the partners should equally take responsibility, but sometimes one partner can supervise or take actions on behalf of the rest of the partners.
Each and every partner is an agent as well as the principal of the partnership, he is an agent when he represents the other partners in some cases, and he is a principle when he is bound by the actions of the other partners.
Types of Partners
In a partnership, not all partners have the same responsibility and functions. There are several types of partners in a partnership, some of them are as follows:
As you can understand by the name these partners take active participation in the firm’s business, they make a contribution in the capital, have a share in profit that the business generates, and also participates in the daily activity of the firm. They have unlimited liability in the firm and also they often act as an agent for other partners.
A dormant partner is also known as a sleeping partner, they don’t participate in the daily functioning of the business. But they make their contribution to the capital of the business. In return, they get a share in profit generated by the business, and also they have unlimited liability in the firm.
Secret partners are the partners whose association with the firm is not known to the public, these partners can not represent the firm outside to agents or parties. He also makes his contribution to capital and in return gets a share in profit generated by the business. He has unlimited liability in the firm.
Nominal partners are the partners only by name, they allow the firm to use his name and the goodwill attached to it. These partners do not contribute to the capital of the business and hence also have no share in the profits generated by the business. He also does not involve in the activities of the business, but he has unlimited liability in the firm.
Partner by Estoppel
If any person by his conduct or behaviour makes it out to be that he is the partner of the firm and he does not correct them, then he becomes a partner by estoppel. However, he will have unlimited liability in the firm.
The Indian Partnership Act, 1932
In India, many businesses opt for partnership business, so in order to govern and monitor such partnerships in the Indian Partnership Act, 1932 was formed on 1st October 1932. Under this Act, two or more individuals make an agreement between them and agree to operate the business together and distribute the profits that are generated from the business.
The Indian Partnership Act, 1932 has five important elements and that are as follows:
Agreement for partners
A partnership arises from an agreement or a contract, an agreement is the base of the partnership between the partners. Such an agreement can be either in written or in oral form. In order to avoid any misunderstandings, it is always better than agreement is in written form and each and every partner shall have a copy of the written agreement.
Two or more persons
For a partnership, it is necessary that there must be at least two (2) persons possessing a common goal. Thus a minimum number of persons required for a partnership is two and there is no constraint on the maximum number of people.
Sharing of profit
Another important element of the partnership is the sharing of profit, in a partnership each and every partner shall equally share profit and losses generated from the business.
A partnership shall have some kind of business motive and each and every partner shall have the same kind of motive and such a motive shall be a profit gaining motive.
In a firm partner are the owners as well as the agent of the firm, any act performed by one partner will affect other partners as well as the firm. Thus, this point acts as a test for the partnership for all the partners.
Depending upon the state and where the business operates partnership is divided into different types. The four most common types of partnership are as follows:
- General Partnership
- Limited Partnership
- Limited Liability Partnership
- Partnership at will
In a General partnership, two or more owners are required to run a business. In this type of partnership, each partner with equal rights represents the firm, and all partners can participate equally in management activities, decision making, and have the right to control the business. Similarly, all the profits and liabilities of the business are equally shared between them.
A general partnership can be stated as that type of partnership where all the rights and responsibilities are shared equally between the partners in terms of management and decision making. Full responsibility shall be taken by each partner for the debts and liability incurred by the other partner. All the other partners are considered accountable if any partner is sued, because of this reason most of the partners do not opt for this partnership.
Following conditions must be satisfied by a general partnership:
- At least two people must be included in this type of partnership.
- Any liability incurred by their partnership must be equally divided among all the partners.
- The partnership shall be formed in a formal written partnership agreement, though oral agreements are also valid.
In a general partnership, either property or cash is contributed by all the partners into the partnership, and once the partnership starts all the partners co-owned the assets. So if one partner contributes his car for a one-third stake in the partnership, it is owned by all the partners jointly. But if due to any reason the partnership is dissolved, the remaining partnership assets are divided among the partners based on the partnership agreement and the partner’s capital accounts.
- A Limited Partnership is a business entity that includes two types of partners that are general partners and limited partners. The general partner’s responsibilities include daily management of the company, while Limited partners invest in the business but do not participate in the management and are also not personally liable for any company’s debt. A General Partner can be anyone either an individual or an entity, such as a corporation.
- In many cases, limited partners only invest and take a share in profits generated by the company. They do not involve themselves in the management or decision-making process, this non-involvement means that they are not liable to compensate the partnership losses from their income tax return.
- Limited partnerships are mostly used in firms in which professionals involved want to give General partners the management of the business. For example- Real estate investors, use a limited partnership.
- Also in the family business, a limited partnership can be used which can be called a family limited partnership. In this, all the members of the family pool their money, and appoint a General partner, and watch their investment grow.
Working of Limited Partnership
- In a limited partnership, there is at least one general partner who is responsible for the management of the business. A general partner can be anyone either an individual or an entity, like a corporation. Decisions made by these partners affect the business and they are fully liable for all the debts and lawsuits that are taken on by the business.
- Other than general partnership, limited partnership also has one or more limited partners, they are also called “silent partners” as they do not involve in anything they only invest in the business in order to get a share in the profit generated from the business. Like owners (members), their liability is also limited to their investment in the partnership.
- Like other partnerships in limited partnership also the income taxes are paid by the individual partners according to their share in the business, the share called a distributive share, is passed through the owner’s personal tax return, and income tax is paid at the individual’s personal tax rate.
- When there is a loss in a limited partnership, there’s a difference in how general and limited partners are treated for tax purposes. The General partner has to take the loss even if he has no other income to offset it. As a limited partner does not materially participate in the running of a partnership they have a passive income, which means that they will not take a loss to reduce income taxes if they have no other income to offset this loss.
Formation of Limited Partnership
Like many businesses, limited partnerships can be formed by registering with the state and paying a filing fee. In addition to this, a partnership agreement shall be made between the partners stating all the responsibilities of the partners. The partnership agreement shall also include how the profit of the partnership shall be divided among the partners.
Advantages of Limited Partnership
- Unlimited Shareholders
- Tax benefits
- Utilization of Financial/Managerial Strengths of Partners
- Unlimited Cap on Capital Acquisition with Partnership Agreement
- Liability Protection for Limited Partners
Limited Liability Partnership
Every partnership form of the business suffers from the problem of unlimited liability, their liabilities extend right up to their personal assets, which makes regular partnership undesirable for many entrepreneurs. This problem can be solved by Limited Liability Partnerships.
Except for the status of the same legal entity and unlimited liability of partners an LLP has all the basic features of a regular partnership firm. A Limited Liability Partnership provides its owners with limited personal liability. These types of partnerships are best suited for professional groups, like lawyers and accountants, in some states LLPs are only available for professionals.
LLPs are preferred by professionals as they don’t want to be personally liable for the mistakes of other partners, particularly those involving malpractice claims. An LLP protects from the debts against the partnership arising out of malpractice lawsuits against another partner.
To govern Limited Liability Partnerships in India, the Limited Liability Partnership Act was passed by the parliament of India in 2008. According to section 2 of this Act, an LLP is a partnership registered under this act, and an LLP agreement means a written agreement either between partners of an LLP’s or between its partners and LLP itself. In this agreement, the rights, liabilities, duties, and powers of all the partners are mentioned.
The provisions of the Indian Partnership Act, 1932 is not applicable on LLPs as it is specifically governed by the Limited Liability Partnership Act, 2008.
Distinct features of an LLP
The peculiar features that a limited liability partnership contains are mentioned below:
Separate legal entity
Limited liability partnerships are considered as a separate legal entity, which means they can own assets and incur liability on their names.
Limited Liability of partners
In a limited liability partnership, the liability of partners is separate and limited. In case of limited liability partnership is winding up or suffering certain legal consequences for repayment of the debt, the personal assets of the partners will not be liable to attachment. However, in case of offences like fraud, or any other wrongful or illegal act, partners’ liabilities can become unlimited.
Sharing of profits
All the profits generated from the business are shared between the partners of a limited liability partnership in the same way it is shared between partners of regular firms. However, they are free to decide the ratio in which they will share profits.
Partners of LLPs
Partners of a limited liability partnership can be anyone, it can be either natural persons, i.e. individuals, or even body corporates. If an individual is of unsound mind or insolvent he cannot be a partner of LLP.
The minimum number of partners that LLPs must have at all times is two, the maximum number of the partners is unlimited. If the requirement of the minimum number of partners is not maintained and a sole partner carries on the business, then his liability towards the firm will become unlimited.
Partnership at will
Partnership at will means a partnership in which no clause regarding the expiration of partnership is mentioned. According to Section 7 of the Indian Partnership Act 1932, a firm has to fulfill the following conditions to become a Partnership at will:
- In the partnership agreement, no clause regarding the expiration of the partnership shall be mentioned.
- Particular determination of partnership should not be mentioned.
If in a partnership agreement the duration and determination are mentioned then it is not a partnership at will. However, if an expiration date is fixed by the firm, but the operation of the firm continues beyond the mentioned date then it will be considered as a partnership at will.
Treatment of outstanding debts at a partnership at will
The presence of outstanding debts in a partnership at will does not mean that the partnership cannot be dissolved by the parties prior to the debt being paid, the debts can be resolved after the dissolution. The same principle will apply on land on lease for a fixed period of time, the lease will not act as an agreement that the partnership will continue till the time as set forth in the lease.
If a partnership at will is formed for the purpose of carrying out a single or particular venture, it will not be dissolved when the venture has been completed in the absence of a contract.
A provision for retirement can be included in partnership at will. A partnership at will does not prevent any of the partners to enter into another partnership for a single adventure or undertaking with another party. One single adventure or undertaking does not mean that it is a short-term event.
Benefits of Partnership at will
- Can be created between any entities.
- Can be terminated with proper notice by any partner of the partnership.
- Provisions can be included.
There are different organizational structures in both LP and LLP. Formation of LP can be done with one person as the general partner, whereas for the formation of LLP there should be at least two persons as a general partner.
In an LP there are two types of owners i.e. General partners and limited partners, there can be one or more general partners or one or more limited partners. The day to day activities and business decisions are taken by General partners in an LP. Limited partners are basically investors in a business who contribute to capital and in return get a share in the profit of the business.
Whereas in an LLP there is only one type of owner i.e. General partners, they are the ones who contribute money, assets, or time in the business. In an LLP all the partners are involved in business decisions and operations and also share profits or losses.
The formation of LPs and LLPs are governed by the law of the State where the business is formed. All the states have different laws governing limited partnerships. In states in which LLPs are allowed they have their own governing laws. In both LPs and LLPs, a registration document has to be filed with the appropriate state agency.
By signing a limited partnership agreement an LP is formed. In this agreement the name of the partnership, the name of the general and limited partners, the contribution of each partner, how profits will be distributed, and how new partners may be admitted are mentioned. In case if there are one or more general partners, there shall be an additional agreement between the general partners.
Whereas, for the formation of an LLP a limited liability partnership agreement has to be signed by all the partners. Except for the provision relating to limited partners, a Limited Liability Partnership agreement is similar to the agreement of a Limited partnership.
Limitation of Liability
For business owners, their primary concern is their personal liability for the debts of the business, including those from lawsuits. If the business does not have sufficient assets, the creditors of the business will go after the personal assets of the owners, if that business is operated as either a sole proprietorship or a general partnership. Thus in order to satisfy business debts and court judgments, the owner’s home, car, personal bank accounts, and so on can be lost.
For offering some limitation to the personal liability, business entities like a limited partnership (LP) and limited liability partnership (LLP), were created.
In Limited Partnership, General partners have personal liability, however, limited partners are not liable for the business debts, including the losses that businesses suffer. The only risk that limited partners take what they invested in the business.
Whereas, in a Limited Liability Partnership, all the partners have limited liability, and this limitation is applied to all the business debts, but it does not apply to claims for certain intentional or criminal acts.
A Limited Partnership is always better than a Limited Liability Partnership when it comes to adding partners for raising funds to expand the business. In Limited Partnership, without giving the right to participate in business decisions, limited partners can be added, whereas, in a Limited Liability Partnership, partners can only be added by giving them the right to participate in business decisions and operations.
Professional Limited Partnerships
In any business type, a Limited Partnership can be formed, whereas a Limited Liability Partnership can only be formed only by certain types of professions, such as lawyers, architects, and accountants. In countries like California, a limited liability partnership is limited only to lawyers and accountants. Each and every partner of a Limited Liability Partnership shall have the appropriate state-issued occupational license, whereas in a limited partnership it is not required.
Income and tax considerations
In a limited partnership, self-employment taxes on money received from the company has to be paid by the general partner, while there is no need for limited partners to pay this. Whereas, in a Limited Liability partnership a self-employment taxes on his/her share of the company’s profits and losses have to be paid by each partner.
In a limited partnership, proceeds are received by limited partners from the business after the general partners received their share of profit. Whereas in limited liability partnership, according to the ownership interest in the company each partner receives its share of profits and losses.
Both Limited partnerships (LPs) and limited liability partnerships (LLPs) are businesses with more than one owner and both provide some of their owners limited personal liability for business debts, but in General partnership, it is not provided.
In limited partnerships, one owner is considered as a general partner, who has the power to make business decisions and also is personally liable for all the business debts. They also have one limited partner who invests in business but does not involve in daily business decisions and operations, one of the advantages of being a limited partner is that they are not personally liable for business debts.
Whereas in a limited liability partnership there are no general partners, and all the partners of an LLP have limited personal liability for business debts.
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