The idea of separate legal entities has been used for more than 500 years. It is simply a way of saying that the firm is distinct in its operations. One of the major benefits of incorporating an organisation is that it becomes a distinct legal entity, which means that it is considered an independent entity from its members that comprise the company.
Because of this distinction between the individual and company, the members' liability is reduced. As a legal entity, the company is entitled to the same rights and obligations as an individual:
- Be sued and sue under the name of the company.
- The assets of the company are distinct from the members of the company.
- Contracts can be entered into with their own rights.
- Have perpetual succession, and remain in existence until it is dissolved by an order issued by a court or liquidation.
Did You Know?
All legal entities can legally be accountable for activities that they do against the law, opt & pay back debts, take part in contracts or agreements, assume obligations or sue/be sued by other entities. However, a legal entity can’t hold a vote/office no matter whether such entities are able to do many things.
What Is a Company’s Separate Legal Entity?
Let’s start with understanding separate legal entity meaning. A separate legal entity separates a business from its owners, shareholders and other stakeholders. An LLC offers the same liability protection as a C-Corp as a separate legal entity.
Unlike a sole proprietorship, an LLC separates the owner from the business and protects them from personal liability. It can appoint other owners or hire staff to work for the business or operate it alone.
A separate legal entity should be treated differently from the owners of a business. This means that it should not be treated as an individual in accounting. An individual owner may treat an asset as his personal property and therefore treat the assets as his own.
But a company will be treated as a separate legal entity from its owners. It has a separate bank account, separate transactions and separate payroll. This means that the company should pay taxes separately from the owner.
In addition to tax advantages, a separate entity may help protect business owners. The separate entity concept protects business owners from financial liability by avoiding personal liability. It also presents a professional image to customers and the public. The separate entity concept is critical to business owners for tax purposes.
Separate Legal Entity Benefits
Now that you understand the meaning of a separate legal entity let’s head toward its benefits. A separate legal entity (SLE) is an organisation recognised by law and has its own rights and obligations, and SLEs include limited liability partnerships and corporations.
Its owners are considered shareholders, which makes it a distinct legal entity.
- An SLE has its own legal rights and obligations, such as a limited liability licence.
- As an individual or business owner, you may want to set up a separate entity for your business. This will help keep you and your business separate from one another and minimise liability.
- It also offers more formality in management and reduces the potential problems associated with commingling business and personal finances.
- Using your own name can also help protect you from unwanted lawsuits. For example, if your business is operating from an office, you'll need to pay the rent. Renting office space for your business means having to report the rent as income.
A separate legal entity also shields corporate shareholders from personal liability. This means that a judgement against a Corporation cannot affect your personal assets.
For example, imagine that Mr Harsh runs a small medical practice in Connaught Place, New Delhi. He's concerned about potential lawsuits stemming from medical malpractice. So, he decides to create a Corporation. A separate legal entity shields Steve Jones and his business from personal liability in a single stroke.
How Can Separate Legal Entities Partnerships Help You?
There are various kinds of partnerships. Also, the partnership's legal obligations are contingent on the sort of partnership that your business selects. Below are the various kinds of partnerships and the obligations they have:
- General partnerships: All partners share similar financial and legal responsibilities for the company. Written agreements could decide the amount of every partner's obligation.
- Limited Partnership: It Combines both limited and general liability partnerships. Each member is personally and legally responsible for the company and its debts. Some or all of the participants in the company are called silent partners, whose responsibility will be limited by the value of their stake in the venture. Most silent partners are not involved in the everyday activities of the company.
- Partnership with limited liability: Limits individual liability for each partner to ensure that in case one of the partners is deemed to be at fault in a legal proceeding, it will not impact the other members. It also lowers the risk of non-involved parties in any dispute.
Also, have a look at Company vs Partnership Firm vs LLP, to get a better understanding of the differences between them.
How Does a Separate Legal Entity of a Company Assist Business Owners?
Being a separate legal entity can have many benefits for small business owners.
- A separate legal entity allows you to have certain property rights and can sue or be sued. But a separate legal entity is not necessary for all types of businesses.
- It provides personal protection as the business has its own rights under the law. For instance, you are not personally liable for any debts or obligations incurred in running the business.
- Being a separate legal entity gives you more protection in court. A court case may arise from a breach of fiduciary duty, criminal misappropriation, or some other cause of action. Then, if you win, you may find yourself personally liable for the court action.
- The owners of corporations are only liable for debts related to their own interests. Therefore, creditors cannot take your personal assets as security if a company defaults on payments.
- The doctrine of separate legal entities protects shareholders and directors against liability for company debts.
- You pay taxes on only your profits as salaries, bonuses and dividends. Corporations pay corporate rate taxes on any additional profits. It helps business owners avoid paying taxes twice.
- You don't need a board of directors to run an LLC.
- Another benefit of being a separate legal entity is that you do not have to deal with annual filings, shareholder meetings and regular maintenance.
What Isn’t Considered a Separate Entity?
While it might appear like it, a legal entity isn't:
- A trademark: trademarks are property that belongs to an entity that is legal, whether an individual or a corporation or another legal entity.
- A brand or a trading name: These are basically aliases for a legal entity. As with trade names, however, the only real reference to a company in this instance is the suffix associated with the company's name.
- A domain name: A domain is registered under the name of a legal entity. The legal entity has the right to use it but is not its owner. The legal entity leases it from the domain name registry.
- A group of companies: Each company in the group is an entity legally recognised. Simply because some companies have parent and subsidiary companies don't mean they are all legal entities with a single existence. All of them are separate legal persons.
It all depends on what exactly is meant by the use of the word "business".
If you find an email that has a certain address, the domain may be used to identify an entity or legal person in the same group of companies.
It's a question of law that is decided based on the facts of the case, which legal entities are separate for whose behalf this email has been sent. Similar to letters and other communications.
Separate Legal Entity vs Limited Liability
Companies become separate legal entities and reserve their own rights compared to their members when incorporated under the separate legal entity law.
The company is unique and different from its members under the law. It owns its own name and a seal. Its obligations and assets are distinct and distinct from the members. It can own properties, acquire debt and borrow money, maintain an account in a bank, enter into contracts, hire individuals, sue and be legally sued separately.
On the other hand, in the case of limited liability, members who are part of the business are limited to contributions to the company's assets, up to the value of shares owned by them.
The company's members are liable to pay only the cash due on shares owned by them when they are asked to pay it and not pay anything more, regardless of whether the business's liabilities are much greater than its assets.
However, the partners in an association firm have unlimited liability. When the company's assets do not meet the requirements to pay the company's obligations, the creditors may compel the partners to cover the gap with their own assets.
This article explained What a separate legal entity is and its benefits. Besides that, it highlighted various ways to benefit the business owners. You got to know the difference between a Separate Legal Entity and a Limited Liability. Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.