Wednesday, June 23, 2010

Homestay Basics: Should I form a company for my homestay?

076/365  I am accountant...Image by Venn Diagram via Flickr

Today's article relates to a basic query that most owners of Holiday Homes and Homestays have. This is even more relevant as quite a few may not be business people or experienced with legal matters. I'm writing this to give a quick overview and to outline the various options. This is my advice as an experienced business person. However, I am not a Chartered Accountant or a lawyer and you may want to take legal advice before you make your decision.

Essentially, there are three main structures that you could follow as any business:-
1. Running it in your personal name
2. A Proprietorship Firm
3. A Partnership Firm
4. A Pvt. Ltd. Company

When choosing a structure you need to keep in mind the following:-
1. Personal Tax Planning: This is the implication of the business income on your personal income tax. Some of the factors that may be important to look at are whether you have borrowed money to buy the property in your personal name and so are able to take a larger tax deduction of the interest payments based on how you classify the property. Also, where you fall in the tax slabs if you were to declare an income from this business Vs. only taking dividends (on which tax has already been paid by the company) Another key consideration here would be if you are already salaried and if your employment contract forbids you from being an employee elsewhere- if so, your only way of income generation could be dividends. If you are not salaried, you could put yourself on the payroll of the homestay.
2. Ease of doing business / Cost of compliance: For many home owners this is a key consideration. Let us face it- doing business in India is sometimes very painful and involves a lot of paperwork. Here starting a business as a proprietorship firm or a partnership firm is much much faster and running the business on an ongoing basis is much cheaper as compared to a Pvt. Ltd. company. A Pvt. Ltd. company will need to have an auditor and a company secretary and maintain board minutes, conduct a yearly audit and submit various returns and the cost of doing these things may not be justified unless you are generating significant income.
3. Protection against any liabilities and litigation. This is an important aspect I would like to dwell on. Luckily we live in India and litigation here is rare - it is not common for a guest to sue you. However for the wise this is an important aspect to consider. Here doing business in your individual name, as a proprietorship firm or a partnership firm are all risky as the partners, proprietor is responsible for the liabilities of the firm. As such, if someone were to sue you for something that went wrong when they stayed in your homestay or holiday home, the judge could ask you to pay damages from your personal funds or by liquidating your assets. The only structure which offers protection here is a Pvt. Ltd. Company (recently india has also allowed Limited Liability Partnerships) - In a Pvt. Ltd. company you put money into the company in two forms - either as share capital or else as a loan from a shareholder. However, the law says that your liability is limited (or capped) at the amount you have put in as share capital. To explain further, if you have put in 1L Rupees into the company and over time the company has done well and has got now 5L as value of total assets and liquid cash, in case you get sued, if you need to compensate the customer upto 5L then the company can pay it from its own assets and if the compensation is greater than 5L, the law cannot ask you as a shareholder to pay the extra amount from your own funds or ask you to liquidate other assets you own (like your car, other properties etc.) In a partnership firm or Proprietorship firm, there is no distinction between your assets and that of the company and all liabilities have to be met by you.
4. Tax planning for the business. This is one of the important aspects that every business person must consider. An important word of advice I got from a very senior person was "Remember, individuals pay tax on their total income while companies pay tax only on their profit. " This is something every homestay owner should keep in mind. What this means is that as a homestay you are running a business and there will be expenses related to the same - these could be in the form of capital expenditures - e.g. new furniture, cutlery, linen or new construction. or else it could be Operating Expenses - .e.g salaries of the caretaker, electricity bill, water bill, commission payments to travel agencies etc. By running the business in your individual name you will lose the ability to claim various expenditures. As such, it is best to follow a corporate structure and at the minimum in my opinion a partnership model.
5. Ability to raise further capital if the business needs more money. This is another important aspect. For those who have larger ambitions, there may be a need to acquire larger plots of land, build bigger homestays and in such a situation get additional capital from external sources. This may be in the form of a financial partner or it could be a bank or Tourism fund. In such cases, you will need to choose a Pvt. Ltd. company so as to be able to issue them shares and to provide them comfort in the running of the company.

Each owner who wants to start making money from their holiday home/ homestay needs to evaluate each of the points above and reach a decision after taking professional advice. My generic advice considering the state of most owners in India would be to use at the minimum a partnership structure. I personally prefer using a Pvt. Ltd. company for the protection it offers though it is a more expensive structure to maintain. Trust this article was useful and I invite you to send me any queries you may have and I will try and answer them to the best of my ability.
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