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Starting Up A New Business? Not Sure The Kind Of Legal Entity You Should Form?

Starting Up A New Business? Learn more

Starting a business venture is nothing short of embarking upon a journey that is marked by challenges and major choices. Making the correct choice with regard to the type of entity or the legal structure of your business is crucial in so many respects. This is not a decision that is made on a whim. Choosing the type of entity to give a legal structure to your business is a process that requires serious deliberation and consideration of all the relevant aspects that influence or would be affected by this choice. A structure that is chosen must be best suited to all the needs of the business you plan to start. Certain points that must be central to your choice of business structure are-

  • Liquidity of ownership
  • Protection from personal liability
  • Best tax treatment
  • The structure that will help your business attract and retain employees and
  • Ability to raise money from angel investors or venture

Obviously, in order to make the correct choice, you must be aware of all the available options. Hence, it’s imperative to carefully assess all types of business entities and their implications to arrive at the correct choice for your business. We are listing the types of business structures that exist and their applicability along with an assessment of the pros and cons of each type.

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In This Blog:

Types of Business Entities

Mainly, we have the following types of entities or business structures in India.

Lets deep dive into the details.

Sole Proprietorship

Often considered the simplest and the most cost-effective way to start a business, a sole proprietorship means that complete managerial control is in the hands of the sole owner of the business. Since you yourself are the owner and all control is in your hands, you are also personally liable for all financial obligations of the business. Basically, if you haven’t created a separate legal entity for your business, then it falls into the domain of a sole proprietorship.

A sole proprietorship is best suited for those who want to be self-employed and run their business on their own with complete autonomy. It’s the easiest to form with no official registration required, though you may need to go through the process of licensing and permits depending on the kind of business you are starting with.

Certain important points to keep in mind are that you will be assuming full responsibility for the business, and you will be personally liable for any sort of financial obligations. You must have enough capital because you won’t be able to raise money through the selling of stocks of your company. In conclusion, this type of business entity is best suited for those who wish to have full autonomy over their venture and do not have any major risk in assuming personal liability. The business need not register separately for a PAN as the owner’s PAN acts as the same for the business. Registration with different tax departments depends on the needs of the business.

GST registration is required. The income earned from the sole proprietorship firm will be added to the individual’s personal income and will be taxed accordingly. He/she will be able to take the benefit of income tax slabs.

 Also read: What Are The Regulations Applicable To A LLP?

Partnership Firm

As the name suggests, this type of entity involves two or more individuals who share ownership of the business (maximum 50). Thus, they share the profits, losses, liabilities, etc. Obviously, designing the structure of your partnership is vehemently important as each and every partnership venture may have different dynamics and the relationship between the partners plays a major role in determining the nature of the partnership business. A formal partnership agreement is quintessential for this type of entity. You need to formulate the structural dimensions of the venture that include the extent of shares, ownership, control, share in profit and loss, and liabilities. Also, important aspects in relation to the dissolution of the business, resolution of disputes, and taking money out of it are integral to the agreement. Some ventures offer the prospect of partnership to their employees as a hiring advantage.

A great advantage of the partnership type of business structure is that the income from the partnership passes through to the concerned partners without having to undergo any tax. However, the risk of personal liability in a partnership depending on the agreement is present. This is exactly why in several partnerships, there are different levels of risks for different partners who could be general or limited partners. Partnerships are best suited for those individuals who share a common idea and want to start a business that would require the work and capital from more than one person. The distribution of roles and duties is integral to this type of structure. This type of entity is often adopted by those who are planning to start a venture together. A Partnership Firm in India is provisioned by the Partnership Act, 1932. A partnership is allotted a separate PAN card. Unlimited liability is an important feature and losses incurred by one partner are liable to each partner of the firm. A partnership firm has the choice to register itself with the Registrar of Firms (ROF) that gives some legal protection to the firm. GST registration and professional tax registration can be taken as per the criteria. The income tax rate for a firm is flat 30% plus CESS.

Limited Liability Partnership (LLP)

If you are primarily looking to reduce personal liability and risks, then a Limited Liability Partnership is a suitable entity for your business venture. This type of structure involves the best of both sole proprietorship/partnership and a corporation. In a Limited Liability Partnership, there is flexibility in terms of ownership and control as well as limited liability and preferential tax treatment for profits and transfer of assets. This type of entity is best suited for those individuals who do not wish to take up complete personal liability or have significant personal assets that they wish to protect.

The Limited Liability Partnership is a new business structure that has been established by an Act of Parliament. It is required to have a separate PAN card and legal status. The liability protection that this form of entity provides limits the liability of each partner to the extent of his/her investment in the firm. It has provisions for legally protecting other partners from the illegal actions of one partner. A limited liability partnership can also be formed by converting a public/private limited company or a partnership firm. It can be directly incorporated at the MCA portal with the help of a consultant. LLP is not recommended to those who are looking to raise funds in the future. The income tax rate for LLP is flat 30% plus CESS which is the highest among all the options. Moreover, it has to file annual returns (Form 8 and Form 11) with the MCA. If the turnover of the LLP exceeds 40 lacs, it is supposed to be audited by a practicing CA. Hence. Managing LLP is a costly affair compared to unregistered entities.

One Person Company

One Person Company has been recently introduced and is an improvement on the sole proprietorship type of entity. The main advantage and feature of this entity are that along with sole control on the ownership, it also provides continuous existence as well as limited liability. Having protection from complete personal liability and continuous existence instead of limited existence is a great improvement on the sole proprietorship business structure. An important point to note is that the One-Person Company or the OPC is required to be registered with the Ministry of Corporate Affairs (MCA) and the annual audited returns are to be submitted to the ROC.

A nominee has to be appointed as the sole shareholder. However, there can be multiple directors for an OPC. The income tax rate for One Person Company ranges from 15% to 25%.

Private Limited Company

This type of business entity is one of the most popular business structures. The owners of this type of entity are required to pay a share capital fee to subscribe to their shares. In doing so, they are designated as shareholders of the company. This type of entity is a separate legal structure both in terms of taxation and liability. The liability of the owners is limited as their personal liability is limited to the extent of their share capital in the company. This type of structure allows for outside funding and employee stock options. Compliance measures are quite stringent and increase the credibility of the company. The company is formed by registering with the registrar of companies (ROC). Such a company can have members ranging from 2 to 50. The minimum authorized share capital is ₹1 lakh. Appointment of directors for the operation of the company is done by shareholders. There are various compliances that are necessary for a private limited company and are more complex than those of a partnership firm or an LLP. There are various advantageous aspects to this type of business entity too. The shareholders of the company can change without affecting the operation of the company. This type of structure provides a distinction between ownership and function. The company can issue debentures and convertible debentures. It has to be noted that a private limited company is supposed to file its annual ROC Returns (AOC-4 and MGT-7) irrespective of whether there has been the business or not. A Practicing CA has to audit the financials of the company that is attached in the above forms. The income tax rate for private limited companies ranges from 15% to 25%.

How to decide on the type of entity for your business?

There are some very serious considerations to be made when choosing the type of entity for your business. You will have to understand the nature of your business and the needs of your venture. Your decision must depend on the amount of liability, tax treatment, charges, the extent of control and ownership, the distinction between operational control and ownership, and such other aspects. You must have a comprehensive outlook on what you want and how you want to run your business and what kind of liability and management you want. The legal implications of the type of entity you choose are also very important and must be duly considered before you choose your business structure.

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