TYPE OF BUSINESS STRUCTURES
When setting up a business, deciding which form of business medium to use is an important decision, with each different structure having its advantages and disadvantages, depending upon what the owner of the business is trying to achieve, and bearing in mind that each different business structure has specific legal and taxation implications.
Broadly speaking, the different types of business structures available include:
- Sole Proprietorships
- Partnerships
- Companies
Sole Proprietorship
A sole proprietorship is the simplest form of business, where an individual owns all of the assets of the business in his/her personal capacity. It is not considered a separate legal entity from its owner and therefore will cease to exist upon the death or incapacity of the owner.
In Sri Lanka, any individual can set up a sole proprietorship without any minimum capital requirement to be satisfied. It is straightforward and cost-effective, only requiring registration at the Divisional Secretariat or the Registrar of Businesses of the relevant Provincial Council that the individual falls within the purview of. The discretion on whether or not to seek registration lies entirely with the inidividual.
A significant disadvantage of this type of business is that the owner is held personally liable for debts and obligations of the business where in the event of distress the personal assets of the owner will be at risk.
Partnerships
Partnerships are governed by the Partnership Act 1890, and is defined as ‘the relation which subsists between persons carrying on a business in common with a view of profit’.
Similar to a sole proprietorship, partnerships have minimal set up formalities and costs. Though formal registration is not a legal requirement, it is recommended that the partnership is registered at the Divisional Secretariat or the Registrar of Businesses of the relevant Provincial Council for legal recognition and taxation purposes.
The parties forming a partnership have the choice of entering into a partnership agreement to set out the conditions governing the relationship of the partners including decision making, management, sharing of profits and continuity of the partnership (upon death of a partner), etc. A partnership is taxed separately in addition to the profits distributed by the partnership to its partners which will be subject to income tax.
Similar to a sole proprietorship, a key disadvantage is that the partners will be held personally liable for debts and obligations of the business. Furthermore, lack of continuity unless devolution has been expressly dealt with in a partnership agreement is an added disadvantage.
To speak of its advantages, a partnership can be formed relatively quickly without many formalities compared to a company and the operations of its businesses can be managed in a flexible manner.
Companies
A Company is a legal entity distinct from its owners and may be established only by filing certain documents with the Department of the Registrar of Companies. The main legislation governing companies is the Companies Act No.7 of 2007.
As opposed to a sole proprietorship and partnership, companies have a separate and distinct legal personality, separate from its owners (i.e. shareholders), and therefore have limited exposure of its shareholders assets in repayment of the company’s debts.
Taking into consideration the requirements, companies can be set up as private, public or companies limited by Guarantee. Forming a company requires registration with the Registrar of Companies and adherence to statutory requirements, such as appointing directors, filing annual returns and maintenance of corporate records. Private companies must have at least one shareholder, while public companies must meet additional requirements for shareholding and public disclosures.
Companies in Sri Lanka are taxed as separate legal entities and must pay corporate income tax on their profits. Additionally, dividends distributed to shareholders are taxed at a personal level based on the income tax rate applicable to the individual.
Conclusion
The choice of legal structure in Sri Lanka depends on the nature of the business, desired protection from personal liability, tax exposure and long-term goals. Understanding these differences can help entrepreneurs and potential business owners, both local and international, to make informed decisions that align with their business objectives.