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5 mistakes entrepreneurs should not commit

Entrepreneurs, especially those starting their first venture, are usually preoccupies with issues such as product development, business development, and marketing and promoting their new enterprise.

November 26, 2012 / 01:11 PM IST

Alok Patnia


Entrepreneurs, especially those starting their first venture, are usually preoccupies with issues such as product development, business development, and marketing and promoting their new enterprise. But here’s the sober truth: There are legal and taxation compliances that must be taken care of or you risk serious penalties that could jeopardise the viability of your business itself.


Some entrepreneurs assume that because their businesses are small, these issues can be taken care of later. I read somewhere that around 60 per cent of entrepreneurs fail in their first venture, although I am not sure how much of this can be attributed to lack of planning for legal and taxation compliances. Instead of pondering this any further, I have just one bit of advice: Why not learn from the mistakes of others, without the pain and suffering of committing one yourself? To help you along the way, here are some common pitfalls you can avoid.


Mistake No 1: Choosing The Wrong Entity


Entrepreneurs often wonder whether to register themselves as a Limited Liability Partnership (LLP) or Private Limited Company (Company). The law of absolute advantage does not apply here as each option has its pros and cons. The choice depends purely on the nature of your business. Here are some pointers.


Founder Vision: An LLP offers the flexibility of a general partnership and suits small-scale concerns that cover a specific area. A Company, on the other hand, has creditability and instils confidence in investors, stakeholders and partners due to stringent compliances under the laws that govern it.


Incorporating Cost and Procedures: Incorporating an LLP is cost-effective and requires fewer legal compliances compared to a private limited company. A Company requires a minimum paid-up capital of Rs lakh whereas there is no specified limit for an LLP. Also, unlike a Company, compliances such as holding of statutory meetings and quarterly board meetings are not required of an LLP.


Taxation: The common flat rate for both an LLP and a Company is 30 per cent plus EC and SHEC. However, a Company is liable to surcharge while there is none for an LLP, which is liable to Alternate Minimum Tax. Companies are already liable to pay Alternate Minimum Tax on the adjusted total income (ie on book profit). Companies are also required to pay advance tax in four quarterly instalments whereas LLPs are required to pay it in three instalments.


An LLP is tax-efficient as Dividend Distribution Tax (DDT) is not applicable while a Company is liable to pay DDT @ 16.609 per cent (ie inclusive of surcharge and education cess) on such dividends. A Company is required to get its accounts audited annually whereas for an LLP, only those whose turnover is more than Rs 40 lakh or a Rs 25 lakh contribution in any financial year are required to get their accounts audited annually.


Mistake No 2: Not keeping records of transactions


To get initial leads and pressed by heavy promotional expenses and set-up costs, most start-ups fail to record their transactions, which is stapling bills and invoices to back financial statements.


At the time of incorporation, a Company pays registration fees, name-approval fees, stamp duty, etc to the Registrar of Companies. Further, the promoters of the Company also hire a professional firm to guide them through the entire incorporation procedure which, once again, involves a cash outflow. These expenditures, though pre-incorporation in nature, provide tax-saving benefits to the Company, to the extent of one-fifth of such expenses every year.


Further, invoices carrying break-ups of VAT and Service Tax are a boon, as far as claiming credit for VAT or service tax is concerned. The Company should keep a record of all expenses made specifically for business purposes, since these are deductible against business revenues. Even if the Company runs into losses, it is advisable to maintaining records to raise the losses and offset them with future profits.
 
Mistake No 3: Not filing returns in the initial years of losses


It is an incorrect notion that a start-up needs to be filed only when the start-up makes a profit. It is quite possible that the break-even period runs into two financial years. It is mandatory to file tax returns to claim and carry forward genuine business losses so that they can be offset by future profits.


Mistake No 4: Not filing ROC returns due to losses


Since every Company and LLP is governed by the Ministry of Corporate Affairs, filing of returns with the Registrar of Companies (ROC) is mandatory for an incorporated business. This is because the business is accountable to investors and stakeholders. Thus, under the Companies Act, a statutory audit is compulsory and applicable to all Companies. Even if the Company is non-operating, dormant or running into huge losses, ROC filings and Statutory Audit still apply.


Mistake No 5: Mixing of personal finance with company funds


To raise initial funding for a start-up, the founders, directors and promoters usually contribute all the cash they can to take care of preliminary expenses, promotional expenses, licences etc. Further, in the start-up phase, when the company does not earn revenue, the promoters may shoulder these expenses from their personal finances. When revenue starts coming in, the promoters withdraw money in the form of repayment of loans. Interest on capital, drawings, remuneration to directors, etc are issues that require separate treatment of funds.


A start-up should make sure that all expenses, regardless of whether or not they are sourced from personal finances, are accounted for. It is important to identify and segregate expenses as this will determine their accounting and tax treatment.
 
Alok Patnia is the founder of Taxmantra.com, an online provider of individual taxation, business incorporation and maintenance services

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