Introduction

Businesses all over the world need to have some form of a structure not only for the concerned state and government authorities monitoring the activities of its citizens but more importantly for the benefit and protection of the business owners and investors themselves.

Business owners and investors need to formalize their engagement into this kind of an activity by somehow putting their agreements in writing. This would create a semblance of order, clarity, ease and specificity in managing the annual and even the daily aspect of their operations. For the concerned government authorities and regulators, a formal and registered business enterprise is a way of monitoring the business activities just to make sure that business owners are paying the required taxes and following diligently the civil and corporate laws of the land and that nobody is taken advantage of. All in all, this would avoid the legal complexities that might arise if business owners and investors will do the otherwise.

Business Structures (Strengths and Weaknesses)

Under the general category of business, there are four possible business structures business owners and investors may choose. These are Single Proprietorship, Limited Liability Companies (LLC), Corporations and Partnerships. The topic for this paper is about corporations but the discussion would be incomplete without discussing first the other three business structure and the role of taxes in them.

All business owners’ main objective is to recover their initial investments in the soonest time possible plus earning a little bit of extra on the side, called profits. These profits are taken by the owners or are taken back into the operation as additional capitalization. Governments on the other hand protect this interest by providing a social and economic atmosphere conducive to business and for everybody concerned. With this set-up, the government collects taxes from these businesses to provide the government the means to continue doing its role in the social contract.[1]

All countries around the world impose taxes on its citizens whether persons or corporations and this are enshrined in their own constitutions. An example would be the US Constitution, under Article 1(Legislative Branch), Section 8 (Powers of Congress) which states that, “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises,…”(The United States Constitution 2009).

In the United Kingdom, there are several Acts of Parliament which were recently passed specifically as regards taxation: Income Tax Act 2007, Finance Act 2003, Income and Corporation Taxes Act 1988 among others (Income Tax 2007).

Taxes are therefore an integral part of what specific business structure to choose. People cannot escape from it but instead must learn to live within it. And the four mentioned business structures provide tax advantages depending on the need of the business being organized.

For people who are just starting their business and are expecting losses for the early part of the operation, the Single Proprietorship form is advisable. Single proprietorship can also be called S corporation where the identity of the business owner cannot be separated from the business or company. Therefore if the business incurred debts, the personal properties of the owner could be taken too if the assets of the company is not enough to pay for all the debts. When it comes to paying taxes, one advantage of single proprietorship is that owners are not subject to double taxation. Double taxation happens when the company and the owners are taxed separately. In single proprietorship only the salary of the employee/owner is subject to employment tax, whatever remains in the income after deducting all the expenses is exempt from taxes (Starting and Operating a Business 2009). Another advantage of single proprietorship is when the owner wanted to divest himself and sell his interest from the business, he can do so without asking the permission of the other shareholders.

If for some reason there are two or more people that are involved and willing to invest in the business, the Partnership form is recommended. The ease of establishing this business structure is the main advantage. The profits once the business starts to run smoothly will be divided equally among the owners. In this set-up the decision of one is applicable to all, meaning everybody will be held liable for the mistake of the partner especially as it pertains to wrong decisions. The separation of the owner and the business is not distinct. On tax matters however, the income or loss of the owners are reported directly on their personal income tax return so there is no double taxation.

Limited Liability Companies (LLC) meanwhile can also be established to prevent double taxation. The owners are taxed while the company is not. In this instance with regard to taxation, the personality of the owners is separate and distinct from the company. This is called “pass-through” tax entities where the income or loss of the company is allowed to be reflected on the personal income tax of the owner (Starting and Operating a Business 2009). Therefore, if there is a loss reflected on the personal income statement, there would be no tax imposed.

Corporations on the other hand or “C” corporation are advised for those business enterprises that are large at the onset. Large in a sense that their assets can amount to millions of dollars and at any given moment can go public for additional capitalization. “A Corporation is an ideal vehicle for building-trade contractors, some service businesses, eating establishments, Internet supported businesses and other active business concerns”(Starting and Operating a Business 2009). This structure is best for long term engagement especially if the owner or owners wanted to offer their loyal employees a chance to own the company thru stock options.

Comparing a corporation with the other business structures earlier discussed specifically when it pertains to taxation, a corporation can be taxed double for their income and operation. One of the underlying principles behind this structure is the so-called “separate legal personality” concept. Under this concept, there are two personalities involved, the owners or stockholders and the corporate person. The first one is a natural person while the other is a person created by law or a juridical person. Therefore, the income of the corporation as a juridical person is taxed separately from the income of the owners themselves as natural persons.

This basically means that the owners or stockholders of the company are separate and distinct from the corporation itself. This also means that when paying the debts of the corporation, the personal properties of the stockholders/owners cannot be taken to pay the debt when the corporation asset is insufficient. This is what business people call the limited liability clause of the corporate agreement. And this is very much different from the single proprietorship concept.

Separate Legal Personality Concept

The concept of separate legal personality was actually decided and made into a law by the House of Lords as early as 1895 in England in the landmark case of Salomon v. Salomon & Co. AC 22. This was followed in Macaura v. Northern Assurance AC 619 and Adams v. Cape Industries plc Ch 433 (Corporate Personality 2008).[2]

However, there are also several instances where this concept cannot be invoked in the courts of law. One instance is when it was found out that that corporation was actually created in order to commit crimes. The corporation becomes a façade of the illegal activities of the owners or incorporators. In this case, the criminal liability of the corporation cannot be separated from the criminal liabilities of the owners or incorporators. The courts must establish the illegality of the acts of the corporation or of the owners so that both natural persons and juridical persons can be both held liable. This is exemplified by the Enron case, where the top executives like Ken Lay and Jeff Skilling, were criminally and civilly convicted and they were ordered imprisoned and to pay back the thousands of shareholders they duped. However, when Mr. Lay died in 2006, the courts decided to drop the criminal cases against Lay because basically there is nobody to imprison – physically. But by dropping the criminal case, the civil case like how to collect the millions of dollars bilked out of the stockholders comes into question because the civil case becomes weaker. There should be a law addressing this question.

Another instance where the separation concept cannot be used as a defense is when bankruptcy is obvious and the inability of the entity to operate normally as a corporation; the inability of the owners to continue doing business and trade with other people and corporations. This would constitute as fraud because the corporation concerned has no means of honoring what was agreed upon because there are no corporate assets to speak of to be used in the agreement. Under any law this is a criminal offense punishable by imprisonment and severe fines.

Still, another example where this concept is not applicable is when the company violates certain environmental laws. As it is today, protecting the environment is one of the paramount concerns of every nation and state. Corporations and owners found to be violating any laws pertaining to the protection of the natural environment are liable. The US Environmental Protection Agency is mandated to initiate lawsuits against severe violators of environmental laws and this could mean criminal cases against the owners of the erring corporations “leading to large fines and prison sentences” (Laws and Regulations 2009).

Another example where the separation concept cannot be invoked is when the European Union member states agreed to put a stiffer penalty against violators of the environmental laws within their jurisdiction. Previously, lighter criminal penalties were imposed on corporations and their owners like several months of incarceration but with the new proposed law, imprisonment for the violators could take years. This is called the “Criminal Penalties in EU Member States’ Environmental Law” (Faure & Heine 2002).

Conclusion

With this development, it is expected that people should not abuse the law and hide behind the cloak of corporate immunity when something goes awry or worst, use the concept of separate legal personality to commit crimes and other illegal activities.

In this day and age of wanting to recover immediately the business investments as well as collect enough profits, people tend to test the limits of the law. They try to look for the holes and lapses in every rule and regulation established by the authorities. Once, they discover some weaknesses in the law, they try to take advantage of that knowledge for their own personal gain without really considering the consequences of their actions.

The executives of Enron tried to do just that believing they can hide under the pretext that they do not know what their accountant is doing because their corporate lives are separate from their personal lives. Skilling even said that “I am innocent of these charges. I am innocent of every one of these charges" (Pasha 2006).

The principle of separate legal personality and limited liability can both be bane and boon for everybody. It is beneficial for stockholders of large corporations so that they can decide freely on what course of action to take especially when large amount of money involved without fearing for their personal assets to be taken when something goes wrong. On the other hand, this provision of the law can also be abused.

It is important for everybody that business and society exist together and without each other, the whole social structure might collapse. It is only up to the major stakeholders like the business owners, government and the society at large to set the limits and controls of their very own activities.

Bibliography

Corporate Personality, 2009, businesspme.com, [Online] Available at http://www.businesspme.com/uk/articles/law/88/Corporate-personality.html [Accessed 18 Dec. 2009]

Faure, M.G. and Heine, G. 2002, ‘Criminal Penalties in EU Member States’ Environmental Law’, Maastricht European Institute for Transnational Legal Research, ec.europa.eu, 4 Oct., [Online] Available at http://ec.europa.eu/environment/docum/pdf/02544_final_report.pdf [Accessed 18 Dec. 2009]

Friend, C. 2004, ‘The Social Contract Theory’, iep.utm.edu, 15 Oct., [Online] Available at http://www.iep.utm.edu/soc-cont/ [Accessed 18 Dec. 2009]

Income Taxes, 2007, opsi.gov.uk, [Online] Available at http://search.opsi.gov.uk/search?q=IPSV:Income_tax&access=p&output=xml_no_dtd&site=opsi_collection&ie=UTF-8&client=opsisearch_semaphore&proxystylesheet=opsisearch_semaphore&concept_name=Income%20tax [Accessed 18 Dec. 2009]

Laws and Regulations, United States, 2009, pollutionissues.com, [Online] Available at http://www.pollutionissues.com/Ho-Li/Laws-and-Regulations-United-States.html [Accessed 18 Dec. 2009]

Pasha, S. 2006, ‘Skilling gets 24 years: Ex-Enron CEO sentenced for his role in the grand-daddy of corporate frauds’, money.cnn.com, 24 Oct., [Online] Available at http://money.cnn.com/2006/10/23/news/newsmakers/skilling_sentence/index.htm [Accessed 18 Dec. 2009]

Starting and Operating a Business, 2009, ukincorp.co.uk, [Online] Available at http://www.ukincorp.co.uk/s-7A-incorporating-delaware-online.html [Accessed 18 Dec. 2009]

The United States Constitution, 2009, usconstitution.net, [Online] Available at http://www.usconstitution.net/const.html#A1Sec8 [Accessed 18 Dec. 2009]

[1] The Social Contract theory explains the dependency between the people and the institutions within the society and how this cooperation can be beneficial to all concerned. Hobbes, Locke and Rousseau were the first to expound on the idea. (Friend 2004)

[2] In the United Kingdom, aside from interpreting the law, decisions of the judiciary become part of the law of the land.