Distinct entity meaning is the accounting principle that a business has its own existence and objectives apart from the people who own it or work in it and should be regarded as a separate entity apart from the owner. Distinct business entity can also refer to a component of a company that operates independently from the rest because of separate geography, product lines, or services. Since it is autonomous, a distinct business entity has flexibility in making decisions. This existence requires the organization to keep its own records separate from the owners' transactions.

What Is the Veil of Incorporation?

The case of Salomon v. Salomon & Co. set out the principle known as the veil of incorporation (or corporate veil) which is that the acts of a corporation are not the acts of that corporation's shareholders, and limits the personal liability of shareholders and other employees for corporate actions. This principle has since been narrowed by other legislative actions to prevent abuses of the limited liability protections and avoidance of taxes.

The principle of the veil can only be disregarded by the court in specific circumstances to avoid injustice. The three main reasons why this may happen are:

  • To enforce the provisions of the Companies Act.
  • To avoid fraudulent activity.
  • To deal with a group of companies.

The veil of incorporation can be lifted in two ways.

  • Through legislation: Statutory provisions can allow for ignoring a company's separate legal existence and allocating obligation to members or directors.
    • Personal liability for the number of members under Section 36 of the Companies Act 1963: If the number of members drops below the legal minimum (two for private companies and seven for public entities) for more than six months, every member during that period who was aware of the violation is liable for the debts the company incurred during that time.
    • Personal liability for offenses related to taxation under Section 94 of the Finance Act: When a company commits a tax offense with the help of an individual within the company, that person can be held legally responsible.
    • Personal liability for fraudulent trading under Section 297 of the Companies Act 1963: During the liquidation of a company, every individual who knowingly participates in an effort to defraud creditors can be held personally liable to an unlimited degree for the debts of the company. In the case Re Hunting Lodges Limited [1985], the court held the directors and buyer of the asset liable for the company's debt.
    • Personal liability for reckless trading under Section 297 of the Companies Act 1963: Any individual who knowingly participates in reckless practices can be held personally liable to an unlimited degree for the debts of the company.
    • To acknowledge the existence of a group of companies under Section 150 of the Companies Act 1963: If a company is involved in subsidiary activities, then group financials must be assembled to show the assets and liabilities of the group as a whole. The corporate veil can be lifted to identify such a relationship.
  • Through court action: Courts have discretion in deciding whether to lift the corporate veil to prevent fraudulent activity.
    • Implied agency situation: In the case of Gilford Motor Company v Horne [1933] Ch 935, the defendant signed a non-compete agreement with a company should he leave the company. He hoped to avoid the agreement by forming his own company using his relatives as directors and hiring himself as an employee. In this situation, the court lifted the veil.
    • Single economic entity: When a parent/subsidiary relationship exists between companies and is so enmeshed that they should be treated as one entity, the courts will lift the veil to reveal the economic and commercial situation of the business.
    • To establish the true residency of the company under Daimler v Continental Tyre Company [1916] 2 AC 307: British wartime laws forbid trading with an enemy. The defendant owed money to the plaintiff, a British registered company, whose directors and shareholders were German. The court lifted the veil to determine that the plaintiff was not liable for the debt since this would be considered trading with the enemy.
    • To determine if a company was formed for an illegal or fraudulent purpose or to avoid a legal responsibility.
    • To determine if a company is being used to carry out a fraud or injustice against minority shareholders.
    • To determine if a company is really a quasi-partnership.

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