Difference Between a LLP and a Partnership Firm

A Limited Liability Partnership (LLP) and a partnership firm are two types of business structures which requires minimum of two partners. The partners in an LLP have limited liability for the debts and obligations of the business. The partners' assets will not be at risk if the company incurs debts or legal action. This structure is usually used in professional services like accounting, law, and consulting. On the other hand, in a partnership firm, the profits and losses of the company are shared by the partners. Also, the partners remain liable for the debts and obligations of the company. 

Although both structures sound similar, the differences between them are significant. In this blog, we will cover the differences between LLPs and partnership firms structurally, legally, and in terms of taxation. 

Key Differences Between an LLP and a Partnership Firm

Both structures involve two or more people running a business together and sharing the profits. However, this is the basic similarity, and both structures may differ considerably. The table below lists the key differences between an LLP vs a partnership firm:

Although both structures are similar forms of entities, they differ in the number of partners, legal entity, account audit requirements, etc. These were the common differences. Moving further, let's see the tax differences between an LLP and a partnership firm. 

Tax Differences Between an LLP and a Partnership Firm 

Under the Income Tax Act, an (Limited Liability Partnership) LLP and a partnership firm are treated quite similarly from a tax perspective. However, there are some differences, which are as follows:

Income Tax Rate

Both LLPs and partnership firms are taxed as separate entities at a flat rate of 30% on their net profits. It is subject to the applicable surcharge and cess. Moreover, neither structure can benefit from the lower corporate tax rates that are available to companies under Section 115BAA (22%), or Section 115BAB (15% for new manufacturing companies). 

Partner's Share of Profit

The profit share received by partners in both structures is exempt from tax in the hands of the partners under Section 10(2A) of the Income Tax Act. It helps avoid double taxation as the entity pays tax on profits and the partners receive their share tax-free. 

Remuneration and Interest to Partners

Partners in both LLP and firms can receive remuneration and interest on capital. Also, these can be deducted as business expenses, subject to limits prescribed under Section 40(b):

• Interest on Capital: up to 12% per annum
• Remuneration to working partners: up to specified limits based on book profit

These deductions reduce the taxable profit of the LLP or firm. 

Alternate Minimum Tax (AMT)

Under Section 115JC, LLPs are subject to the alternate minimum tax (AMT) at 18.5% of adjusted total income. It applies if the AMT is higher than the regular tax. Similarly, partnership firms are also subject to AMT. 

Capital Gains on Conversion

One tax benefit of an LLP is that the conversion of a partnership firm into an LLP is not treated as a transfer for capital gains purposes under Section 47 (xiiib). It means no capital gain tax is triggered; however, it applies only when certain conditions are met. 

GST and Other Indirect Taxes

Under GST, both structures are treated the same. Registration thresholds, return filing obligations, and input tax credits rules apply equally. 

To make it easier for you to understand, here is a table summarizing the tax differences for an LLP and a partnership firm:

Consider this table to understand how LLP and partnership firms differ in terms of tax perspective. Now, let's understand which structure is better for NRIs. 

Which is Better for NRIs: LLP or Partnership Firm?

An LLP is usually the more practical and appropriate choice for NRIs choosing a business structure in India. Here are some reasons why an LLP is ideal for NRIs:

Limited Liability Protection is Priority

NRIs usually hold assets in multiple jurisdictions, like property, savings, investments in their residence country, and in India. Unlimited personal liability in a partnership firm means all those assets are at risk if the Indian business faces financial trouble. Conversely, an LLP's liability protection keeps the Indian business risk from affecting your personal wealth built abroad. 

NRIs' Participation is More Clearly Regulated in LLPs

Under FEMA regulations, NRI investment in LLPs is permitted under the automatic route, but only in sectors where 100% FDI is allowed. It is also strictly subject to specific conditions. However, investing in a traditional partnership firm is not defined clearly and can be more complex, mainly around profit repatriation and FEMA compliance. 

Banking Ease and Professional Credibility

An LLP that is registered as an MCA entity is considered more favorable by banks, vendors, and counterparts in commercial dealings. As compared to a registered or unregistered partnership firm, some activities are smoother for an LLP. It includes opening a current account, entering into contracts, and dealing with larger clients. 

Higher Compliance Yet Better Governance

LLPs have more compliance requirements, such as annual returns and financial statement filing with the MCA. However, instead of considering it as a burden, view it as a formal governance trait. This trait is important for NRIs who may be present in India physically to check day-to-day operations. 

An LLP structure with a designated partner in India that is properly documented offers a clearer operating framework for businesses that are managed remotely. 

To understand everything easily, let's take an example of an NRI:

NRI Example

Rony is an Indian professional based in Canada. He wishes to start a technology consulting business in India along with his brother, Prashant, who is an Indian resident. They are confused about whether to set up an LLP or a traditional partnership firm. 

They consult their accountant, and she explains the key considerations, which are:

• If they choose to set up a partnership firm, both Rony and Prashant would have unlimited personal liability. It means that if the business faces any losses or legal claims, both their personal assets could be at risk. It will also include Rony's Canadian savings and property. 
• If they choose an LLP, their liability would stay limited to the extent of the capital they have contributed. 

If looked at from a FEMA perspective, Rony's participation as a designated partner in an LLP is allowed on the automatic route. It is because IT consulting is a sector where 100% FDI is allowed. Also, he can repatriate his profit share from an NRO account, subject to applicable tax deductions. 

Moreover, they can manage the compliance burden of an LLP, like annual MCA filings, provided their accountant handles it. The LLP structure will give their business a formal registered identity. It is important when approaching enterprise clients. 

They end up choosing the LLP structure. Clear FEMA compliance pathway and limited liability protection make choosing an LLP a more sensible option. 

The Bottom Line

A traditional partnership firm is better for small, informal, low-risk businesses where partners know each other. Also, when there is no concern about personal liability exposure. It is easy to set up and has lighter compliance requirements. Conversely, an LLP is the better choice when liability protection matters, when an NRI or foreign participation is involved, or when commercial credibility is important. 

As an NRI, if you are confused about choosing the right structure for your business, connect with Savetaxs and let the experts help you. At Savetaxs, we have an entire team of experts who can help you choose the right structure based on your requirements. Our experts can also help resolve all the doubts, LLP registration, and any assistance you need. Contact us right away and start and grow your business with confidence.