Alok Patnia
Alok Patnia founded Taxmantra.com, an expert in tax advisory & compliance. He is a Chartered Accountant having prior exposure with Ernst & Young & KPMG.
Starting your own business? One of the first questions which might come to your mind is that which legal structure your business should take? In this article we will discuss about different types of entity structures available and how can we decide upon the right business structure.
In India we have basically three types of business structures namely Sole proprietorship, Partnership firms and Company (pvt or public), however a new hybrid form of partnership firm and company known as Limited liability (LLP) emerged a few years ago. Each structure has its own pros and cons and it depends upon the individual circumstances of each business owner as to which structure will best suit his business. These include the level of personal liability you are willing to take for business debts, your personal tax position, the level of administration you want to do and how you want your business to be perceived.
Below mentioned factors are crucial and can guide you to decide on the right form of business structure.
Liability
When you are looking to minimize your personal liability you can generally rule out sole proprietorships and partnerships firms right away because there is lack of liability protection in these two forms. With these two forms, the business is not regarded as a separate legal entity from you, so your personal assets are part of the business. This means that if the business is sued for whatever reason, your personal assets are at stake. In a partnership form of business, even your personal assets are at stake for anything that your partner may do.
In an LLP form, your liability is limited to the extent of your contribution towards LLP, except in case of intentional fraud or wrongful act of omission or commission by the partner. What is at stake for you as an owner is what you have put into the business along with any personal guarantees you have made.
In case of a Company, liability is limited to the amount required to be paid up on each share.
Both LLP and limited company exists as a separate business entity and this creates a wall between your personal assets and the business. Thus your personal property is protected and this gives you the ability to build business credit, get loans and raise capital.
Taxation
Below are the various tax implications of the DTC.
Taxes on Income: Both LLP and Limited Company are taxed at a flat rate of 30% plus Education Cess & Senior and Higher Education Cess. LLPs are liable to pay surcharge at 10% w.e.f FY 2013-14 if the total income exceeds Rs.1 Crore. While companies have to pay surcharge at 5% if the total income exceeds Rs.1 Crore and at 10% % if the total income exceeds Rs.10 Crore from FY 2013-2014.
Minimum Alternative Tax: LLP is liable to pay Alternate Minimum Tax @ 18.5 % + surcharge + Cess with effect from financial year 2011-12 on the adjusted total income if regular income-tax on total income of LLP is less than the Alternate Minimum Tax.
Companies are also liable to pay Alternate Minimum Tax at 18.5% + surcharge + Cess on the adjusted total income.
Dividend Distribution Tax: LLP is tax efficient than that of limited company as Dividend Distribution Tax (DDT) is not applicable on LLP and Companies are liable to pay DDT @ 16.609 % (i.e. inclusive of surcharge and education cess) on such dividends.
Advance tax: Companies are required to pay advance tax in four quarterly installments, whereas, LLPs are required to pay in three installments.
When it comes to reporting your taxes, the sole proprietorship gives an easy way out. Since it is not a separate legal entity, you can declare your business income on your personal income tax form.
Ownership and control
The forms of Sole Proprietorship and partnership firms limit the number or type of people who can invest in your business. If you’re seeking a large number of investors or international investors, you may opt for LLP and Company.
If you desire to maintain a direct relationship between ownership and management of the business then limited liability partnerships (LLPs) are preferable over limited Company. However if the objective is to maintain complete authority, then sole proprietorship form of business is best suited.
Having discussed the most important factors to consider while deciding upon the correct business structure, I am putting down some questions below which will further ease your decision making.
Q: Are you participating in an industry that is vulnerable to lawsuits? Do you want to protect your personal assets (i.e. home, car, and savings) from lawsuits and judgments against your business?
If your industry is vulnerable to lawsuits, you may opt for a business structure like LLP and company where your liability is limited and doesn’t extend to your personal assets. LLP and company form of businesses protect your personal assets from any liability of the business.
Q: When it comes to funding, are you planning on seeking a loan from a bank, or other commercial lender?
If you are seeking to raise finance from a bank or an investor to develop the business, your options will be more restricted if you act as a sole trader rather than forming a limited company. In a sole proprietorship form, the owner only is liable to bring in the entire capital. So, if the business needs expansion, it becomes difficult for the owner to arrange that big amount. Bankers, lenders and other investors generally see a limited company more credible, due to stringent compliances and disclosures required for a company.
Q: Do you want to minimize your record keeping, audit and administrative requirements?
There is no provision for regular meeting of Board and members for LLPs. Partners can decided when and how to meet decide on delegation of powers etc. However, provision exists that LLP should maintain minute book. However, Quarterly Board of Directors meeting and annual shareholding meeting is mandatory for a limited company. If you want to lower your liability with regards to paperwork and administrative activities, opt for an LLP business structure.
Also Companies are mandatory required to get their accounts audited annually whereas for LLPs only those having turnover more than Rs.40Lacs or Rs.25Lacs contribution in any financial year are required to get their accounts audited annually as per the LLP Act.
To Conclude
Decision about choosing a business structure is technical and complex, but it can have far-reaching consequences for your business. Yet, there’s no quick answer to the question, LLPs and limited companies are preferable. The goals of the business play an important role in the decision making however, identifying the best choice involves balancing a range of factors like nature and objectives of the business, degree of control desired by the owner, amount of capital required and sources of funding, liabilities to be borne, tax implications etc.
The table starting on the next page provides a side-by-side detailed comparison of the different types of entities and sets forth characteristics of each.
| Features | Partnership firm | LLP | Company |
| Statute | Partnership Firms are governed and regulated under The Indian Partnership Act, 1932 | LLPs are governed and regulated under Limited liability Partnership Act,2008 | Companies are governed and regulated under Companies Act, 1956 |
| Registration | Not compulsory. However If the firm is unregistered then 1) a partner cannot sue the firm or any other partner,2) Partners and firm cannot sue a third party, 3) Firm cannot claim set off against a third party sue | Compulsory registration required with the ROC | Compulsory registration required with the ROC. Certificate of Incorporation is conclusive evidence. |
| Name | No guidelines. | Name to end with “LLP” Limited Liability Partnership” | Name of a public company to end with the word “limited” and a private company with the words “private limited” |
| Creation | Created by Contract | Created by Law | Created by Law |
| Formalities of Incorporation | In case of registration, Partnership Deed along with form / affidavit required to be filled with Registrar of firms along with requisite filing fee | Various e-forms and the LLP Agreement are filed with the Registrar of LLP along with the prescribed Fee. | Various e-forms along the Memorandum & Articles of Association are filled with Registrar of Companies with prescribed fees |
| Cost of Incorporation | Rs 500 | Rs 800 | Rs 6,000 |
| Time line | It will take 7 days (approx.) to incorporate | It will take 10-15 days (approx.) to incorporate (inclusive of time taken to obtain DPN) | It will take 10 days (approx.) to incorporate (inclusive of time taken to obtain DIN) |
| Capital contribution | Not specified | Not specified | Private company should have a minimum paid up capital of Rs. 1 lakh and Rs.5 lakhs for a public company |
| Listing of shares | Firm cannot be listed on the stock exchange | LLP cannot be listed on the stock exchange | A company can list its shares on the stock exchange |
| Distinct entity | Not a separate legal entity | Is a separate legal entity under the Limited Liability Partnership Act, 2008. | Is a separate legal entity under the Companies Act, 1956. |
| Perpetual Succession | It does not have perpetual succession as this depends upon the will of partners | It has perpetual succession and partners may come and go | It has perpetual succession and members may come and go. |
| Charter Document | Partnership Deed is a charter of the firm which denotes its scope of operation and rights and duties of the partners | LLP Agreement is a charter of the LLP, which denotes its scope of operation and rights and duties of the partners vis-à-vis LLP. | Memorandum and Article of Association is the charter of the company, which defines its scope of operation. |
| No. of shareholders / Partners | 2- 20 partners | LLP should have a minimum of 2 partners. There is no limit on maximum number of members. | Private company should have minimum 2 members, maximum 50 members; public company should have a minimum of 7 members |
| Board Of directors | Firm does not have directors or board of directors | LLP does not have directors or board of directors | Companies to have board of directors |
| Meetings | Not required | There is no provision for regular meeting of Board and members of LLPs. Partners can decided when and how to meet decide on delegation of powers etc However, provision exist that LLP should maintain minute book. | Quarterly Board of Directors meeting, annual shareholding meeting is mandatory. |
| Minimum number of directors | No Directors/designated partner requirement | Minimum number of designated partners is 2 | Minimum number of directors- Private company -2 and Public company 3 |
| Taxability- tax on Income | The income is taxed at 30% + 3 %cess | The income is taxed at 30% + surcharge at 10%+ 3 %cess | The income is taxed at 30% + surcharge at 5 %+ 3 %cess |
| Taxability- MAT | NA | 18.5%+Surcharge at 10%+3% Cess | 18.5%+ Surcharge at 5 % + 3% Cess |
| Dividend distribution tax | NIL | NIL | 15%+ surcharge 5 % + cess 3 % |
| Foreign Nationals as shareholder / Partner | Foreign nationals cannot form partnership firm. | Foreign nationals can be partners. | Foreign nationals can be shareholders. |
| FDI | Permitted on non-repatriation basis. | LLPs with FDI will be allowed, through the Government approval route, in those sectors/activities where 100% FDI is allowed, through the automatic route and there are no FDI-linked performance related conditions | Permitted |
| Ownership of Assets | Partners have joint ownership of all the assets belonging to partnership firm | The LLP independent of the partners has ownership of assets | The company independent of the members has ownership of assets |
| Rights / Duties / obligation of the Partners / Managing Partners / Directors | Rights / Duties / obligation of the partners are governed by Partnership Deed. | Rights / Duties / obligation of the partners are governed by LLP Agreement. | Rights / Duties / obligation of the directors are governed by AOA and resolution passed by shareholders or directors. |
| Liability of Partners/Members | Unlimited. Partners are severally and jointly liable for actions of other partners and the firm and liability extend to their personal assets. | Limited, to the extent their contribution towards LLP, except in case of intentional fraud or wrongful act of omission or commission by the partner. | Generally limited to the amount required to be paid up on each share. |
| Annual Return | No return is required to be filed with Registrar of Firms | Annual Return has to be filed with ROC within sixty days of the closure of the financial year. | Every company having a share capital shall within [sixty] days from the day on which each of the annual general meetings is held, prepare and file with the Registrar |
| Audit | Partnership firms are only required to have tax audit of their accounts as per the provisions of the Income Tax Act ( Limit- 60 Lakhs for business and 40 lakhs foe profession) | All LLP except for those having turnover less than Rs.40 Lakhs or Rs.25 Lakhs contribution in any financial year are required to get their accounts audited annually as per the provisions of LLP Act 2008. | Companies are required to get their accounts audited annually as per the provisions of the Companies Act, 1956,irrespective of share capital and turnover |
| Holding / subsidiary company | There is no provision for a holding firm or subsidiary firm in Partnership Act. | There is no provision for a holding LLP or subsidiary LLP in LLP Act. | Companies can have a status of holding company or subsidiary company as defined in the Companies Act |
| Transfer / Inheritance of Rights | Not transferable. In case of death the legal heir receives the financial value of share. | Regulations relating to transfer are governed by the LLP Agreement. | Ownership is easily transferable. |
| Transfer of Share / Partnership rights in case of death | In case of death of member, shares are transmitted to the legal heirs. | In case of death of a partner, the legal heirs have the right to get the refund of the capital contribution + share in accumulated profits, if any. Legal heirs will not become partners | In case of death of a partner, the legal heirs have the right to get the refund of the capital contribution + share in accumulated profits, if any. Legal heirs will not become partners |
| Transferability of Interest | A partner can transfer his interest subject to the Partnership Agreement | A partner can transfer his interest subject to the LLP Agreement | A member can freely transfer his interest |
| Legal Proceedings | Only registered partnership can sue third party | A LLP is a legal entity can sue and be sued | A company is a legal entity which can sue and be sued |
| Creditworthiness | Creditworthiness depends on goodwill and credit worthiness of the partners | Perception is higher compared to that of a partnership but lesser than a company. | High creditworthiness, due to stringent compliances and disclosures required |
| Dissolution | By agreement of the partners, insolvency or by Court Order | Less procedural compared to company. Voluntary or by Order of National Company Law Tribunal | Very procedural. Voluntary or by Order of National Company Law Tribunal |
| Suitability | More suitable for small businesses like retail ,wholesale trade or small manufacturing units, legal firms ,etc. | More suitable for professionals like CAs, CSs, advocates etc and service sector. | More suitable for businesses, trade, manufactures, large industrial establishments etc |
