Limited Liability Partnerships (LLPs) are slowly gaining preference as business and investment vehicles in Kenya in comparison to ordinary partnerships, limited companies and sole proprietorships.
When choosing the form of legal vehicle through which to invest or carry out commercial activities, flexibility and tax efficiency are key considerations for investors and entrepreneurs. LLPs should not be mistaken for limited partnerships. Limited Partnerships (LP) have a general partner (GP), who is generally responsible for managing the limited partnership, and whose liability is therefore unlimited, and limited partners, who have no right to participate in the management of the limited partnership, and whose liability is limited to their capital contribution. The Attorney General has not brought the Limited Partnerships Act into effect, more than five years after it was passed by Parliament.
LLPs are partnerships registered under the Limited Liability Partnership Act, 2011. Unlike ordinary partnerships and sole proprietors, LLPs have corporate personality, meaning that they are body corporates in their own right, with perpetual succession and limitation of liability for the partners. Partners in ordinary partnerships are jointly and severally liable for all the debts, and the acts and omissions of the partnership. In contrast to this, the liability of partners in an LLP is limited to their capital contribution to the LLP. Each partner is personally liable for acts of negligence and fraud committed by him, without the liability extending to the other partners.
LLPs possess similar attributes to companies and may be considered as a hybrid of limited liability companies and partnerships. They also offer several tax benefits particular to partnerships which are not available to companies.
LLPs are easy to form and dissolve. The minimum number of persons required for registration of an LLP is two while there is no maximum prescribed number. This contrasts with private companies which have a limitation of a maximum of 50 members. Additionally, the entire capital of LLPs can be freely paid back to the partners, whereas a company cannot return all its share capital without going through the process of liquidation or obtaining a court order for reduction of capital.
The ease of formation and dissolution makes LLPs the most suitable vehicles for transactional deals like funds and special purposes vehicles. However, investors should ensure that a solid partnership agreement is drawn to protect the rights of the individual partners and establish sound governance procedures.
The biggest tax benefit enjoyed by LLPs is tax transparency. They are not subjected to corporation tax in their individual capacities as they are not considered taxable persons under the Income Tax Act. Their income is taxed on the individual partners after distribution of profits.
Moreover, tax exempt partners are able to enjoy the exemption status if they invest through an LLP. If the same investment was made through a company, the returns would suffer corporation tax before distribution.
If the partners are natural persons, what is paid is final tax. This leads to additional tax savings as compared to companies where distribution of dividends would trigger withholding tax at either five percent or 10 percent for resident and non-resident shareholders respectively.
In cases where the LLP are used to hold investments, the expenses incurred by the LLPs in managing the investments would be tax deductible. In the case of a holding company, the expenses incurred in managing its investment in another company in most cases, would not be tax deductible.
LLPs are also exempt from thin capitalisation rules which affect financing arrangements of companies.This refers to the situation in which a company is financed through a relatively higher level of debt compared to equity. In Kenya, the thin capitalisation rules apply only to foreign controlled companies whose debt to equity ratio is more than 3:1. Deduction of interest expense for a thinly capitalized company is restricted to 75 percent of the interest. However, LLPs are able to deduct all their interest expense regardless of whether they are thinly capitalised.
LLPs are more attractive investment vehicles than limited companies, ordinary partnerships and sole proprietorship.
It is imperative to note that limited companies can be converted to LLPs but LLPs cannot be converted into companies under the provisions of the Limited Liability Partnership Act.
The writer is Senior Tax Associate at KN Law LPP.