By Luke Michael Valdez
AS mentioned in my earlier column, partnerships and corporations alike are registered with the Securities and Exchange Commission. For the registration costs, it will be relatively the same for both entities. In terms of costs to maintain your business structure, it is also relatively the same. So, fees aside, you also have to consider the time and effort you’ll put in as there is a lot of bureaucracy to go through not only in SEC but also in local government units.
One characteristic of a partnership is that in general, all partners have unlimited liability. In other words, if the partnership is unable to meet its obligations, its creditors can go after the personal assets of all of the partners. However, you can avoid this from happening by becoming a limited partner, a partner who has limited liability. You become a limited partner at the price of losing some partnership rights and the right to manage the partnership. General partners, on the other hand, enjoy multiple rights and the right to manage the partnership affairs but have unlimited liability. The principle “to whom much is given much is expected” applies in this case.
On the contrary, shareholders of a corporation enjoy limited liability. Only the amount put in by the shareholder can be sought out by its creditors. That sounds appealing but that isn’t always the case. Loan contracts from creditors may include clauses where they can apply payments of their loans through personal assets of shareholders. In addition to that, the courts can also make shareholders liable when it has been established that a corporation has been used for fraudulent and illegal acts. The corporate veil can be pierced when a corporation is used as a mere alter ego of a person or corporation to evade its obligations. So watch out for conditions that may make the limited liability characteristic of a shareholder invalid.
Notwithstanding nonprofit organizations, partnerships and corporations ordinarily exist to earn income. What you do (or can do) with that income largely varies depending on what business type you choose to register.
For partnerships, partners agree upon inception on an income distribution plan. They can agree on how much a partner gets on net profits, and how much a partner absorbs on net losses. This is particularly useful when you want to hold yourself and your partners accountable for their participation in the partnership. Income will be proportionately reflected in their capital balance, which makes it easier to keep track of how much the partnership owes a partner.
In corporations, shareholders only earn their due through dividends or selling of shares (if there is any share appreciation). All income accumulated throughout the years are kept in a retained earnings account and for that to be distributed as dividends, there are certain limitations that the corporation must abide. One limitation is that not all retained earnings can be given out as dividends as only unrestricted retained earnings can be distributed. Unrestricted retained earnings arise from deducting all restrictions placed on a corporation’s earnings because of funds set aside for future projects or legal requirements, such as those to assure creditors are paid. Conversely, you also have to take note to declare dividends to avoid being assessed of improperly accumulated retained earnings tax. The computation for dividends is also complex if you take into account different classes of shareholders and the different terms of paying dividends. Ultimately, it is also up to the board of directors to make a resolution to declare dividends just.
In general, partnerships are taxed just like corporations. They are subject to the same rules when it comes to determining taxes. Only general professional partnerships are different as the partners are taxed based on their individual capacities. Meaning, the share of the partner in the GPP net income is taxed under their own name. On the other hand, share of the profit of a partner in a regular partnership is subject to final withholding tax just like dividends paid to individual shareholders.
There is no clear-cut winner on what business type is better. It’s a combination of your purpose, appetite for risk, plans for harvesting your investment, tax implications as an individual, and desired management style. It is also a question of your plans in the future. Ask yourself how big do you see your business growing and ask if a certain type of business will help you achieve your vision now and still be appropriate in the future.
Luke Michael Valdez is a consulting associate of UpSmart Strategy Consulting Inc., a financial consultancy firm that specializes in strategic finance, structuring and restructuring of start-ups, social enterprises and SMEs.
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