Selecting the right form of entity to do business in India

India of the 21st century is a dream for any aspiring business owner.

There are many different ways and forms of entity to do business in India, because of which people who are interested to start their own business may get confused regarding which type of entity to choose. Hence, to remove the confusion regarding the types of entity to choose, let us discuss the tax and legal compliances that different type of entities have to follow, giving the intended user the proper view, by which he will be able to decide which form of entity will suit best for him.

First let us see the types,

The types of entities generally used to start a business are:-

1. Sole proprietorship

2. Partnership firm

3. Limited Liability Partnership (LLP)

4. Private limited company

Sole proprietary concern:-

Sole proprietary concern is a business organization which is owned, controlled and managed by a single person.

It is a business which is operated at a small scale and hence the rules and regulations relating to sole proprietorship are minimal as compared to other forms of businesses.

To start a sole proprietary firm, the incorporation expenses are very low and less time consuming.

The liability of the proprietor is unlimited (means liability can go up to personal assets).

There is no requirement of initial capital in this case, being a sole owner results into very low scalability.

Proprietary firm is eligible to get registration for ESIC (Employee State Insurance Corporation), EPF (Employee Provident Fund), shops and establishment registration, but on the other hand he is not eligible for benefits under the startup scheme. Sole proprietary firm is eligible to be registered under MSME development Act 2006 (Micro, Small and Medium enterprises).

There is no prescribed limit as to registration of sole proprietorship under GST but registration will be required as per the basic limits of GST (for e.g. when sales of goods exceeds ₹40lakhs or interstate supply and such other rules).

The proprietor is under no obligation for statutory audit, but he will be required to do tax audit if turnover exceeds 1 crore in the previous year, in case transactions is > 95% are non-cash (online) than the limit is increased to 10 crores.

The entity can get registered under presumptive taxation i.e. tax payable at lower rates (i.e. 8%/6%) if the turnover is within the prescribed limit, if not covered under this, than tax payable as per slab rates for the business as well as the owner of the entity.

A proprietor will not be willing to withdraw salary for himself as he can reinvest the same to grow the business, however, drawings are allowed.

Hence, sole proprietorship is good in terms of compliance, low cost and time for incorporation but in this growth is the constraint.

Partnership firm –

A partnership firm is governed by Indian Partnership Act 1932, where two or more people come together to start a partnership firm, and these people are known as partners.

Partnership can be of 2 types-

1. Registered partnership firm; and

2. Unregistered partnership firm.

It is easy to form a partnership firm as the legal compliances are less as compared to company. The growth of the firm is very limited. Every partner shall bring capital into the firm for the initial capital requirement.

The liability of the partners in the partnership firm is unlimited (means it can extend to their personal assets). Same as sole proprietary, partnership firm can also get registration under ESIC, EPFO, and shop and establishment, Micro, Small and Medium enterprise (MSME) Act 2006 and will also be eligible for benefits of startup scheme if it is an eligible startup as prescribed.

GST registration is not mandatory to partnership firm but it is decided upon the limits on turnover as per the GST Act 2017. There is no requirement of audit to a partnership firm but tax audit will be applicable if turnover exceeds 1 crore in previous year but, if the aggregate turnover >95% is non cash than the limit will be 10 crores. It can apply for presumptive taxation if the amount is lower than the prescribed limit.

The tax rate applicable to a firm is 30% and if Turnover greater than 1 crore than surcharge of 12% and health and education cess of 4 %, the total of which comes to 34.944%

Remuneration to the partners in the firm is subject to a limit as per the Income-tax Act 1961 and the same will be allowed as deduction to the partnership firm and some more benefits on tax deduction are allowed to the registered firm. The remuneration and such other incomes received (except for profit) from the firm will be the taxable in the hands of partners.

Limited liability partnership –

Limited liability partnership is a kind of corporate version of a partnership firm.

The big change is, the liability of the partner is limited to the extent of contribution and cannot extend to their personal assets. The LLP is a separate legal entity different from its members.

The firm requires initial funds for incorporation and various other activities which is bought by the partners. LLP has great potential and as a result the growth in this type of firm is higher than the previous two types, though the incorporation expenses are relatively higher.

LLP can get benefits of startup scheme as it is eligible to be one. It can get registration under ESIC, EPFO, Professional tax, shops and establishment also it can get registered under MSME ACT by fulfilling the necessary condition. There is no specific law for LLP under GST hence, no compulsory registration, but if it crosses the prescribed limit than registration is necessary.

The expense for compliance of law, annually is a bit higher than the other two mentioned above, it shall have to conduct statutory audit if its turnover is greater than ₹ 40 lakhs in a year. Tax audit will be applicable similarly as above (will be applicable if turnover exceeds 1 crore in previous year but, if the aggregate turnover >95% is non cash than the limit will be 10 crores.). LLP cannot opt for taxation under presumptive basis as it is specifically removed from the sectionand has tax at a rate similar to that of a partnership firm i.e. 34.944%.

Hence, LLP is a firm where the expenses for incorporation and such other for compliance are higher than the two previously mentioned but it is also better than those two in many terms.

Private limited company –

A private limited company is an entity incorporated for the purpose of doing business. The process of incorporating a company is comparatively expensive as well, that is why to pay the expenses it requires initial capital. It is one of the most popular type of entity to do business in India and every year thousands of companies get incorporated. The liability of members of a private limited company is limited to the extent of shares held by them. Being a company it enjoys perpetual succession and can raise funds through various kind as a result of which it can expand its business very well.

In private limited company there is one type i.e. One Person Company (OPC), so OPC is again a kind of sole proprietorship but in the form of company and has a nominee. This type of company is suitable for small business, lack of management skill as one person cannot be good at all part of business all these acts as growth constraint. The compliance of an OPC is minimal as compared to a private limited company

A company can get registered in EPFO, ESIC, Shops and establishment, professional tax and such other things as it will employee people, it becomes necessary to get registered under such funds, have its own bank account, GSTIN if required. A private company can get registered under MSME act and can also avail benefits under Startup scheme.

A company has to comply with various rules such as appointment of auditor, annual ROC filling, Board meeting, annual general meeting if applicable, tax audit, maintenance of records for the period prescribed. It cannot opt for presumptive taxation, as the LLP and a Company are specifically removed from the section. Income tax rate applicable for a company is 25.168% as per sec 115BAA and 17.16% as per sec 115BAB. There is no restriction on amounts of remuneration to owners and at the same time it is deductible to the company, but it will be taxable to the owner (salary, dividend received and such other amounts as prescribed)

To conclude, there is no one-size-fits-all approach. The right type of entity depends on the type of business, scalability, capital etc!

It is best to seek professional advise on structuring the entity before incorporating the business.

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Should you require any further information or clarification, please get in touch with us at contact@vprpca.com