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Budget 2020: LLPs and shadow banking sector expect big bang reforms from FM Nirmala Sitharaman

Budget 2020 is expected to usher in reforms that will help in reviving growth of the Indian economy. While the extent of these reforms remains to be seen, we set out here our expectations for limited liability partnerships (LLP) and the shadow banking sector from the budget

Budget 2020: LLPs and shadow banking sector expect big bang reforms from FM Nirmala Sitharaman

Budget 2020: LLPs and NBFCs will keep a close eye on FM Nirmala Stharaman's Budget speech

Budget 2020: The government and the Reserve Bank of India (RBI) have taken several measures during the last year to boost the economy and ensure ease of doing business. Budget 2020 is expected to usher in more reforms that will help in reviving growth of the Indian economy. While the extent of these reforms remains to be seen, we set out here our expectations for limited liability partnerships (LLP) and the shadow banking sector from the budget.

LLPs

LLP, as an alternative form of business vehicle was introduced to provide impetus to India's growth story, hoping that a nimble organisational structure would provide the flexibility for entrepreneurial initiatives. As a corporate entity which provides benefits of a limited liability company and the flexibility of a partnership, it was also expected to be a suitable vehicle for investment by venture capital. However, due to certain regulatory limitations and ambiguities, this potential of LLPs is yet to be fully realised.

The Foreign Exchange Management (Non-debt Instruments) Rules 2019 (Non-Debt Rules) currently allows foreign investment only in such LLPs which operate in sectors where: (i) foreign investment up to 100% is permitted under automatic route; and (ii) there are no foreign direct investment (FDI) linked performance conditions.

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This essentially means that a new venture or a start-up cannot be organised as an LLP if it is, for instance, operating in the insurance services sector and is looking to access foreign capital. A similar restriction is applicable to downstream investments by an LLP which is foreign-owned or controlled, affecting flexibility in structuring private equity transactions and possibly bolt-on acquisitions.

Another restriction in structuring transactions is non-recognition of foreign investment in LLPs which are engaged in the business of investing in the capital of other entities under the Non-Debt Rule.

These restrictions, however, are not applicable to companies. It is hoped that this budget will bring an end to this differential treatment and bring LLPs on par with companies for the purposes of receiving foreign investment.

This will be in line with the government's policy of ensuring ease of doing business and perhaps, boost the usage of LLPs and promote foreign investments in the process.

FULL COVERAGE:Union Budget 2020

NBFCs

Another major sector that requires special attention at this point in time is the non-banking financial sector (NBFC). The government has already taken various measures to improve the liquidity crunch in the NBFC sector and increase regulatory supervision to avoid any future debacles like IL&FS crises.

These measures include providing partial credit guarantee to the pooled assets of NBFCs and housing finance companies and relaxing the minimum retention time to promote loan securitisation.

With budget 2020, we expect the government to announce more steps to help promote the shadow banking sector.

While the Partial Credit Guarantee Scheme came to rescue of the high-rated pooled assets of financially sound NBFCs, the budget is expected to introduce steps so that even not so highly rated assets and small entities are able to access funds.

The government is also expected to introduce a plan similar to the US Troubled Asset Relief Programme (TARP) which was adopted in the US after the subprime mortgage crisis in 2007-2008. The government or the RBI may set up a special purpose vehicle to purchase assets from distressed NBFCs and consequentially provide liquidity in the hands of such NBFCs to lend more.

Another much-awaited measure is to provide an exemption to NBFCs from thin capitalisation rules. Thin capitalisation rules provide for disallowance of interest expense where interest exceeding Rs 1 crore is paid in respect of the debt raised from foreign associated enterprise, subject to certain limits.

While this rule is not applicable to banking and insurance companies, a similar exception has not been carved out for NBFCs which operate in similar domain and are similarly regulated. Budget 2020 is expected to announce this much-awaited exclusion for NBFCs.

While the government has been implementing steps introduced in the interim budget of 2019 and otherwise, we eagerly look forward to seeing the aforesaid measures being introduced in the upcoming big announcement.

(Akshay Bhargav is Partner and Vidushi Gupta is Principal Associate, Khaitan & Co.)

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