One of the key decisions a person must make when starting a business is choosing what form of business organization to use. The choice is crucial as the type of business structure affects the business’s ability to raise capital, its tax liabilities, and protection from potential law suits. In the Philippines, there are three basic forms of business organizations - these are the sole proprietorships, the partnerships, and the corporations. Each form has its own advantages and disadvantages, and there are various factors to consider in deciding which form to use.
Sole Proprietorship
A sole proprietorship is the primitive form of business to start because its formation does not require any form of legal document. An individual personally conducts business with his own capital and he is solely responsible for its success or failure. Income from a sole proprietorship forms part of the gross income of the individual proprietor. Thus, it is subject to graduated income tax rates of 0% to 35% or the individual proprietor may avail of the 8% tax rate based on gross sales or receipts subject to certain conditions provided under Philippine tax laws, rules, and regulations.
Legally, the business and the owner are the same and the business has no personality separate and distinct from the proprietor. As such, a sole proprietorship provides no liability protection in that the proprietor is personally liable for the debts of the business, placing his or her personal assets at risk.
Partnerships
In a partnership, two (2) or more persons bind themselves to contribute money, property, or industry to a common fund with the intention of dividing the profits among themselves. Partnership relation is fundamentally contractual as it is created by mere agreement of the parties. Registration with the Securities and Exchange Commission (SEC) is necessary when the capital of the partnership is P3,000.00 or more. However, registration with the SEC is not necessary for a partnership to acquire juridical personality.
With this type of structure, a business can raise more capital by taking on partners and investors. Partnerships whose income is derived from trade or business are considered as "corporations" under the Tax Code. As such, the partnership itself is subject to 30% corporate income tax and the partner's distributive share is subject to a separate final tax as provided in the Tax Code. However, a General Professional Partnership (GPP), or a partnership formed solely for the exercise of a common profession, is not a taxable entity. But the distributive share of a partner in a GPP forms part of his gross income subject to graduated income tax rates of 0% to 35%.
A partnership has a juridical personality distinct and separate from that of the partners. Even so, a partnership still provides no liability protection because the debts and obligations of the partnership are, in substance, also the debts and obligations of each partner. This puts the partner’s personal assets at risk. The individual liability of the partners, however, is merely subsidiary because the partners become liable for partnership debts only after all the partnership assets have been exhausted.
Corporations
A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence. Unlike sole proprietorship and partnership which have minimal formalities, forming a corporation is complex and costs more because it requires filing of articles of incorporation and other incorporation documents with the State. It must also adhere to certain formalities required by law. With the effectivity of the Revised Corporation Code (R.A. 11232), there is no more requirement of at least five incorporators to form a corporation. The new law permits less than five incorporators to form a corporation. Even a single person may now form a corporation called One Person Corporation (OPC).
The corporate structure also has the ability to raise more capital by selling shares of stocks to investors. However, these investors or shareholders have no hand in the management of corporate affairs as opposed to a partnership, where a partner generally has a right in the conduct and management of the partnership business except when otherwise provided in the partnership agreement. A domestic corporation is subject to 30% corporate income tax, and the cash and property dividends received by its shareholders are also subject to a separate final tax.
A corporation is also a juridical entity separate and distinct from its shareholders. One of the main advantages of a corporate structure is its ability to provide liability protection because shareholders are liable for corporate debts only to the extent of their investment as represented by the shares subscribed by them. The personal assets of shareholders are not subject to the liabilities of the corporation.
Each of the basic forms of business organizations has distinct advantages and disadvantages in terms of creation, liability protection, legal and tax consequences. Business owners, or those intending to do business, must decide which one to choose according to benefits that are the most important to them and which risks they are willing to assume.
The foregoing article is for general informational and educational purposes only. It should not be treated and is not to be considered as legal advice or opinion. The views expressed in this article are those only of the author.
Jasmine Clarissa C. Palma is an Associate at Cokaliong Menchavez & Senining-Judilla Law Offices (CMS LAW), Cebu.
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