As part of our business basics series, this article studies the concept of a Private Limited Company. It will details how to make and run a Private Limited Company, and the compliances involved. As well as, situations in which one should avoid creating a Pvt Ltd Company. If you’re a budding entrepreneur or a seasoned business looking to convert to a Pvt Ltd Company, this article will be helpful for all.
What is a Private Limited Company?
It is a business entity formed under the Companies Act, 2013. A Private Limited business is a company that is privately held and formed with laws and regulations, where the shareholders have limited liability and restrictions on the ownership. The liability of members of Pvt Ltd firms is restricted to the number of shares they hold. Private Limited company shares cannot be traded publicly in the stock market.
The Private stands for the company being privately owned. Limited means that the liability of shareholders in this firm is limited as the company is seen as a separate legal entity. The Company part means that this firm is regulated under the Companies Act of India and is governed by the Ministry of Corporate Affairs (MCA).
What does limited liability mean?
When a shareholder is part of a Private Limited Company then his liability towards the business, be it in terms of losses/profits/debts, all become limited. The shareholder’s liability is equal to his shareholding capital. No more or no less. However, this is in major difference from Proprietorship and Partnership Firm, where the shareholders have full liability in the businesses. Hence, their assets can be sold off to pay for debts or losses in the business. But this cannot happen in Pvt Ltd.
Difference between Private Limited Company and LLP
For example, A and B are two people who want to start a Pvt Ltd firm. They each invest Rs 10 lakh into it but hire two other people for executing the business idea. In an LLP both A and B will have to contribute capital as well as labour themselves. However, in Pvt Ltd, A and B can hire other people and give them remuneration for labour while A and B get shareholder profits in the business.
Hence, there is a major difference between ownership and management for Pvt Ltd and LLP. In LLP the owner and management have to be the same. However, in LLP the owner and management can be different individuals.
Who can create a Private Limited Company?
To create a Private Limited Company, there should be a minimum of 2 shareholders and 2 directors. When a Pvt Ltd Company is formed, then its shares are issued in the stock market to raise capital. People who purchase the shares of the company become shareholders of the company. They in turn enjoy the growth and profit of the company. Directors can be hired externally to manage and run the company. The directors will get a salary or remuneration from the company.
Moreover, some of these shareholders might also be the directors in the company and be involved in its management. Although it is not necessary that the directors and shareholders have to be the same people, it may sometimes happen so. Therefore, a minimum of 2 people is definitely required to create a Pvt Ltd Company who can be both shareholders and directors.
A foreign resident may become a shareholder in as Indian Pvt Ltd subject to the FDI policy of India. Similarly, a foreign resident may also become a director in an Indian Pvt Ltd provided there is at least one director who is an Indian in the company.
How to create a Private Limited Company?
It is recommended to take the professional help of a CA or CS in the process of creating a Pvt Ltd. The steps for creating a Pvt Ltd are as follows:
- One has to firstly apply for a Digital Signature Certificate (DSC).
- Secondly, one has to apply for a Director Identification Number (DIN) for all the directors joining the firm.
- Thirdly, one has to apply for the name of the Private Limited Company. One can only use names approved by the Registrar of the company from the MCA. It is not possible to get names that are already registered by other businesses. Additionally, the suffix os Private Limited is added to the name to distinguish it. Up to six name options can be given to the MCA for approval.
- Next, the Memorandum of Association (EMoa) and Article of Association (EAOA) will be drafted which will be document the shareholders of the company, the directors and how the company will be run and governed. Both documents will be uploaded on the MCA website. These documents are basically the company’s partnership deed.
- Next, one has to apply for the Company Identification Number (CIN) on the MCA website. Along with CIN, the PAN, TAN, GST, PF, ESI of the company will get simultaneously generated.
After the above steps are completed, it may take 2-6 weeks for the company name approval to arrive. Then the company incorporation certificate and CIN will arrive. Using the above documents, one needs to open a current bank account for the company and then they can start their business.
Important terms for Private Limited
Face Value: The initial value of each share of the company.
Authorized Share: The total shares of the company which will be up for purchase.
Authorized capital: The total face value of all the authorized shares. Thus,
authorized capital = face value X authorized shares. Authorized capital is the maximum share value that can be given to shareholders. However, it is not necessary to distribute all the authorized capital at one go.
Issued Share: The number of shares which are reserved by the owners of the company for themselves.
Paid Up Capital: The total value paid by the owners for the issued share in the Pvt Ltd company.
Unissued Share: Shares which are unissued to anybody but are authorized shares. It is always a good practice to keep some unissued shares for purchase later, else one will need to take approval from the government for issuing new shares if all the authorized shares have been already sold.
Unissued Capital: Total face value of the unissued shares.
Premium Value: After a period of time has passed, some of the unissued shares can be sold to an investor at a higher price than its initial face value. This is called a premium.
How to manage a Private Limited?
A Pvt Ltd Company is run by its Board of Directors. In the beginning, there are at least two directors. As new investors join the company, more directors are hired, thus making a board of directors. This board of directors hold an Annual General Meeting (AGM) and any emergency meetings as necessary and take overall decisions on the running of the company. Directors are responsible for the day to day management of the company as well as liable for any issues that arise related to the company.
On the other hand, the shareholder of the Private Limited Company has the power to appoint the board of directors and set their terms and conditions of working in the firm. Moreover, the shareholders cannot receive any kind of salary or remuneration from the company. They can only receive dividends from the company or sell the shares that they hold of the company.
Income tax payment
Although the standard 30% tax rate is applicable for Pvt Ltd companies, there are different slab rates for Pvt Ltd companies depending on some conditions as follows:
- If the company’s turnover is up to Rs 400 crore, then a Pvt Ltd Company needs to pay 25% tax rate.
- If the Pvt Ltd Company is newly established and into the manufacturing sector, then it needs to pay 15% tax rate.
- However, if it’s an old Pvt Ltd Company that may or may not be into the manufacturing business, then it needs to pay 22% tax rate.
The Pvt Ltd Company shareholders also pay tax on dividend received.
- Private Limited Company has to file their GST returns.
- They have to maintain all labour laws such as PF and ESI.
- There are several MCA norms and compliances which they have to mandatorily follow as it is a highly regulated entity.
- All legal documents of Pvt Ltd Company have to be uploaded on the MCA website which is accessible for viewing by anyone by submitting a nominal fee.
- It is mandatory for a Pvt Ltd Company to file income tax returns.
- Moreover, if the company’s turnover is more than Rs 500 crore, then it will require a tax audit.
- A statutory audit as per the Companies Act is also mandatory.
- If the company falls under the 25%-30% tax rate bracket, then it needs to check its Minimum Alternate Tax (MAT) tax liability. Either MAT or normal tax, whichever is higher, will be finally payable.
OPC and Public Limited Company
Similar to Pvt Ltd Company, there are OPC and Public Limited Company. Where Pvt Limited needs two directors and two shareholders, OPC needs only one individual who can be both.
Meanwhile, Public Limited Company will just have “Limited” mentioned after their name. In terms of shareholders, Pvt Ltd needs two while Public Ltd needs a minimum of seven shareholders. The number of directors though remains the same.
Pvt Ltd shareholder cannot exchange his shareholding. Generally, Pvt Ltd firms restrict the transfer of shareholding in their Article of Association. This prevents any of the shareholders from transferring their shares to third party and leave the company. To leave the company, the shareholder will have to file a Right of Preemption and ask current shareholders if they want to purchase his stake. If current shareholder will not purchase it then only can it be given to a third party for purchase. Thus, Pvt Ltd firms have a stricter control over the company than Public Ltd.
When to create a Pvt Ltd Company?
Create a Private Limited Company if:
- The business is a risky venture
- Business will incur debts
- The liabilities will be high
- There will be high chances of loss
- External capital or funding will have to be raised
- Once the valuation of the company increases, then you want to sell it out
Do not create a Private Limited Company if
- The business is profitable from the start
- There is low-risk involvement
- There will be organic growth and no external funding
- No debts or loans incurred
- There will be no liabilities involved
- No valuation angle is involved
Watch complete information on Private Limited Company in the video below.
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