The Indian government’s proposed relaxation on penalties over compliance-related offences for limited liability partnerships (LLPs) has largely been welcomed by the startup sector.
Last week, reports indicated that the Indian government is looking to reduce penalties for LLPs by almost 50% for nearly a dozen offences by startups incorporated as limited liability partnerships. This move is expected to provide a much-needed sigh of relief for directors and founders looking to startup in the country.
Both LLP and companies (set up as private limited firms) are expected to file routine documentation, including updating the registrar for new director appointments, maintaining registered office addresses, changes in the designation of directors, filing of income tax returns and financials, and other statutory documents.
Hence, failure to update several documents with the registrar earlier attracted hefty fines which could run up to lakhs, and some of them were also considered as criminal offenses.
However, some legal experts and investors have cautioned that further relaxations on filing of annual financial returns could set a bad precedent.
Investment bankers, lawyers, due diligence consultants and journalists usually depend on publicly available financial statements with the registrar of companies (RoC) for their work. Although companies privately prepare these statements for the purpose of fundraising due diligence and income tax filings, startups have been regularly skipping to file statements in time with the RoC.
Currently, the Limited Liability Partnership Act, 2008 (LLP Act) penalises companies for skipping to submit their annual returns or financial statements with the registrar. The LLP Act specifies that all LLPs must file “annual return duly authenticated with the Registrar within sixty days of closure of its financial year”.
The LLP Act further states that failure to file financials after the closure of the year currently attracts a minimum fine of INR 25,000 which could extend up to INR 5 Lakhs, in case the LLP fails to file documents in the months after the financial year ending. A new amendment proposed by the ministry has reduced this fine by almost 50% of this earlier specified amount.
However, several startups including companies valued over $1 Bn continue to skip filing financial reports in time, with some skipping to file financial statements since FY19. Hence, experts argue that further relaxation on penalties would only contribute to the trend.
Note that the relaxations on compliance-related penalties for LLPs are in line with the relaxations that were already offered to private limited companies last year. In September last year, the Lok Sabha had passed around 40 amendments to penalties in the Companies Act which regulates private limited companies.
Startups Face an Ethical Dilemma
Subodh Sadana, partner at AnantLaw who advises startups, told Inc42 that companies face an ethical dilemma and could face significant consequences while fundraising or exploring M&A in case they don’t fully disclose financials with the registrar.
Sadana said that some startups may prefer to pay the penalty than filing annual financial returns in time. However, when it comes to filing GST and Income returns, these startups will have to privately share financial statements with their CAs/tax advisors on request.
“LLPs and private limited companies also prepare their financials for the income tax returns and for certifying their valuations with auditors. So almost half their documentation work for annual filings with the RoC is already done. It is not ethical for LLPs/companies to skip filing financials with RoC for more than a year or two. If a startup is defaulting for such a long time, it will impact the credibility of such LLPs/company and any investor would be wary of making investments in them,” Sadana added.
India’s most valued startup BYJU’s is yet to file its annual returns for FY21 which closed in March 2021. The company had filed its FY20 financials nine months after the closure of the financial year.
ANI Technologies Pvt Ltd, the parent company of mobility startup Ola, is yet to file financials for FY20 and FY21. ANI had last reported financials to the registrar in FY19, which was almost 6 months late.
Food delivery unicorn Swiggy’s parent company Bundl Technologies Pvt Ltd is yet to file FY21 financials, and had submitted its FY20 financials in December 2020, almost 9 months late.
Anup Jain, Managing Partner at Orios Venture Partners, said that if an LLP or a private limited company chooses to update its financials late, then it has to be within the legal limits allowed.
As per the law, both private limited companies or an LLP are allowed to have some leeway when it comes to filing of annual financial statements, Jain added.
“Many startups, especially large and prominent ones, choose to delay disclosure of financials because they want to maintain some amount of confidentiality within their peers. Big startups see their financial statements as sensitive information and, hence, they don’t need to reveal it unless they may end up compromising their next funding round”, Jain noted.
Jain also pointed out that VCs usually check most documents available with the RoC website as part of the due diligence process. “If some document that was supposed to be filed is delayed, and it is within the law, then we will ask for that document. And we will make it a condition subsequently. We (as a VC firm) will not wire funds before the document is filed,” he added.
Exit-focused Startups May Prefer Private Structure Over LLPs
An LLP structure offers far greater flexibility to founders when they are looking to incorporate. Sadana of AnantLaw and Jain of Orios told Inc42 that the compliance cost for creating an LLP structure is much lower than going with a private limited structure.
“Companies who adopt the LLP structure have fewer compliances when compared with private limited entities… Private Limited entities go through stringent audit checks, third-party audits, and they have to make a lot more compliance-related submissions, including KYC submissions,” Jain informed.
However, when it comes to startups that have a planned exit window, founders are advised to usually set up as a private limited firm. Since private-limited firms spend a far greater amount of time and money in compliance, investors usually trust the private limited structure to reduce the due diligence work.
“From the perspective of an M&A or large liquidity event, the limited liability company structure is a more preferred mode since the rules and regulations are very well laid down. In addition, most LLPs who are looking at large liquidity events such as public listing, will eventually have to convert into a limited liability company,” Sadana added.