Any person while beginning a business is confused regarding the legal structure of the organization. In a broad sense, there are four types of structure that a company can be set up with: Self proprietorship, Limited Liability partnership, partnership or a one person company.
One can pick any of these types for their business based on their requirements and going through the benefits and drawbacks. Let’s look at self-proprietorship, its rules regarding tax and registration procedures. This model also has certain advantages and disadvantages which is also discussed.
And finally a comparison with one person company structure.
What is sole proprietorship?
The basic meaning of the structure can be understood from its name ‘Sole’ means single and ‘proprietorship’ means ownership. Sole Proprietorship is a business model that is owned and controlled by one person who has the complete authority and responsibility in regard of the business. Such an arrangement is made so that the owner gets the entire profit and is also responsible for all the loss. Meaning the business and the owner are not different they are the same entity. This structure is suitable when the business is small and the market for the products is also small. Business with low capital investment requirements and low-risk factors can go for it.
The benefits of a sole proprietorship
The most important feature of sole proprietorship is the simplicity and informality with which it can be created and dissolved. It requires no formal registration and it costs nothing to set up a business in this structure (except for tax and business specific registration work). As the business is owned by just one person the decisions can be made faster and is also flexible because even fundamental changes are decided by the owner.
The owner has complete control over the finances meaning that he or she has more reward for the money earned through business.
The sole proprietorship business structure is common in areas of work where close personal relations are followed as the sole proprietor is enough for having adequate one-on-one relation with both employees and customers. Maintaining business secrets is also easier in this structure.
Disadvantages of a sole proprietorship
The disadvantages of the sole proprietorship structure of business are of four types.
Firstly, the business can exist only as long as the owner exists (the business can come to an end due to the owner’s death or insolvency).
Secondly, expansion of the business after growing to a certain limit becomes difficult as since the proprietor cannot be a knowledgeable person or expert in every domain and therefore requires people to join in. However, knowledgeable and well-experienced employees (whose long term aim to share the benefits of ownerships) will not be interested in the business because of the structure in which it is laid out, sole proprietorship is self centered.
The third problem is related to the difficulties related to raising the capital amount required for the business by a single person. The owner should be a credible person if not it will hinder the flow of cash. Apart from this, the owner of the business has unlimited liability. In case the owner is not able to repay the debt his or her personal properties and money can also be confiscated.
Legal requirements for running a sole proprietorship business
Here are some of the few legal requirements one has to fulfill before beginning a sole proprietorship. There is no requirement for formal registration but certain tax registrations are required. Also, it is better to get a trade name for the business and then get it trademarked. To complete all this, the owner should go to a bank and obtain the forms for a proprietorship firm.
All the business activity can be carried out within the house or in a commercial place, in the second case, one has to follow the shop and establishment act. The provisions of the act will vary in each and every state within India.
Across states, the general rules will be like getting the business establishment registered along with the fee that is specified. Also, information such as manager’s name, category of the business and establishment name and address has to be provided.
Opening and closing hours are detailed out along with the norms relating to work and other activities. The owner of the business should possess PAN (Personal Account Number), as all the tax returns are filed under the owner’s name.
Businesses which have a total income of over 9 lakh are supposed to pay 10 percent service tax thus making it mandatory to hold PAN. If the function of the business is to buy and sell taxable goods in the state then VAT (Value Added Tax) should be registered. If the purchase and sale of taxable goods is across multiple states then CST (Central sales Tax) registration is required.
If the owner is interested in doing international trade then he or she needs to get importer and exporter code from the director of foreign trade. If the business has employees apart from the owner then it is necessary to pay professional tax. Again the rate of the tax varies across the states and some of them do not have it. However, professional taxes are generally very low. When 10 people are employees in a factory or 20 people are working in an establishment other than a factory, then a registration in accordance with the employee state insurance act, 1948.
Difference between a sole proprietorship & a one person company
The one person company model is common in many countries outside India but recently has gained prominence in Indi with the companies’ act 2013. One person companies (OPC) are a separate legal entity and differ quite a lot from sole proprietorship. In one person company there is a limitation for liability unlike sole proprietorship where the entire liability lies on the owner. The entire liability means it can be extended over to the individual properties of the owner. The benefits of OPC it is believed to attract more investments and they also need not conduct regular board meetings and general meetings. However, all the resolutions passed should be entered into the minute’s book and all the financial statements should be audited. In sole proprietorship the audit functions should be carried in accordance with the income tax act based on the turnover of the company. One of the biggest drawback of OPC is it has 30 percent base tax, dividend distribution tax of 15 percent and a minimum alternative of 18.5 percent.
The other issues with setting up a one person company are the initial amount time and paperwork which is very lengthy. Also expenses like hiring a lawyer and getting a company secretary to do required drafting work. However, it can be converted into a private limited company in the near future. This may sound as a huge advantage but at present this is a difficult task given that there are no clear rules and regulations to do so.
Anand Rajendran, CEO of Uptra.in, a leading provider of legal services, including company registration. He is the Head of Communications at Uptra Consultancy Services, India's largest online legal services facilitator and can also be reached at contact.uptra@gmail.com.
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