Revamped ecosystem will generate higher growth, goods and services tax, employment and exports – The Economic Times

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Synopsis–Most MSME units were mainly operating as partnership firms, and some as limited liability partnerships (LLPs), or private companies.

The Atmanirbhar Bharat scheme, announced by GoI in May 2020, provided special guaranteed credit support to those micro, small and medium enterprises (MSMEs) whose credit record was regular as on February 1, 2020. For others, banks were to plan restructuring. Significantly, criteria for MSMEs were raised in June to up to ₹250 crore turnover and ₹50 crore investments. This group can be nurtured to become engines of employment and export.

Can MSMEs be seen as growth-stage startups ripe for investment by venture capital? How can reliable information on an MSME — financials, business models, track record of promoters, etc — be accessed by potential investors? Can such information depositories be created, pooling data from credit information companies, rating agencies, mutual funds, etc?

Most MSME units were mainly operating as partnership firms, and some as limited liability partnerships (LLPs), or private companies. These firms need to convert to companies so that investors have an exit route by selling shares. Also, unlike facilitating laws for companies, there is no law for firms to merge or demerge, or to enjoy tax exemption.

So, equity resources need to be attracted to strengthen core capital. Equity investors look for critical mass and an exit path. The latter is available only if firms and LLPs convert or merge into limited companies. To achieve size and to enhance competitiveness, these entities should either grow organically, or 2-3 of them should merge. Sometimes, only one or two divisions of the firm’s business may attract an investor. Then, a demerger of the division is required.

An ecosystem for such business entity restructuring needs greater flexibility. As the LLP Act, 2008, is under review, and the Union budget is due in less than a month, these aspects — restructuring under the Partnership Act or tax laws, introducing stamp duty, making the tax law more flexible, etc — must be considered for amendments.

The LLP Act does contain provisions for converting firms to LLPs, and converting companies to LLPs. These processes could be extended to cover inter se restructuring of firms, or their conversion into companies in a simplified manner. Otherwise, provisions could be brought for entity restructuring in the Partnership Act.

Tax laws do not grant any exemption from tax on firms or LLP restructuring except upon conversion of firm to company — but with highly restrictive conditions. Non-compliance gives rise to tax. Flexibility is needed in these conditions. And in line with exemptions for corporate mergers and demergers, suitable exemption should be sculpted into the law for erstwhile partners and a recipient company.

These conversions are at book value (as per accounting standards), whereby the partners acquire 100% shares at inception, and then raise fresh capital at a premium. These facilitating laws for restructuring that exist in the LLP Act should be extended to firms, and new measures in Company Law are essential. For ‘ease of doing business’, the regional director of companies, or separate benches of NCLT, should be authorised to implement a simplified process.

Tax laws specify that partners must hold 51% of shares in a converted company for five years. This does not encourage 2-3 firms joining hands to achieve critical mass. The benchmark of 51% should be brought down to 20%, to be locked in for three (instead of the current five) years. This will allow business combinations and capital raising for growth, with suitable safeguards.

Currently, Company Law only allows the entire firm or LLP to be registered as a new company, not any one division. The Registrar of Companies (RoC) should be authorised to register a demerger at par with companies, and also to register 2-3 firms as one company. The residuary firm would continue.

The LLP Act has provisions for restructuring. But the framework for conversion into a company is provided in the Companies Act. This requires the firm or LLP itself to register as a company. LLPs have to convert into a company and then merge or demerge into an existing company, as recently declared by NCLAT. An amendment is, hence, required in Company Law or in the LLP Act to allow direct mergers of firms or LLPs, or any division thereof, into any company, including a listed one. Tax exemptions need careful change, and be on the lines of laws for demerger or merger of companies that will protect the company, revenue interests and shareholders.

Supportive tax amendments to carry forward unabsorbed depreciation and losses are also needed, whether the merger is of inter se firms or inter se LLPs. These do not exist now for firms and LLPs. This revamped ecosystem will generate higher growth, goods and services tax (GST), employment and exports.

(The writer is managing partner, SS Kothari Mehta & Co)

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