In this blog post, Tusharika Bhattacharya, who is pursuing her Company Secretary Finals from Institute of Company Secretaries of India and is also pursuing a  Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the advantages and disadvantages of running a business as a sole proprietorship. 

For anyone who is keen on starting a business of their own, they must analyse and study the legal skeleton of the business they wish to choose before they start their own. Broadly, there are four types of legal structures: sole proprietorship, partnership, LLP or a company.  Each of these structures will have their own advantages and disadvantages. Thus, it is of utmost important to know the meaning of sole proprietorship, its advantages and disadvantages.

What is a sole proprietorship?

‘Sole’ means single whilst ‘proprietorship’ means ownership.  Sole proprietorship is the oldest, simplest and most common form of business   entity. In order to gain the benefits of tax, the owner and business are kept one and the same.  Sole proprietor is a business that is owned and controlled by one person; he possesses the entire authority and responsibility with respect to the business. He can hire employees and pay them salaries, but legal responsibility is on the sole proprietor. The main advantage of such an arrangement is that the owner gets all the profit. However, at the same time he is personally liable for all the debts. Sole proprietor is not a distinct business entity, rather the business and entity. For example, no separate tax returns are required to be filed by the business.

The sole proprietorship is useful and suitable under the following circumstances;

1. When the nature of business is simple.
2. When financial risk is less.
3. When there is no need to take huge debts
4. When the product’s market is small
5. When the capital is minimal
6. When the owner wants to have full control over decision making

 Procedure to form a sole proprietorship

Sole proprietorship is the easiest form of running a business because no separate registration is required in this case. The only thing you must take care of is that you need to ensure that you have the specific license to your line of business. In order to open a bank account for the sole proprietorship, RBI’s KYC norms mandate any of the following two documents:

1. Certificate / license issued by the municipal authorities
2. Sales and income tax returns
3. CST/VAT certificate
4. Registration/licensing document issued by the proprietary concern by the central government
5. Banks may also accept IEC issued to the proprietary concern by the office of DFGT
6. The complete income tax return in the name of sole proprietor where the firm’s income is reflected by income tax authorities.
7. Utility bills such as electricity, telephone bill in the name of proprietary concern

 Advantages of a sole proprietorship

1. The most important advantage of this business is that the business owner has absolute control; he can make decisions that are quick and be flexible with his policies.
2. The second important advantage is that profits flow directly to the proprietor’s personal tax; they cannot be made subject to another level of taxation which means that profits will not be taxed at the business level. Sole proprietor retains complete control over the finances of the business which gives a very strong incentive to work for the business.
3. The third advantage states that the business can be dissolved as informally as it was begun.
4. The fourth advantage states that the sole proprietor business maintains close relationship with both employees and customers.
5. The fifth advantage is that it can maintain business secrecy. In any form of business structure secrecy is of utmost importance and sole proprietorship makes it is very to maintain confidentiality.
6. Last but not the least, any person who want to set up a shop and begin dealing with customers can get it done without the intervention of the government, bureaucrats or lawyers.

Disadvantages of a sole proprietorship

1. In a sole proprietorship which is run by a single person, it is difficult to raise capital; lack of separation of the business from the proprietor hinders the flow of capital and thus expansion of business slows down. Loans from friends and family are generally taken in this case.
2. No perpetual succession, it exists only till the owner exists.
3. Lack of credibility.
4. It cannot add partners

 Suitable business under sole proprietorship

This form of business is suitable for the businesses which involve low risk, small financial resources, the capital requirement is small and the risk involvement is not heavy, like automobile repair shops, small bakery shops, tailoring shops, etc. It is most suitable for businesses like selling grocery items, stationery, furniture, garments telephone booths, making jewellery, haircutting, cycle or mobile repair shop.

One Person Company: A hybrid of sole proprietor and the corporation

The concept of a One Person Company was a very popular concept in U.S.A. The formation of a single member Limited Liability Corporation, China introduced One Person Company in 2005. According to Turkish Commercial Code since 2012, a joint stock company or limited liability company may be established with one or more shareholders. The code also sets forth certain obligations and conditions for such companies. In addition, limited liability companies and joint stock companies can have a board of directors that consists of only one board member. Single Member Companies Rules, 2003 of Pakistan provide for incorporation of single member company. In India, it got introduced through the new Companies Act, 2013 in Section 2(62).

One Person Company form of business has been provided with concessional /relaxed requirements under the Companies Act, 2013 which will be discussed. With the implementation of the Companies Act, 2013, a single national person can constitute a Company, under the One Person Company (OPC) concept.

The concept of One Person Company exists in many countries. United Kingdom is the first country which paved the way for the formation of a one man company through a precedent set in its famous case Saloman v. Saloman & Co. (1897) AC 22. Section 7 of the UK Companies Act, 2006 deals with the method of forming a company. It provides that – (1) A company is formed under this Act by one or more persons— (a) subscribing their names to a memorandum of association (see section 8), and (b) complying with the requirements of this Act as to registration (see sections 9 to 13). (2) A company may not be so formed for an unlawful purpose.

OPC in India and its impact

In the last few years, the increase in the use of information technology and computers and the emergence of the service sector has been tremendous, thus giving the entrepreneurs an opportunity of participating in the economic activity. Such economic activity may take place through the creation of an economic person. The committee thus recommended that law should recognise the formation of a single economic entity in the form of One Person Company. OPC in Indian entrepreneurship has revolutionised the way corporate world works, especially by fostering the micro businesses and entrepreneurship with its simple structure which can be registered with one member and one director. The OPC in India is still in its early stages and would require some more time to mature and be accepted in the business world. It is indeed a launch pad for such entrepreneurs to showcase their capabilities in the global arena. The One

Person Company definitely carries an advantage for small businessmen, traders and artisans since they can make use of it with less risk.

OPC v. Sole Proprietorship: the better option

The biggest disadvantage of One Person Company in comparison to sole proprietorship business is that of tax liability, an OPC is taxed at 30% on its net tax liability of the financial year. Sole proprietorship’s income gets clubbed into the individual’s income and then taxed in the hands of sole owner which means that in case of proprietorship business, income will be taxable based on the slab rates that are applicable to individual and tax deduction under different sections of income tax act will also be available. A person in lower tax bracket will be benefited by having a proprietorship business as compared to the 30% tax rate of One Person Company. Other benefits accruing to the sole proprietor is that it can get started without any registration which enables the sole proprietor to close down the business without much legal compliance. However, in the case of OPC, the sole owner has to follow legal procedures to get out of the business and close the business. The requirement of minimum paid up capital is Rs. 1000000 whereas, in sole proprietorship business, such requirement is not there. The formalities of board meeting, general meeting, audits and other compliance will be increased for One Person Company in comparison to sole proprietorship business. The cost of books of accounts will be increased and more work will be required for these compliances in case of a One Person Company because of which registration fees also increases.

For anyone who wants to run a small business, it is still more viable to run a sole proprietor but if anyone is aiming for long term solution with more credibility and is ready to take on the legal compliance requirements and cost, than they can start an OPC.