Article by Smrithi Shibichakravarthy.
As an entrepreneur, managing your business single-handedly means that your business could be considered either as a sole proprietorship or as a one-person company (OPC).
Though both of these terms sound alike and have major similarities there are also a few very important differences which you need to be aware of in order to take your business down the path you’re looking for. So, what’s so different, when it comes to a Sole Proprietorship vs One Person Company?
There are differences concerning entities, liabilities, taxation, and succession. Based on the type of business you’re running, and the business you one day want it to be, it’s important to understand these differences before declaring it as a sole proprietorship or OPC.
Through this article, you’ll be able to choose which one you want to go for in order to ultimately achieve your business goals.
What is a Sole Proprietorship?
To start with the basics, we need to understand the term ‘sole proprietorship’:
The Government of India defines a sole proprietorship as a “one-man organization where a single individual owns, manages, and controls the business.”
A sole proprietorship is the simplest business form in India, it’s basically run by a single person and there is no legal differentiation between the owner and the business.
The moment a person starts offering goods and services through a lawful business they will be considered as a sole proprietorship, there is no compulsory registration and hence there is a very minimum legal framework to go through.
Examples of sole proprietorships include freelancers, business consultants, and speakers, professional cleaners, landscapers, etc. They run their business on the basis of their personal reputation.
Four Considerations for Sole-Proprietorships:
- This enterprise is considered to be a single entity as there is no legal differentiation between the owner and his business.
- There is an unlimited liability that means the debts, profits, and losses of the business would be considered as the owners.
- The taxation is individual taxation because the income generated by the business is considered to be individual income. There is no need to file separate tax returns, the owner must only furnish the details of his business while filing his own individual tax returns.
- Succession depends upon the last testament or the will of the owner and the ownership is passed on to another individual, otherwise, the business dies with the death of the owner. It is also easy to wind-up the business by simply canceling any tax registrations.
In this type of enterprise, it is not necessary that the owner is working alone, they may employ other people, but it remains as a single entity.
The sole proprietorship allows the business owner to hire employees and also to enlist the services of independent consultants but their work towards managing the business would only be considered as a ‘recommendation’ because ultimately the liability falls upon the owner alone.
The partner of the owner can work in the business and there would not be a necessity for the business to register as a partnership.
The owner may choose to name their business as something other than their legal name which could either be a ‘DBA’ “doing business as” or a fictitious name – they will have to register with the local authorities to make sure that their business name does not clash with an already existing business entity. If they want to trademark their business, then they will have to go for Trademark Registration.
Since there is no one-specified registration for a sole proprietorship, the legal expenses to be concerned mainly include the registration for licenses, permits, and certificates that are required to sell the type of services or goods being offered by the business.
For example, Drug license, Certificate issued by the Institute of Chartered Accountants of India (CA certificate), Food Safety and Standards Authority of India (FSSAI) license, labor license, etc.
However, when a business owner wants to start a bank account in the name of their business, they would be insisted by the Bank to register their sole proprietorship. Through the registration of their sole proprietorship, they may also receive certain benefits.
Three Ways to Register a Sole Proprietorship in India:
- To register the business as a sole proprietorship under the Shop and Establishment Act by making an application to the local Municipal Corporation of the owner’s city.
- To register the business as a sole proprietorship through ‘Udyog Aadhaar’. The Ministry of MSME provides a unique identification number that allows the business to have a unique identity. The business would also be able to avail the various benefits given by schemes under the Ministry of MSME.
- To register the sole proprietorship through GST registration. GST registration allows the sole proprietorship to obtain a unique identity, it’s meant for the business that deals with the exchange of goods and services. It is useful for businesses that have a turnover of more than 20 lakhs as it is the most common way of getting an identity. It requires the business to collect tax from their customers and file GST returns as a part of mandatory compliance after registration, so it is not very favorable to businesses making less than 20 lakhs of turnover per year.
Banks may insist on registration of sole proprietorship, but it is not mandatory by law, each bank has their own procedure related to opening an account in the name of a sole proprietorship, but an account is an important part of being able to manage the finances of the business and to also prove the existence of the business entity.
Major Advantages of a Sole Proprietorship:
In our comparison on One Person Company vs Sole Proprietorship, the main reason, individuals go for a sole proprietorship are:
- Easy to start with less compliance
- Cost-efficient and time saving; can be started with less investment and no lengthy legal formalities
- Full control of the business, freedom to make self-decisions
- No need to share profits, 100 percent of profits for the owner
- Lesser income tax as there is no separate tax for a sole proprietorship.
- Financial statements and audit reports are not required to be made public through MCA (Ministry of Corporate Affairs) and they do not have to get their financial accounts audited every year, auditing is as per section 44 of Income Tax Act and is per the condition of meeting a turnover above a particular threshold.
- Easy to close up by canceling tax registrations
The disadvantages pertain to unlimited liability. It’s already discussed that a sole proprietorship is considered to be a single entity where the owner and the business are legally the same.
This gives rise to the unlimited liability of the owner with regard to their business meaning that the owner is responsible for all the profits and losses incurred and for any debts taken in the name of the business. It’s a sort of personal liability arising that puts the owner at risk and holds him liable to pay out of pocket if the business is suffering.
So, the risk involved is a major disadvantage and this means that a sole proprietorship is more convenient for a smaller business.
If you’re looking to grow your business on a large scale, dealing with huge amounts of money that you would not be able to pay out of your own pocket then a sole proprietorship is not for you.
There is also an issue of investors being hesitant to invest in sole proprietorships because the business is not considered as a separate legal entity so the unlimited liability arising is a turn off for them.
What Is a One Person Company (OPC)?
A One-Person Company (OPC) is defined under Section 2 (62) of the Companies Act, 2013 as “a company which has only one person as a member.”
It means that it is a company that has only one shareholder or one member and one director. Being that there is only one person in the company it seems very similar to the previously discussed Sole Proprietorship but there a few major and significant differences between them again regarding the entities, liabilities, taxation, and succession.
There are certain rules under the act for the formation of One Person Company such as:
- Section 12(3) of the Act states that only an Indian resident (natural-born citizen) can avail of ‘One Person Company’ benefit and the word ‘One person Company’ shall be a part of the name of the company.
- The memorandum of association of the OPC is supposed to indicate a nominee for succession in case of incapacity to contract or death of the owner.
- The paid-up capital of the OPC is not supposed to exceed 50 lakhs and the annual turnover cannot exceed 2 crores. If it exceeds these limits then it has to mandatorily convert itself into a private or public company. The conversion is done as per the rules and regulations laid down by the Companies Act, 2013 under Section 18, and Rule 7(4) of the Companies (Incorporation) Rules, 2014. If it exceeds these limits overtime period of commencement then it is given a period of six months for conversion.
- As per Rule 2.1(2), a person can incorporate a maximum of 5 OPCs.
The first country to introduce this concept of One Man Company in the United Kingdom in the case of Soloman V. Soloman & Co. (1897).
Other countries gradually began to adapt this concept with their own modifications, for example in the United States this type of enterprise comes under a Limited Liability Company (LLC) and in Singapore, their laws allow the formation of an OPC under the Companies Act, 2004.
The concept of OPC in India is still in its initial stages but it is predicted that OPC could be one of the most popular business models in the coming years.
Four Major Points of a One Person Company
- The company and the owner are considered legally separate entities. So the company is its own separate entity recognized by the law.
- There is limited liability. Since there are separate entities, the owner has only limited liability and is not held responsible for the profits, losses, and debts of the company. If he ever files for bankruptcy the assets of the company would be seized and not the assets of the business owner.
- An OPC is taxed under the Income Tax Act since it is registered as a private limited company so there is separate taxation. Unlike a sole proprietorship, an OPC is audited annually and hence it is more trusted by lenders and financial institutions.
- Succession takes place by transferring ownership of the company to a designated nominee in the event of the death of a managing member. The nominee must be a citizen and resident of India.
In our comparison on Sole Proprietorship vs One Person Company, the main reason to go for a One Person Company is to avoid the risk of Unlimited Liability and to have Limited Liability instead which essentially provides the company owner a safety from suffering major losses while dealing with huge amounts of money.
If they ever need to file for bankruptcy then their personal assets would not be seized and only the company assets would be. The limited liability serves as sort of a safety net.
This is the attraction towards going for a One Person Company, the business owner can grow their business onto a large scale without worrying about getting into huge personal losses however along with this limited liability there are conditions and requirements.
An OPC also has Certain Exemptions:
- As per Section 2(40) of the Companies Act, 2013 an OPC is not required to prepare a cash flow statement as a part of their financial statement.
- The proviso to section 92(1), the annual return can be signed by the director of the company if there happens to be no secretary.
- Section 96(1) states that an OPC is not required to hold an annual general meeting
In order to register an OPC, there is a more complex procedure than a sole proprietorship but overall it is still a pretty straight-forward process.
Here’s how you do it –
How to Register an OPC
- Applying for a Digital Signature Certificate (DSC) of the proposed Director which includes his identity proof (Aadhar card), address proof, PAN card, photo, email id, and phone number.
- Applying for a DIN number which is Director Identification Number. It can be applied using SPICe (Simplified Proforma for Incorporating Company) form.
- Name Approval by the MCA using RUN (Reserve Unique Name) web service for reserving unique names. Form SPICe 32 is used for this application.
- There is a list of Documents required as per the MCA website which include a Memorandum of Association (MoA) and Articles of Association (AoA) along with consent form of the nominee which is applied using Form INC-3, Form INC-9, and DIR-2 are used for affidavit and consent of the proposed Director, proof of the registered office of the company with proof of ownership and NOC from the owner and finally a declaration by the professional which certifies that all compliances have been made.
- These forms will be filed with the MCA as per their procedure.
- The Certificate of Incorporation will be issued by the Registrar of Companies (ROC) after verification, following which the company is ready to commence business.
The major advantages of One Person Company are as follows:
- Easy to start with less investment
- Less Compliance due to exemptions
- The company is recognized as a separate legal entity
- Limited liability protects the owner from risk
- Single shareholder, freedom to make decisions and reap benefits of the company’s share value
- Trusted by lenders and financial institutions as it is a separate legal entity
- It exists for a longer time compared to Sole Proprietorship.
The disadvantages of One Person Company are as follows:
- There has to be a nominee who is an Indian citizen and resident.
- There is a limitation on who can form an OPC, minors, anyone incapacitated to contract, foreign citizens, or Non-Residents, cannot form an OPC.
- There are conditions for the mandatory compliance of registered One Person Companies (OPCs):
- An OPC is forced to hold at least one board meeting in each half of the calendar year and the time gap between each of those meeting should not be less than 90 days.
- An OPC is also required to have proper maintenance of books and accounts because unlike a sole proprietorship they are expected to audit their financial statement annually through Form AOC-4 and ROC Annual Return in Form MGT 7.
- There is also a filing of business income tax every year before 30th September.
- Another disadvantage includes the flat tax rate of 30 percent which is pretty steep along with the tax provisions that apply to other companies such as MAT and Dividend Distribution Tax.
- After crossing a certain threshold OPCs are required to convert into public or private companies, these are paid up investment of 50 lakhs and an annual turnover of 2 crores.
- For Voluntary conversion, an OPC has to wait 2 years from the date of Incorporation before it converts itself into a public or private company.
A one-person company hence is suitable for you if you are looking for expanding your business with limited liability, starting off with a lower investment, and eventually scaling your business up to incorporation.
An example of incorporated companies that started out as One Person Company includes Karuna Technology Private limited and Myonlineca etc. One Person Company can include business in any sector and has a broad scope in India today.
There are plenty of success stories and yours could be next by making the right choice between a sole proprietorship and an OPC.
Wrapping it Up
We have gone in detail about Sole Proprietorship vs One Person Company, discussing their meanings along with the advantages and disadvantages of each of these business models essentially bringing out their significant differences in order to highlight the more suitable one for you.
The major point lies with the difference in liability, unlimited liability versus limited liability, and also the scope for expanding business in the long-run. Neither business model is superior to the other because they are catered towards particular businesses on different levels.
Hopefully, this article has helped you in deciding between a Sole Proprietorship and One Person Company, as to which one is the best for you. If you have any question, drop them in the comments and we’ll get back to you.