Partnership vs Private Limited Company Tax Point of View
Every business setup must deal with a challenge to identify the most beneficial business entity registration type. There are several options but two of the most common considerations are Partnership Firm and Private limited company. To analyze the key distinctions and potential benefits based on the business type, it is worthy to analyze a few factors to make a wise decision. These factors can be listed as follows:-
The Partnership firm is registered under the 1932 Indian Partnership Act. There can be registered or unregistered partnerships. Both are considered as legal entities. However, it is suggested to opt for registered partnership.
On the other hand, the Private Ltd Company should be registered under the Companies Act, 2013. There is no option to set up a registered or unregistered and all the Private Ltd companies should comply with the Companies Act of 2013.
• Members and taxation entity
A partnership must have a minimum of 2 partners to form a legal business entity. The maximum limit is capped to 50 partners. The partnership entity acts as a flow-through entity. It does not have a separate entity presence unlike a private ltd company.
The private limited company also has similar obligations. The minimum number of partners is the same (2) but the maximum ceiling is slightly higher to 200 partners. It is not a flow-through entity and the income is taxed at the entity level and the profits are then distributed to the partners.
• Liability terms
The liability ideally of a private limited company is limited to the unpaid value of shares owned or held by the shareholder/investor. On the other hand, the partnership firm since it is not a legal entity on its own, partners may be fully liable for any losses/debts or any other expenses incurred due to the functioning of the partnership.
Partnership Firm Compliance is slightly simpler compared to the private limited company as there is no creation of a new legal entity. There is no special requirement of the statutory audit unless and until a threshold of 50L is breached. The Partnership firm as such does not have to file any return and only partners should report the income so acquired from the partnership in their individual tax returns. Therefore, Partnership Firm Compliance is considered favorable.
Pvt Ltd Company Compliance, on the other hand, is quite cumbersome. A tax auditor must be hired within a month of incorporation. It has an annual filing requirement and must also comply with various other rules under the Companies Act, 2013 to operate smoother.
• Ownership and Existence
The Partnership owners can be modified, but it is a slightly more tedious process as the partnership agreement needs to be amended and the partnership deed clause must be updated as well. Similarly, the Partnership firm does not accommodate foreign partners, unlike the Pvt Ltd Companies. Also, the Pvt Ltd company can rest be assured of long term existence with minimum inconvenience even with death or exit of founders/managers or executives. These are a few benefits of the offsets for cumbersome Pvt Ltd Company Compliance.
The most important factor deciding the business entity setup is taxation. The corporate tax rate is about 25% for Pvt Ltd Companies. The income which is passed through in the form of dividends may be taxable for the shareholders or investors. This creates double taxation. This isn’t favorable by any means especially if the company is looking to distribute profits to its shareholders.
On the other hand, the partnership firm acts as a flow-through. This means the income generated from the partnership will essentially flow in the business income section and the rates can be 5%, or 10% or 15% or 20% or 25% or 30% depending on the tax slab the partner is in. Unless and until the partner is hitting the 30% slab without partnership income inclusion, opting for a partnership is more beneficial if it is expected to distribute income soon.
With efficient Partnership Firm Compliance or Pvt Ltd Company Compliance and planning, both the business entity types can be made favorable.