Introduction

Choosing the type of business structure for your new small business is a crucial decision, with both legal and tax implications. Tax implications may not always be obvious, and many business owners don’t realize they can save a lot of money by choosing the right company structure. Each business type has a different income tax classification, financial reporting requirements, and regulatory compliance. This article will give you an overview of what options are available and how to choose between them.

The structure of a business refers to the legal form a business will assume for the purposes of operating. It informs what the statutory, financial, tax, and other responsibilities of the business will be. It is one of the key decisions to be made when starting a business. The choice of structure usually depends on the size of a business, type of business, industry requirements, personal preferences, etc. A business is allowed to change its business structure to meet changing circumstances.

Unfortunately, from experience, a lot of entrepreneurs do not give much thought to the business structure. This can have significant repercussions for a business eventually.

By the end of this article, readers should be able to answer the following frequently asked Google questions:

• How do I decide what business structure to use?

• What are the business structures in Nigeria?

• What are the most common types of business structure?

• Which business organization is suitable in Nigeria and why?

Legal characteristics of a business in Nigeria

Before we get into business structures, it’s important to note that a legal business should have the following characteristics:

1. The business is registered with the Corporate Affairs Commission-Compulsory.

2. The business has a Tax Identification Number (TIN)-Compulsory

3. The size or scale of activities is consistent with other businesses in the industry.

4. Have a separate business bank account.

5. Have the required licenses or qualifications.

6. Keep business records and account books.

7. Operating from business premises.

If your business does not have any of the above characteristics (especially the first two), it may be classified as a hobby, and there may be some legal and tax consequences if one continues carrying out business-like activities without registering as a business.

The types of business structures and their financial implications

In terms of finance, the business structure determines responsibilities as a business owner, potential personal liability, asset protection, operational costs, regulatory obligations, tax liabilities, and so on. The structure is everything.

In Nigeria, the law recognizes businesses in three major categories: business names, incorporated companies, and incorporated trustees, all of which have financial and accounting implications.

1.    Business Names

The main characteristic of businesses registered under business names is that they are not separate entities. They are an extension of the owners. The owners are personally responsible for the losses and liabilities of the business.

Check the availability of a business name as a trademark, business name, and domain name (website address) before deciding on one. If the name has already been registered as a trademark in Nigeria by someone else, it is best to choose a different name in a class relevant to your business. If the name is registered as a trademark in relevant classes, it may give that name exclusive rights in those classes. Only registering as a business name, company name, or domain name does not provide the same level of exclusivity.

There are two main types of business names:

1. Sole Proprietorship

2. Partnership

Sole Proprietorship

A sole proprietorship is the simplest form of business structure and is easy and inexpensive to set up. A sole proprietor is legally responsible for all aspects of the business. They make all the decisions about starting and running the business and employment. It is the most preferred option for entrepreneurs that are just starting out or individuals who have a side business to complement their normal paid jobs.

Finance implications of a sole proprietorship structure:

• Simple to set up and operate – Lower startup costs

• Retains complete control of assets and business decisions- Easier to identify the owner’s contributions

• Fewer reporting requirements- Cheaper accounting and financial reporting costs

• Losses incurred by the proprietor’s business activities may be offset against other income for tax purposes- Reduced tax liability for the owner based on global income in event of losses.

• A sole proprietor is not considered an employee of their business and therefore is not expected to directly pay payroll tax on income drawn from the business- Only one tax computation for the owner

• Easy to change the business structure if the business grows – Simple financial reporting structure

• Easy to wind up – Simple financial reporting structure

• If the assets of the business are insufficient to cover the liabilities of the business, the proprietor’s personal assets are at risk – Business assets and liabilities are computed as part of the Owner’s net worth

• A sole proprietor is personally liable to pay tax on the income from the business- Overall Business incomes belong solely to the owner

A sole proprietorship business will need to register a business name with the Corporate Affairs Commission. The CAC will assign a business name registration number.

Sole proprietors are taxed as individuals and pay income tax at personal rates, i.e. business profits are not directly taxed. The TIN for the business must be obtained from the tax authorities.

A sole proprietorship’s financial statements are not required to be prepared in accordance with International Financial Reporting Standards (IFRS), but they must follow Generally Accepted Accounting Principles to ensure the reliability of the financial reports.

Partnership

A partnership is a group of two to fifty people who go into business together with the goal of making a profit. In simple terms, a partnership is a sole proprietorship with multiple owners. A general partnership is the most common type of partnership formed by small business owners, in which all partners participate in the day-to-day management of the business, though this is not always the case.

A partnership can be formed by any group of people, but it is most common among professional firms that need to spread professional liability risks, such as accounting firms, law firms, and so on.

** It is also important to note that there are several types of partnerships, including one that is more like a corporation.

Finance implications of Partnership structure:

• Simple to set up. – Lower startup costs

• Minimal reporting requirements- Cheaper accounting and financial reporting costs

• Shared control and management with other partners – Accounting for each partner’s contributions and withdrawals.

• A partner’s share of the business losses may be offset against other personal income, subject to certain conditions- Reduced tax liability for the owner based on global income in event of losses.

• Easy to dissolve the partnership – Simple financial reporting structure

• Partners are not employees. Employee costs are not compulsory for partners. – Only one tax computation for the partner

• Easier to obtain finance as the partnership is not relying on one person’s income or assets-Accounting for each partner’s contributions and withdrawals.

• A partnership is not a separate legal entity. Partners are personally liable for the debts incurred by the partnership, meaning there is no asset protection – Partner’s share of business assets and liabilities are computed as part of the Partner’s net worth

• Potential for disputes over profit sharing, administrative control, and business direction- Accounting for each partner’s contributions and withdrawals.

Before entering into a partnership, it is best to have a formal agreement outlining:

• each partner’s role and level of authority.

• each partner’s financial contribution.

• a procedure for resolving disputes.

• a procedure for ending or resigning from the partnership.

It is important to have a formal agreement because personal liability is unlimited for each partner. Each partner will be held liable for any shortfall if the business fails, and a partner cannot afford to pay their share of any debts. All partners are also jointly liable for any liabilities that one or more partners incur on behalf of the business, with or without the knowledge of the other partner(s).

If there is no agreement in place, each partner is deemed to own equal shares of each asset. A formal partnership agreement is an important tax document if profits and losses are not distributed equally amongst the partners.

Partnership accounting follows the same principles as sole proprietorship accounting, but there are special considerations to account for each partner’s capital account.

A partnership does not pay tax on its income. Instead, each partner pays tax on the portion of net partnership income that they receive. The TIN for the business must be obtained from the tax authorities.

2. Company

A company is a separate legal entity and can incur debt, sue, and be sued. The company’s shareholders (the owners) can limit their personal liability and are not responsible for company debts. A company is a complex business structure and has high set-up and reporting costs. You can form a company as either a private or public company.

A registered company must have at least two directors, one of whom must be the company secretary (one director for a small business). A director is responsible for managing the company’s business activities.

To become a company, an entity must be incorporated under the Companies and Allied Matters Act 2020 with the Corporate Affairs Commission.

Shares of public companies are registered with the Securities and Exchange Commission and the Nigerian Stock Exchange.

With private companies, the founders are legally permitted to be both shareholders and directors, which makes it appealing to entrepreneurs who want to protect their personal assets while maintaining creative control over their businesses. In practice, it is common to see companies run as if they were business names.

A registered company:

• is a separate legal entity distinct from its members (i.e. shareholders) and directors

• remains in existence until deregistered

• has the same powers as individuals

• is entitled to privileges (e.g. a corporate tax rate, limited liability)

• can hold property, enter contracts, sue and be sued, and

• has money and assets that must be used for the company’s purpose.

Finance implications of Company structure:

• Limited liability for shareholders- Business assets and liabilities are NOT computed as part of the Owner’s net worth

• Well understood and accepted structure – Simple financial reporting requirements derived from the incorporation documents of the company

• Able to raise significant capital – By having separate assets and liabilities, a company can generate money on its own recognizance and capacity.

• Can carry forward losses indefinitely to offset future profits – Losses are not transferred to the owners in their personal capacity. This can help with tax breaks.

• Easy to sell and pass on ownership – Accounting for owners’ contribution is simpler

• Profits can be reinvested in the company or paid to the shareholders as dividends – Company income is not added directly as part of owners’ income at the end of the reporting period excepted dividend is paid. A dividend is subject to withholding tax.

• Significant set-up and maintenance costs – Higher startup costs

• Do not retain complete control – The founders of most companies with diverse shareholders tend to lose creative control of their companies

• Complex reporting requirements – Higher accounting and financial reporting costs

The tax requirements for a company are different to those of other business structures. A company pays income tax on profits at the defined company tax rate. The TIN for the business must be obtained from the tax authorities.

Company officers and directors have legal obligations that specify how they perform their duties and manage the company’s affairs. These obligations are outlined in the Companies and Allied Matters Act 2020.

Financial Statements for Companies are prepared under the International Financial Reporting Standards (IFRS) framework administered by the Financial Reporting Council, and they are expected to be audited by a licensed Chartered Accountant. Depending on the size of turnover of the company and a few other factors, a Company may be permitted to use IFRS for SMEs.

3. Incorporated Trustees

A trust is a structure where a trustee carries out the business on behalf of the trust’s members. Incorporated Trustees are non-profit making organisations formed to facilitate the acquisition of corporate personality by a community of persons bound together by custom, religion, nationality, or any association of person established for religious, educational, literary, scientific, social developments, sporting, or charitable purpose. This is where you find Co-operative societies, Clubs, Churches, NGOs, and the likes. These organizations take on legal personalities upon incorporation, which is vested only on the incorporated trustees and not on all the members.

A trust acting on behalf of a group of people can own shares in Companies.

Finance implications of Trustee structure:

• Inexpensive to register – Lower startup costs

• Members have an equal vote at general meetings regardless of their level of investment or involvement – Easy to account for owners’ contributions

• Other than trustees, members can be aged under 18 years. These members cannot stand for office and do not have voting rights- Easy to account for owners’ contributions

Trustees carry all the risk from a legal perspective.

There is usually limited distribution of profits to members and some co-operatives may prohibit the distribution of any surplus.

Specific rules (forming a contract) must be developed to register an organization requiring a trust.

Taxwise, an Incorporated trusteeship is still expected to register for TIN. Although it is exempted from taxes to the extent of which profits are derived from its original charter. For example, if a Church deals in Vatable products, it is mandated to remit VAT to the tax authorities despite the Church profits not being assessable to tax.

Accounting wise, the principles of accounting typically remain the same as the other business structures but with a difference in nomenclature for most of the terms.

Conclusion

I hope the article has given you some useful, important tidbits of information. In a nutshell, as a new business owner, you should always consider the financial implications of your business structure. This will allow you to make key financial decisions within each structure that can either minimize or optimize your tax burdens. This can aid you in choosing the business structure that is best suited for your goals with your company.

While there are many, many factors to consider before you choose a business structure, in the end, it could be the difference between reaching your goals and falling flat on your face. With so much involved — from startup costs to profits –, every entrepreneur needs to take this major decision seriously or risk significant financial losses. Keeping these considerations in mind helps reduce that risk and will help turn your business dreams into reality.

It is highly recommended that business owners consult experienced business advisors like myCFOng before choosing the best structure for their business. It will help with profitability and sustainability.