IMAGINE: YOU INC.
In Hong Kong, a 1-person director is allowed for corporations. The same goes in other jurisdictions. These have been observed for decades now.
In the Philippines, setting up a corporation requires at least 5 individuals who will stand as shareholders and eventually directors. The same number will compromise the Board of Directors, until the corporation closes business.
It is impractical.
An entrepreneur often finds it difficult to look for four (4) other individuals who will be the other shareholders and directors. This results in many businesses not pushing through and foreign investors looking elsewhere to do business due to this limitation.
For the undanted, they end up setting up a business often as a sole proprietorship, with a few percentage using a partnership model.
On a rough estimate, and if memory serves me right, a Goverment statistics once indicated that around 70% of businesses are registered as sole proprietorships.
This is dangerous. Sole proprietorships have no separate personality from the sole proprietor or the business owner. Meaning, a sole proprietorship which has a Php1 Milliom declared capital and incurs a Php3 Million liability, the Php2 Million may be collected from the sole proprietor’s personal assets, i.e. cash, bank accounts, cars, jewelry, houses, and so on.
Thus, it has been over 5 years since a law was lobbied to allow 1-person corporations in the Philippines.
Now we have one.
What does this mean for entrepreneurs?
This means that they can avoid the sole proprietorship trap and instead avail of the following benefits of a Corporation:
- Limited liability
- Separate Tax Identification Number
- More tax deductions
- Formal structure
Let’s discuss each one.
1. Limited Liability of a Corporation
A corporation is a juridical (synonym: artificial) person.
Meaning, insofar as the law is concerned, a corporation is a person similar to a human being. (The obvious difference being is that a corporation does not breathe.)
As a person, it has almost the same rights as an individual when making transactions or doing business. Thus, a corporation can enter into contracts in its name as it has its own personality, separate and distinct from its shareholders.
When a corporation incurs liability, its own assets and properties will be used to pay off its debts. If all of its assets and properties have been used and there are still liabilities, the unpaid debts cannot be collected from the shareholders who have fully paid their subscription.
This is the limited liability benefit of a corporation.
Otherwise stated, if a corporation has Php5 Million worth of assets and properties and it incurs liability of Php8 Million, then only Php5 Million will be paid resulting in the Php3 Million balance written off as a bad debt by the creditors, as such balance cannot be collected from the shareholders who have fully paid their subscription.
Compared to a sole proprietorship and general partners in a partnership, they are fully liable for the entire liabilities of their business, regardless of how much capital is disclosed or registered with the Government.
Exceptions to limited liability:
- Shareholders with unpaid subscription
By now, you would have noticed that we have twice qualified the shareholders in the discussion (i.e. those who have fully paid their subscription). Meaning, the other group of shareholders are those who have not fully paid their subscription.
If a shareholder is subscribed to Php1 Million worth of shares and only Php800,000.00 has been paid, the shareholder may be held liable to pay for the Php200,000.00 balance as such amount is considered an asset or property of the corporation, although a collectible.
Once fully paid, the shareholder will be re-classified with the first group of shareholders who have fully paid their subscription.
- Corporate veil is pierced
If a corporation is being used by a person for fraud and other unlawful means, the law allows for piercing the veil (or shield) that is separating the personality of the individual and corporation. Both of them will be considered as one person resulting in the individual personally liable for the entire liability.
In our example, the Php3 Million balance may be collected from said individual-shareholder even if the corporation’s assets and properties are worth Php5 Million only and the said shareholder has fully paid his subscription.
2. Separate Tax Identification Number
A corporation is issued a separate Tax Identification Number (TIN) since the law recognizes it as a person, i.e. an artificial/juridical person.
This is important since tax compliance will be separate for the corporation and its shareholders. Any tax compliance of a corporation is its own and not of the shareholders.
The significance of having a separate TIN is highlighted when it comes to closing a business. It is a long and arduous process to close a business. For sole proprietorships, this has an impact as their TIN cannot be transferred until the business is completely closed. Meaning, a sole proprietor who closed a business in Cebu City and then finds gainful employment at Manila City will be unable to transfer his/her TIN.
3. More tax deductions
A corporation enjoys more tax deductions compared to an individual and/or a sole proprietorship.
These come in business deductions, which are costs and expenses used in the ordinary course of business. Tjese include rent, utilities,vendors, among others.
4. Formal structure
A corporation has a more formal structure. Observe:
- Board of Directors
- Corporate Officers
The structure makes the business more organized and formal.
While sole proprietorships and partnerships have their own structures as well, a corporation has more levels which can provide more flexibility.
In summary, with the new law, a person can easily set-up and enjoy the benefits of a corporation. In turn, this will spur the growth of business, creation of jobs, and develooment of the local and national economy.