Business Legal Entity - Forming a Company and other options

Posted by Namita Gad on 12 Dec, 2017

Starting a business in India is indeed a tough task and it starts with the brainstorming activity of selecting the appropriate constitution for the company. The first question which comes in the mind of founders is which legal structure would be the best fit for the venture. Constitution or legal structure of your business is as important as the business idea. Therefore, you should do your homework before embarking on your venture.

Once you validate your idea, you should research on the legal formalities to register your entity. The type of entity you choose will have an impact on taxes, compliances under various laws, payment of obligations, record maintenance, etc. In India, we have 4 basic structures – sole proprietorship, partnership firm, limited liability partnership and private limited company. Each structure has its own pros and cons; and there is no definite answer for the best business structure. It all depends on multiple factors such as business plans, vision, risks, resources, etc.

Below characteristics can help you to get right constitution for your business:

  • Ownership: If you are starting a business on your own on a small scale, then better to go for a sole proprietorship. This entity can be formed with minimum cost, time and effort. You need not have any separate registration, start off your business with your individual PAN card as this business is no different from the proprietor.

  • Business Viability: If you are unsure about your business idea and wish to experiment market sentiments before expansion then again sole proprietorship is good for you. Shutting your sole proprietorship does not require any additional procedure. Once you are satisfied with the product viability, you can go for a more structured form of business such as a firm or a company.

  • Liability: Business is all about risks. You can go bankrupt if your business goes haywire. In case you want your business losses not to have an adverse impact on your personal assets, then you should opt for a LLP or a Company. Sole proprietorship and partnership are not separate legal entities per se, which means that your personal assets can be attached if business is sued for any reason.

  • Taxation: Income from sole proprietorship is taxed as the personal income of the proprietor as per normal slab rates, whereas in all other forms, a flat tax rate of 30% is applicable. Moreover, Companies also have to pay dividend distribution tax (DDT) on dividend payouts.

  • Ownership & Control: There is no separation between ownership and control under sole proprietorship and partnership firm. Therefore, if you are planning to seek investment from outside by giving away portion of your holding then you should opt for a LLP or a Company.

  • Legal Compliance: The strictness of laws is the highest for a Company and then for LLP in that order. Companies have to get their books audited under the Company Law, follow administrative documentation and file returns with registrar. Other entities enjoy lenient formality requirements.

Decision of choosing business structure is complex and has far-reaching consequences. There is no perfect answer to it and one has to evaluate different factors to arrive at the best structure. It is better to consult a Chartered Accountant (CA) or tax advisor to understand all factors involved before making the decision.