Establishing Business in India

1. Sole Proprietorship​

A form of business wherein one person owns all the assets of the business. No legal formalities are required to create a sole proprietorship other than appropriate licensing to conduct a business and registration of a business name if it differs from that sole proprietorship. The owner reports income/loss from this business and his personal income in the tax return.

2. Partnership Firm

The Indian Partnership Act, 1932 govern partnership firms in India. Partnership firms are created by drafting a partnership deed among the partners, and the partnership deed may or may not be registered to make a firm.

3. Limited Liability Partnership (LLP)

LLP is an alternative corporate business entity that provides the benefits of limited liability of a company but allows its members the flexibility of organising their internal management based on a mutually-arrived agreement, as is the case in a partnership firm introduced in India by way of Limited Liability Partnership Act, 2008.

4. One-Person Company (OPC)

An OPC means a company with only one person as a member. The shareholder can make only one nominee who shall become a shareholder in case of death/incapacity of the original stakeholder.

5. Private Company

A Private Company is a company which has the following characteristics:

  • Shareholders' right to transfer shares is restricted.

  • A minimum number of 2 members in the company.

  • Number of shareholders is limited to 200.

  • An invitation to the public to subscribe to any shares or debentures or any type of security is prohibited.

6. Public Company

A public company is a company which has the following characteristics:

  • Shareholders' right to transfer shares is not restricted.

  • Minimum 7 members.

  • An invitation to the public to subscribe to any shares or debentures or any type of security is permitted.

1. Nature of Business Activity

This is an important factor that directly affects the choice of ownership. In small trading businesses, professions, and rendering of personal services, a sole proprietorship is predominant.

The partnership firm is suitable in all those cases where sole proprietorship is suitable, provided the business is to be carried on a slightly bigger scale with the help of one or more partners (owner).

Where the persons intending to start a business wish to launch a business organisation clothed with a legal entity and in corporate form with a feature of having their sole ownership and control thereon, they may decide to form a One-Person Company (OPC).

LLP is generally suitable in the service industry and where there is no dependence on large amounts of financing from outside sources.

A One-Person Company (OPC), LLP, and limited company exist as separate business entities in the eyes of the law, and this creates a wall between the personal assets of the investor and that of the business. In these business organisations, the personal property of the owner(s) is protected, which gives the owner(s) the ability to build the business credit, get loans and raise capital.

2. Scale of Operations

If the scale of operations of business activities is small, a sole proprietorship or One Person Company (OPC) is suitable.

If the scale of operations is modest - neither too small nor too large – a partnership or limited liability partnership (LLP) is preferable. In the case of large-scale operations, the company form is advantageous.

The scale of business operations depends upon the size of the market area served, which in turn depends upon the size of demand for goods and services. If the market area is small and local - sole-proprietorship, OPC, or partnership, may be opted. If the demand originates from a large area- partnerships, including LLP or Company, may be adopted.

3. Capital Requirements

Capital is one of the most crucial factors affecting the choice of a particular form of ownership organisation. The requirement of capital is closely related to the type of business and scale of operations.

Enterprises requiring heavy investment should be organised as companies. Depending on the capital required, they can be set up as public companies and, in some cases, maybe in the form of listed companies by raising money from the public and being listed on the stock exchanges.

Enterprises requiring small investments can be best organised as sole proprietorships or partnerships. Apart from the initial capital requirement to start a business, the future capital requirements - to meet modernisation, expansion, and diversification plans - also affect the choice of form of organisation.

4. Managerial Ability

It is difficult for a sole proprietor to have expertise in all functional areas of business. In other forms of organisations like partnerships and companies, there is a division of work among the partners, which allows the partners to specialise in specific areas, leading to better outputs and decision-making.

However, this may sometimes lead to conflicts due to differences of opinion. Forming a company is a better alternative if the operations are far-flung, complex, and require professional management at various levels.

5. Degree of Control and Management

The degree of control and management that an entrepreneur desires to have over business affects the choice of form of organisation.

In sole proprietorship and OPC, ownership, management, and control are completely fused. Therefore, an entrepreneur has complete control over his business.

In a partnership, management, and control of the business are jointly shared by the partners and their specific rights, duties, and responsibilities would be documented through incorporating various clauses in this regard in the partnership deed. They have an equal voice in the management of partnership business except where they agree to divide the business responsibilities differently among themselves. Even then, they are legally accountable to each other.

In a company, there is a divergence between ownership and management. The management and control of the company business are entrusted to the Board, who are generally the elected representatives of shareholders.

In a nutshell, a person wishing to have complete and direct control of business prefers a proprietary organisation rather than a partnership or company. If they are prepared to share it with others, he/she will choose a partnership. On the other hand, if the activities are large, professional managers are required to handle the day-to-day affairs, and there is a need for corporate structure and management, he will prefer the company form of organisation.

6. Degree of Risk and Liability

The size of the risk and the willingness of owners to bear it is an essential consideration in selecting a business organisation. The amount of risk involved in a business depends, among other factors like nature and size of the business.

The smaller the size of the business, the smaller the amount of risk. In a nutshell, a sole proprietary business carries a small amount of risk with it as compared to a partnership or company. However, the sole proprietor is personally liable for all the debts of the business to the extent of his entire property.

7. Stability of Business

The owners prefer a stable business in so far as it helps them attract suppliers of capital who look for the safety of investment and regular return and also helps in getting competent workers and managers who look for the security of service and opportunities for advancement.

From this point of view, sole proprietorships are not stable, although the law places no time limit on them. The owner's illness may derange the business, and his death can permanently close the business operations.

Partnerships are also unstable since they are terminated by death, insolvency, insanity, retirement, admission, expulsion, or withdrawal of/ by one of the partners.

Companies and LLPs have the most business stability due to their feature or perpetuity being an artificial or legal person. The life of the company and LLP is not dependent upon the life of its members/partners. Members/partners may come, members/partners may go, but the company/LLP goes on forever unless and until it is wound up.

8. Flexibility of Administration

The form of organisation chosen should allow flexibility in administration. The flexibility of administration is closely related to the internal organisation of a business, i.e. how organisational activities are structured into departments, sections, and units with a clear definition of authority and responsibility.

The internal functioning of a sole proprietary business is very simple. Therefore, any change in its administration can be affected with the least inconvenience and loss. To a large extent, the case is the same in a partnership business also.

In the case of a company, the administration is not that flexible because its activities are conducted on a large scale and are quite rigidly structured. Thus, any substantial change in the existing line of business activity is in this form of structure.

From a flexibility point of view, sole proprietorship has a distinct edge over other forms.

9. Division of Profit

Profit is the guiding force of private business, and it has a tremendous influence on the selection of a particular form of business organisation. An entrepreneur desiring to pocket all the profits of the business will naturally prefer sole proprietorship.

In a sole proprietorship, personal liability is also unlimited. However, forming a partnership firm would be preferred if a person is willing to share the profits.

In a company, the profits (whenever the Board of Directors decides) are distributed among shareholders in proportion to their shareholding, but the liability of the shareholders is limited. The percentage at which the dividend is to be distributed is decided by the Board though approved by the shareholders. Companies may also reward shareholders by the issue of bonus shares. In the case of listed companies, the equity shares are tradable on the stock exchanges, enabling the shareholders to exit the company at any time at their discretion.

10. Costs, Procedure, and Government Regulation

Different forms of organisation involve different procedures for the establishment and are governed by different laws that affect an establishment's immediate and long-term functioning.

From this point of view, sole proprietorships are the easiest and cheapest to start. There is no specific government regulation but it is guided by various state and central laws to give valid proof of existence, for instance, the Shops and Establishment Act. The owner's technical competence, business acumen, and the requirement of meeting tax liabilities are necessary.

Partnerships are also quite simple to be initiated. A written document is not always necessarily a prerequisite since an oral agreement can be equally effective. However, a written partnership deed is usually entered into in actual practice, as it is needed for the firm's registration and tax authorities. The procedure for the dissolution of the partnership is relatively simple.

Forming a company as a business organisation is more complicated. It can be created by law, dissolved by law, and operated under the express provisions of the law. In forming a company, several legal formalities must be gone through, which entails substantial expenditure. Further, various formalities must be complied with to close companies. Non-payment of dues may land the company into insolvency or liquidation.

11. Tax Implication

In the choice of the form of business organisation, tax implication plays an essential factor.

In smaller entities such as sole proprietorships or partnership firms, the tax liability depends on the extent of profits. However, the liability of the owner(s) is unlimited.

In the case of companies or LLPs, the liability of shareholders is limited to the value of the shares they have purchased. In the case of companies or LLPs, tax liability could be higher.

12. Geographical Mobility

The extent to which the product or service is proposed to be manufactured or made available also plays a vital role in choosing the type of business organisation.

If a concern deals with the local market, a seasonal product, or perishable goods or is meant to cater to a specific city or locality, then a sole proprietorship or partnership form of business may be suitable.

If it is proposed to market the product or service all over India (which may also entail providing customer support services), a company form of organisation may be preferred.

13. Transferability of Ownership

A sole proprietorship, being a one-person entity, does not lend itself to the transferability of ownership as the owner enjoys the profits and suffers the losses in his business.

A partnership form of organisation is one where two or more partners share the profits and/or losses in the agreed proportion. If a partner exits, the partnership, may decide to induct a new partner with benefits of ownership and share of profits or losses.

In the company form of organisation, transfer of ownership is possible by transfer of shareholding by any person or group of persons in favour of another person or group of persons.

14. Managerial Needs

Managerial and administrative requirements also affect the decision about the form of organisation. When the concern is small and caters to local needs, only one person will be enough to manage the business.

A sole proprietorship form of organisation will be suitable for such a business. If the business caters to more areas, more people will be needed to look after various business functions.

When a business is run on a large scale basis, it will require the services of specialists to manage various departments. The company form of organisation will be suitable for such concerns.

15. Secrecy

Secrecy is of supreme importance, particularly in small business concerns. The entrepreneur would select the sole proprietorship for that reason. In case he has partners, he will have to carefully determine whether other partners will be able to maintain the secrecy. He will have to exercise great care in taking partners.

In the case of a company, secrecy may be restricted to the manufacturing process or how business is conducted. However, certain aspects of their business, such as their Board of directors, shareholding, financial statements, and other information which are statutorily required to be placed in the public domain, are accessible to any person.

16. Independence

The company is subject to strict government regulations. If the entrepreneur wants freedom in business with little governmental interference, he/she has to go for either sole proprietorship or partnership.

To comply with the Income-tax law, a person needs to obtain a Permanent Account Number (PAN). The Permanent Account Number (PAN) is a ten-digit alphanumeric number, issued for the purpose of identification of a taxpayer in the form of a laminated card. PAN has to be mentioned in all communications with the Income-tax Dept. and in specified financial transactions which exceed the threshold limit. Aadhaar can also be used in place of PAN with effect from September 1, 2019.

How to apply for a PAN?

A resident person can apply for PAN in Form No. 49A and a foreign citizen can apply in Form No. 49AA.

A person files SPICe Form (INC-32) to incorporate a company. By filling out this form, the applicant can also apply for an allotment of PAN. The company incorporation process has been changed with effect from 23-02-2020, wherein PAN shall be allotted through Part B of the SPICe+ form which is an integrated Web Form.

Further, a person who files Form FiLLiP to incorporate a Limited Liability Partnership (LLP) can apply for allotment of PAN through the same form.

Any person, who has not been allotted a PAN but possesses an Aadhaar, may apply for allotment of PAN by intimating his Aadhaar number. He shall not be required to apply or submit any documents for allotment of PAN. The Government has enabled functionality on the e-filing portal i.e. Income Tax Portal, Government of India instant E-PAN page to instantly obtain a PAN on the basis of the applicant's Aadhaar.

Compliances under Income-tax law –

There are various compliances which a business entity needs to be fulfilled. These compliances are categorised as monthly compliances, quarterly compliances, and yearly compliances. Apart from the following compliances, there are some other compliances also available which are event-based and applicable when some conditions are satisfied by such business organisation. If a taxpayer has not followed these compliances then he will face penal provisions like interest, late fees, penalties, and prosecutions under various sections.

(a) Monthly Compliances – The following are the monthly compliances that should be followed by a business organisation to comply with the Income-tax law:

  • Payment of TDS and TCS if tax is deducted or collected by such business entity.

  • Furnishing of challan-cum-statement where tax has been deducted under section 194-IA, 194-IB, 194M, or 194S (by a specified person)

  • Issue of TDS certificate where tax has been deducted under section 194-IA, 194-IB, 194M, or 194S (by a specified person)

(b) Quarterly Compliances - The following are the quarterly compliances that should be followed by a business organisation to comply with the Income-tax law:

  • Payment of advance tax

  • Furnishing of TDS/TCS returns where tax has been deducted/collected by the business organisation

  • Furnishing of TDS certificate in respect of tax deducted from payment other than salary and return has been submitted

  • Furnishing of TCS certificate in respect of tax collected and the return has been submitted

(c) Yearly Compliances - The following are the yearly compliances that should be followed by a business organisation to comply with the Income-tax law:

  • Furnishing of TDS certificate to employees in respect of salary paid and tax deducted during the previous year

  • Furnishing of return of income including revision and updated return

  • Furnishing of audit report under Section 44AB

  • Furnishing of transfer pricing report where assessee entering into international or specified domestic transactions under Section 92E