Correlation between Capital Contribution and Profit-Sharing Ratio
Poonam
Army Law College, Pune
This Blog is written by Poonam, a First Year Law Student of Army Law College, Pune
Introduction
A Limited Liability Partnership (LLP) is a body corporate constituted and incorporated or consolidated under the Limited Liability Partnership Act, 2008 (LLP Act, 2008) and operates as a separate legal entity i.e. an entity or organization distinct from its partners. The existence of the separate legal entity concept in the partnership of the partners indicates that the LLP can enlist assets, ingress into contracts or agreements, and be held accountable solely in its name unyoked of its partners, bestowing a plication of tutelage to the individualistic assets of the partners. A Limited Liability Partnership (LLP) has perpetual succession i.e. members/partners may come and members/partners may go but the existence of a Limited Liability Partnership goes on forever irrespective of the changes in the composition of the partnership of the partners like a departure, death, insolvency of aught partner, etc. subject to the agreed terms and conditions of the LLP agreement Penned or executed among the partners.
Any individual or anybody corporation can become a partner in an LLP.
The reciprocal powers and responsibilities of the partners of an LLP and the reciprocal powers and responsibilities of an LLP and its partners are radically governed by the LLP agreement enforced between the partners or between the Limited Liability Partnership (LLP) and its partners i.e. LLP Agreement.
In the scenario where there is no existence of an LLP Agreement or where the LLP Agreement does not speechify or cater to the resolution mechanism of any particular matter brooding with the reciprocal rights and duties of partners or the propinquity between the LLP and its partners, hereby the provisions of the First Schedule of the LLP Act is exercisable for this matter.
How Capital Sharing Ratio and the Profit and Loss Sharing Ratio are correlated?
The capital sharing ratio of an entity indicates the amount or the proportion of capital contributed by each partner to the total capital of a Limited Liability Partnership (LLP). Then the profit-sharing ratio of an entity indicates the percentage or proportion of profits or losses apportioned to the denominator partner in the LLP. The Consideration between the both profit sharing ratio and the capital sharing ratio is that they should coordinate or be in the homological amount or proportion i.e., the much a partner would be contributing to the capital, the much they would be liable to effectuate the share of the profits. The First Schedule of the LLP Act also bestows that, if there are no specific ratios mentioned in the LLP Agreement as agreed upon between the partners then the instinctual consideration is that profits, losses, and capital contributions will be shared equally proportionally among all the partners.
However, In LLP the partner’s contributions are multitudinous and can concatenate tangible, intangible, movable, or immovable property as well as other benefits, such as money, promissory notes, or contracts for specific performance performed or to be performed. The partner’s liability to contribute to the total capital, however in the form of money, property, or services, is administered by the terms and conditions of the LLP Agreement. Partners are rendered excessive autonomy to solidify how they desire to draft or construct their terms of contribution. Partners also have the autonomy to confabulate and cohere on a profit and loss sharing ratio that may be completely unyoked of the capital contributions.
Hereupon, an epitome can be withdrawn that the capital sharing ratio need not Primordially be equal or proportionate to the profit and loss sharing ratio. For example, one partner can contribute 80% of the total capital, while another can contribute only 20%, and still, the dispensation between the partners for sharing the profits and losses may be in the ratio of 50:50 each or such other proportion as the partners may deem fit in this matter relying upon the reciprocal conciliation between the partners under the LLP Agreement.
Therefore, the contribution or the proportion of the profit or loss sharing ratio may be dissimilar from the capital sharing ratio owing to multifarious factors involving moreover services conferred by the partner, etc.
A similar finding was reasserted by the ITAT in the case of JCIT (OSD), Circle-32 Vs. Aditya Kumar Singhania, under which it was seen that the Kolkata Bench mentioned that “ Nowhere it was made a compulsion that the partners shall effectuate their share or portion in the profits or losses in the proportion or in the ratio in which the funds are contributed by the partners; Neither in any provisions of the Income Tax Act nor in any provisions of the Limited Liability Partnership Act, 2008. Conversely, it is unanimously recognized Inhesion that in the scenario of a partnership firm or LLP, the partner has the liberty to solidify the terms and conditions of the LLP agreement as all the partner may deem fit in this matter or regarding the terms of profits and losses ratio, etc. There is no statutory peremptoriness as to whether the proportion of capital contributed by the partner shall be equal in the same apportionment to profit sharing ratio. It is also rightly said that the business is not carried on only with the amount of money contributed as capital but instead, the profitability of any partnership relies verily upon the efforts contributed by each partner.
There is no punishment or infringement of any provision in the LLP Act on dividing the profits or losses in the apportionment which was different from the apportionment in which the capital was contributed by the partners.”
This case scrutinizes that the profit-sharing ratio i.e. the appointment of profits (or losses) to each partner of the LLP can be constructed solely on the basis of the capital contributed by the partner in the LLP, thereby in this manner assenting the partners to distribute the profits as per their terms of contributions or as such mentioned in the LLP Agreement.
Conclusion
The efficiency of having variant capital and profit-sharing ratios in an LLP is not just a portent of statutory pliancy but also a crucial mileage. By conferring partners, the liberty to draft or constitute their financial and operational propinquity as an impact the LLP would be more effectively able to coordinate the interests of its partners and ameliorate the long-term success of the business. This unprecedented dimension of LLP makes them circumstantially compatible with the modern business atmosphere, wherein the partners are independent to contribute in as diverse a manner as the businesses themselves.
References
2.https://indiankanoon.org/doc/67711706/
3.https://vakilsearch.com/blog/profit-and-loss-sharing-ratio-in-partnership-deeds/
4.https://www.investopedia.com/terms/c/contributed-capital.asp
5.https://zeus.firm.in/correlation-between-capital-contribution-and-profit-sharing-ratio-in-an-llp/