It is extremely important to choose the right type of business entity for your business. Because the right choice leads to more tax savings, availing the advantages of the particular form of business enterprise. The most efficient way of selecting the correct business entity depends around the legal and taxation benefits it offers. There are number of variables which are to be kept in mind while zeroing in on a particular form of business entity. Since times immemorial there are the 4 basic kinds of business entities: sole proprietorship, partnership, corporation, Private Limited Company and Limited Liability Company. It also includes NPO’s and SBC’s.
The first step is to understand each type of entity in detail:
PARTNERSHIP FIRM:
It is basically an association of two or more persons carrying on business with a mutual intention of a future benefit. Partnership firm can be started by any number of persons (minimum 2 and a maximum of 20). A partnership deed is required mandatorily to start a partnership business.
| Liability of owners; | Usually unlimited |
| Continuity: | Usually ends with death of any partner or bankruptcy, |
| Transfer of interest | Requires approval of all members |
| Management decisions | Not centralized |
| Double taxation issue | No |
| Fringe benefits | Usually limited in case of accident, death, life insurance and medical reimbursement |
| Members | Min 2 Max 20 |
| Legality issues | Required legal formalities to be fulfilled in each states |
| Tax year | Calendar year |
Some degree of income tax and tax planning is possible since ownership percentages can be transferred fairly easily. The disadvantages are similar in scope to a sole proprietorship. No limited liability protection exists; the partnership usually ends upon the termination of a majority partnership interest, so continuity is limited; earnings cannot be retained, and tax-free fringe benefits are limited.
SOLE PROPRIETORSHIP:
This includes basically a freelancing individual who operates a trade or business where all the tax consequences fall to that proprietor, including all liabilities, debts, profits, and losses. It is a popular form of self-employing businesses.
Advantages:
This is usually the easiest type of entity to set up or terminate.
Losses from the business can offset income from other sources.
Management is totally centralized since there is only one legal owner.
Recordkeeping may be a bit easier.
Taking money out of the business is very easy.
Disadvantages:
The owner has no limited liability protection.
Continuity and transferability of interest is limited.
The advantages are much more than the disadvantages. A person looking out for setting up an intervention free and a self-controlled business, this is probably the best option available. Apart from transferability issue, this kind of entity usually requires less number of statutory requirements to be fulfilled than the other types.
| Liability: | Majorly unlimited |
| Continuity: | Ends with the death of proprietor |
| Transfer of interest: | No |
| Management decisions: | In the hands of the sole propreitor |
| Double taxation issue: | No |
| Fringe benefits; | Limited as in case of partnership firm |
| Members: | One |
| Tax year: | Usually Calendar year basis |
CORPORATONS:
Usually of two types: The regular C kind
The Small business Corporations (SBC)
Corporations usually are formed to avail the benefits of a separate legally identified person. Its members and the corporation itself has a separate legal identity.
| Liability: | Majorly limited to the assets |
| Continuity: | Continues indefinitely |
| Transfer of interest: | Yes unless restricted |
| Management decisions: | Centralised by the BOD |
| Double taxation issue: | Quite low possibility |
| Fringe benefits; | Much more than other kinds |
| Members: | Unlimited |
| Tax year: | Usually Calendar year |
| Setting up: | Usually costly and tiresome |
Advantages:
Limited liability protection to owners.
Easy transferability of ownership in the event of death, insolvency of any member.
Continuity even if original owners no longer exist,
Tax planning opportunities,
More possible tax-free fringe benefit plans, and more flexible pension plans.
In addition, it allows for a number of owners to participate. Obviously there can be numerous advantages.
Disadvantages:
A corporation is usually more difficult and costly to set up or terminate.
Much more planning is required to avoid double taxation issues.
Recordkeeping can be quite complicated to preserve the limited liability feature.
Tax return filings tend to be more involved and complicated.
LIMITED LIABILITY PARTNERSHIP COMPANY:
This form of business is commonly known due to its limited liability benefit. It functions just like a corporation or a company registered in India but extends the benefit of limited liability. This is a hybrid, or combination, with some of the features of a partnership and the limited liability aspect of a corporation. To qualify as an LLP Company, it can have at least two of the main components of a corporation: continuity, centralized management, transferability of ownership.
Advantages:
Offers limited liability protection
Acts like a regular partnership
This entity has some of the better aspects of a partnership coupled with that of a corporation. It has limited liability protection.
There is much more flexibility here.
Income and losses can be allocated more easily.
Disadvantages:
It is still a relatively new form of business
Has various varied requirements in each different states
| Liability: | Exclusively limited |
| Continuity: | May end with the death of proprietor, insolvency |
| Transfer of interest: | No. requires approval of partners |
| Management decisions: | Not centralized |
| Double taxation issue: | No |
| Fringe benefits; | Limited as in case of partnership firm |
| Record keeping requirements | Complicated and tiresome |
| Tax year: | Usually Calendar year basis |
PRIVATE LIMITED COMPANY REGISTRATION IN INDIA :
According to the Companies Act, 2013, a private limited company limits the;
-right to transfer its shares
-limits the number of members to 200
-prohibits any invitation to the public for selling its shares.
Advantages:
-funding of business is easy
-limiting the risk to the personal assets
-private limited companies allow direct 100 percent FDI Allowance.
PUBLIC LIMITED COMPANY REGISTRATION IN INDIA:
Public Limited Company is where, its formation, working, its winding up is strictly governed by rules, regulations and applicable laws. This type requires minimum 7 members to and the required (5 lacs) paid-up capital, as may be prescribed, and no limit on the amount of members. There is free transferability of shares (Refer case: Western Maharashtra Development Corporation Ltd. V. Bajaj Auto Limited, 2010).
The Companies Act contains provisions regarding the legal formalities for setting up of a public limited company.
To select the best kind of business entity for your business, one needs to look for in the above mentioned matters. After a close inspection and research, the best kind of entity suitable for your business needs to be selected after considering the following matters:
-Liability (whether limited or unlimited)
-Taxation benefits offered
-Fringe benefits which can be availed
-Management control (whether wholly, centralised or partial)
-Various returns to be filed and the filing fees
-Member requirements
-Statutory compliances which needs to be fulfilled
-Continuity of existence of business
-Other mandatory requirements (depends from entity to entity)
For a full and proper guidance in choosing the right entity for your Business visit Company Vakil and discuss it with their Expert Legal Consultants, Advocates, CA and CS.