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May 16, 2011 Government Permits FDI in LLPs: A Welcome Move, But Restrictions May Be A Dampener In a welcome move, the Cabinet Committee on Economic Affairs of the Government of India (Committee) has finally approved the proposal to allow foreign direct investment (FDI) in limited liability partnerships (LLPs). The proposal allows FDI in LLPs that operate in sectors where no monitoring is required. While such investments into an LLP structure require prior governmental approval, it still opens up an opportunity for FDI investors for structuring their Indian investments in a tax efficient manner1. LLPs are hybrid entities, formed and incorporated under the LLP Act, 2008, possessing characteristics of both companies and partnerships and are considered a good alternative to companies in many jurisdictions. It is expected that the Department of Industrial Policy and Promotion (DIPP) would roll out a notification in future to give effect to the Committees approval (Approval). Through this update, we intend to provide an insight into the intricacies of the Approval, the various conditions prescribed therein and some further expectations which remain to be fulfilled. Introduction Stakeholders had long been expecting the regulators to permit foreign investment into LLPs; ever since the LLP Act, 2008 was notified in January 2009. Such expectations soared but were left unfulfilled, at the time of issue of the Consolidated FDI Policy in April, 2011 (FDI Policy)2. The Approval in that sense, acknowledges a long standing demand of stakeholders; but with a lot of caveats. Importantly, the Approval specifically provides that LLPs would not be able to avail the benefits of the Foreign Institutional Investor, the Foreign Venture Capital Investor and the External Commercial Borrowing routes of raising foreign investments, for the time being. The conditions prescribed, by the Committee, on FDI in LLPs, can be categorized under the following broad heads viz (i) investment restrictions, (ii) funding restrictions, and (iii) ownership and management restrictions; each of which is discussed below in greater detail. Investment Restrictions FDI in LLPs has been approved subject to the following important conditions:
While the Approval does not provide for a clear definition of the expression FDI linked performance related conditions; this expression may be interpreted to refer to the investment conditions prescribed under the FDI Policy for certain sectors, which may be in the nature of minimum capitalization requirements, or a lock-in of investments etc. Consequently, LLPs may not appeal as a viable option in sectors such as real estate or non-banking financial business, which seek foreign investment, losing an edge to the traditional option i.e. companies. Further, unlike corporate
structures, LLPs that have received FDI are
disqualified from making any downstream investments. This restriction may
make LLPs unviable for multiple tier holding
structures in Funding Restrictions
Permitting downstream investments
by companies into LLPs may provide some flexibility
for foreign owned entities in terms of downstream investments. By way of an
illustration, please refer to Figure 1 below for a possible structure of FDI
(in Approved Sectors) in Fig 1: Investments in Approved Sectors
Ownership and Management Restrictions
Analysis The Approval has been coupled with
certain onerous restrictions due to which LLPs may
lose a competing edge against corporate structures, for the time being.
Further, restricting FDI to LLPs only in the
Approved Sectors and prohibiting downline
investments by such LLPs may prove to be an
impediment on their use in structuring businesses in India, since one of the
most important advantages of an LLP is that LLPs
are not subject to dividend distribution tax, which benefit may not be
available in absence of use of LLPs for multi-tier
holding structures. Additionally, the Reserve Bank of Presently, these changes appear more to be in the nature of testing the waters by the government for permitting FDI in LLPs. Hopefully, as the Approval itself provides, FDI in LLPs will be implemented in a calibrated manner. As things progress, the Government may remove the shackles imposed on FDI in LLPs, with more experience building in using LLPs as structural alternatives. ____________________________ 1 Currently, LLPs are not subject to any dividend distribution tax which is currently leviable on companies at a rate of 15% (subject to applicable surcharge and education cess) 2 Refer to our Hotline dated April 5, 2011 on the Consolidated FDI Policy. 3 As per the LLP Act, 2008, a Designated Partner shall be the person responsible for and liable in respect of the compliances stipulated for an LLP.
You can direct your queries or comments to the authors
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