Should freelancers start One Person Company? Here are the pros and cons

The owner of a one-person company has limited liability, but has to go through more paperwork

A 2018 study by PayPal revealed that one in four freelancers is from India. According to the global freelancing and crowdsourcing marketplace Freelancer.com, India is among the countries where gig economy is on the rise rapidly. People working outside regular employment can operate as freelancers or they can set up a One Person Company (OPC).  
 

A freelancer is also referred to as sole proprietor. Says Balwant Jain, chartered accountant and CFP: “When you work as a freelancer, you run a business where you are the sole owner, hence the legal term ‘sole proprietor’ applies to you. In a sole proprietorship, there is no distinction between the business entity and its owner.”
 

A new concept was introduced in the Company’s Act 2013 called OPC. Says Ashok Shah, partner, N. A. Shah Associates LLP: “The Companies Act 2013 has introduced the concept of OPC, providing an alternative to the proprietorship model of business. Earlier, a private company could be incorporated with minimum two members. It had a lot of compliance requirements. OPC can be incorporated with only a single member.”

Registration: Formal registration is not a pre-requisite for sole proprietorship or freelancing. For OPC it is a must to be registered with the Registrar of Companies (RoC). 

Liability: A sole proprietorship has unlimited liability, which means that if the business incurs losses the assets of not only the company, but also of the owner may be used to pay off debt. On the other hand, an OPC is a separate legal entity, which means the owner has limited liability if the business suffers a loss. Says Rakesh Dharawat, partner, Dhruva Advisors: “A key benefit of an OPC is that the company’s liability does not extend personally to the shareholder.”

Tax: A freelancer’s income is that of the individual, who is also the owner, and he is taxed accordingly. Says Dharawat: “An OPC would, typically, be subject to tax at the rate of 30 per cent (excluding surcharge and cess). Further, upon distribution of profits by the OPC to its individual shareholder, the former would be subject to dividend distribution tax (DDT) at 20.56 per cent. A freelancer or sole proprietor, on the other hand, will be taxed on the profits of the business according to the applicable slab rates (maximum rate would be 30 per cent, excluding surcharge and cess). There is no further tax for withdrawal of money from his business.” From a tax perspective, OPC is not a beneficial form. Says Shah: “Sole proprietorship is taxed as an individual, wherein all exemptions are available, and it does not pay tax if income is below the basic exemption limit. However, the person has to keep separate accounts of the business.”

Succession: In a sole proprietorship, succession happens according to the provisions of the owner’s will. Says Shah: “OPC provides the benefit of perpetual succession.” Here, a nominee designated by the individual shareholder becomes a member of the company and becomes responsible for running it. 

Cost and compliance: From the cost and compliance point of view, freelancing is a better option. In an OPC, there is a cost of formation, cost of running, as well as compliances. Says Dharawat: “In an OPC, you would need to factor in several administrative and tax costs, for instance, getting accounts audited compulsorily, applicability of minimum alternate tax (MAT) provisions (if claiming income tax exemptions), and so on.” As a freelancer you only need to file the annual returns.

Creditworthiness: Here too there is a difference in how the two entities are viewed. Says Hrushikesh Mehta, country director and managing director, Clearscore India: “While giving loan to an OPC, reports are pulled from the consumer as well as business bureaus, to determine previous repayment behaviour. Both have an impact on creditworthiness.” 

Loans: This is by far the key advantage of an OPC. If you are a freelancer, getting a business loan is more difficult unless you meet certain conditions. Says P P Narayanan, president–MSME & transaction banking, Lakshmi Vilas Bank: “A freelancer who is a professional or self-employed can avail a loan under the MSME business segment under services category if he satisfies the investment in equipment criteria defined for micro, small and medium enterprises. For a micro enterprise investment in equipment is up to Rs 10 lakh and the loan type and quantum would be assessed according to business requirement.”   
 

The other options include funding the business using collateral such as securities, property, personal loan, and in case of an interesting start-up, crowdfunding. Adds Narayanan: “In the normal course, an OPC will be eligible for a business loan based on its cash flows and supported by collateral security/Credit Guarantee Fund Trust for Micro and Small Enterprises(CGTMSE ) guarantee. Only in exceptional cases where an entity does not fit into a bank’s policy guidelines are business loans denied.”

Closing the business: A freelancer can re-join the workforce almost immediately, while for an OPC a process has to be followed, known as Strike Off or Company Closure, according to Section 248 of the Companies Act 2013. The owner has to fill the requisite forms as required by the RoC. The entire process takes four to six months.
 

Both freelancing and OPC have their pros and cons, which you should weigh carefully. If you are looking for perpetual succession of your business, limited liability, or intending to build operational transparency to raise funds in the future, OPC is a good alternative. If you do not mind the added cost and compliances, go for OPC, or else choose the freelancing route where you get greater freedom from compliances.