Whether Consolidation of Limited Liability Partnership [‘LLP’] is Necessary? - MMJC

Introduction.

The very concept of Limited Liability Partnership (LLP) originated from the thought that, advantages of companies and partnership firms should be combined in one entity and drawbacks thereof should be eliminated. That is the reason, an LLP has multiple features which resembles that of company. Especially after Ministry of Corporate Affairs (‘MCA’) has made certain sections of Companies Act 2013 [‘the Act’] applicable to LLPs, the difference between the two has reduced further.

Since requirement of preparation of financial statements are present in both laws, we shall try to deliberate through this article, whether a LLP can become as an ‘associate’ of a company for the purpose of consolidation.

‘Associate’ under Companies Act 2013.

The term ‘associate company’ is defined in section 2 sub-section (6) of the Act[1]. But this clause defines an ‘associate company’ and not an ‘associate.’ That means, as per the Act, only a company can become an associate of other company. The term ‘Company’ is defined under section 2(20) of the Act[2]. As per this definition only that entity which is registered under the Act can be termed as a Company. Since LLP is not registered under Companies Act, it cannot be called as a ‘company’ and hence cannot be termed as ‘associate.’ Therefore, an LLP cannot be considered as ‘associate’ from the point of view of provisions of companies Act. Associate under INDAS 28.

Other than Companies Act, there is one more place where we can check whether a LLP can become associate of a company or not and that is, INDAS-28? Talking about investments in associates, this INDAS-28 defines [3]associate as an entity over which the investor has a significant influence. That means; to find out any entity is an associate as per INDAS-28 or not, existence of significant influence has to be determined.

The term ‘significant influence’ is defined under, both INDAS-28, and Companies Act. INDAS-28 defines [4]significant influence as, power to participate in financial and policy decisions of the investee entity. Whereas, as per [5]section 2(6) of the Companies Act, significant influence refers to control over 20% voting rights of the investee entity or control or participation in business decisions. Now there arises a question that which of the two definitions to apply?

The answer to this question can be found in [6]Para 5 of INDAS-28. This Para of INDAS-28 in a way aligns both these definitions. It says that if an investor holds 20% or more voting power in an investee, then the investor is presumed to have significant influence over the investee and if he holds less than 20% voting rights, then he is presumed not to have significant influence over the investee. The Para further states that, if the investor holds less than 20% voting rights but still has significant influence or holds more than 20% voting rights but still does not have significant influence, then that fact must be proved with the help of parameters provided in Para 6.

Therefore, conjoint reading of definitions of ‘associate’ and ‘significant influence’ under INDAS-28 and Para 5 thereof along with definition of ‘significant influence’ under Companies Act, we can say that, if a company holds 20% or more voting rights in an LLP, then unless proved otherwise, that LLP is an associate of that company from the point of view of accounting standards.

Consolidation whether applicable.

If we look at the status of LLP as associate from the Companies Act perspective, it cannot be considered as associate. But if we look at the same from INDAS perspective, then it can be considered as associate. That means, there arise 2 contradicting views from reading of both set of rules and therefore, there arises a question that if a company holds say 25% voting rights in an LLP, then while preparing consolidated financial statements, should the company take in to consideration, the financial statements of LLP in the capacity of associate? The answer to this question can be found in [7]section 129(1) of the Companies Act 2013. This section says that consolidation of accounts should be done as per applicable accounting standards. And since as per INDAS-28, LLP is an associate, the effect of its financial statements on company shall be considered while consolidating the accounts of the company. Other than section 129 of the Act, this view finds support from INDAS-110 which talks about consolidation of financial statements and [8]FAQs on consolidated financial statements issued by ICAI. Both these documents state that consolidation must be done with every entity over whom reporting company has control and entity includes LLPs as well. Therefore, despite not being a company, consolidation of accounts of LLP has to be done by companies.

[1] (6) “associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company

[2] (20) “company” means a company incorporated under this Act or under any previous company law;

[3] An associate is an entity over which the investor has significant influence.

[4] Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.

[5] [Explanation. —For the purpose of this clause, —

(a) the expression “significant influence” means control of at least twenty per cent. of total voting power, or control of or participation in business decisions under an agreement

[6] 5 If an entity holds, directly or indirectly (e.g. through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or indirectly (e.g. through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the entity does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence.

6 The existence of significant influence by an entity is usually evidenced in one or more of the following ways:

• representation on the board of directors or equivalent governing body of the investee;
• participation in policy-making processes, including participation in decisions about dividends or other distributions;
•  material transactions between the entity and its investee;
• ) Interchange of managerial personnel; or
• ) Provision of essential technical information.

[7] [(1) The financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under section 133 and shall be in the form or forms as may be provided for different class or classes of companies in Schedule III:

Provided that the items contained in such financial statements shall be in accordance with the accounting standards

[8] https://www.icai.org/post/faqs-on-preparation-of-consolidated-financial-statements-24-06-2016F