CONVERSION OF PROPRIETORSHIP BUSINESS INTO A COMPANY

The demands of growth in business, credibility and future funding are some of the downsides of a proprietorship business. As business grows, these constrain result in a business person to begin the procedure for converting its business into private limited company. A private limited company offers considerable benefits over proprietorship business, including that of constrained obligation, brand building, capacity to draw in fair capital, constant presence and so on. The Key Benefits, Process to be followed and Tax Implications on conversion of a proprietorship business into a company has been listed below:

KEY BENEFITS

1. Lower Corporate Tax Rates

2. No Capital Gain on Transfer of Assets

3. No GST on Transfer of Assets

4. Helps in creation of a brand value

5. Provides credibility which helps in future external funding for the business.

BRIEF NOTE ON PROCESS TO BE FOLLOWED

1. Incorporation of a company with the Memorandum of Association (MOA) of the Private Limited Company containing an object clause that states - "The takeover of a sole proprietorship concern".

2. Board Resolution for takeover of the sole proprietorship is to be carried out.

3. Obtain valuation for Sole Proprietorship’s Assets & Liabilities

4. An agreement must be entered into between the sole proprietor and the private limited company for conversion.

5. All the assets and liabilities of the sole proprietorship firm must be transferred to the private limited company.

6. Further issue of shares of the newly formed company to the proprietor for a consideration other than cash.

7. Complying with all the provisions as per Section 47 (xiv) of the Income Tax Act, 1961.

8. Modifying details of the bank accounts and other formalities in relation to the conversion.

TAX IMPLICATIONS

Conversion of a proprietorship business into a company has a lot of tax implications by way of Direct and Indirect Taxes. If the correct methodology is not followed, it might result in huge tax burdens. Tax Implications and methodology to be followed are listed below:

1. Income Tax

As per Section 47 (xiv) of the Income Tax Act 1961, Transfer of a capital asset or intangible asset on conversion of Sole Proprietorship Concern into a Company is not treated as Transfer if following conditions are satisfied:

a. All the assets and liabilities of the sole proprietary concern relating to the business immediately before the succession become the assets and liabilities of the company;

b. The shareholding of the sole proprietor in the company is not less than fifty per cent of the total voting power in the company and his shareholding continues to remain as such for a period of five years from the date of the succession; and

c. The sole proprietor does not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company;

That is, if the above conditions are satisfied, then Capital Gain shall not arise on the part of the proprietor.

Additionally, the Mumbai High Court held that goodwill that was not recorded in the books of a sole proprietary concern, but which arose on conversion of the proprietary concern into a company, was not exempt under section 47(xiv) of the Income-tax Act, 1961, but would be taxable in the hands of the sole proprietor under the head Capital Gains. Hence it is imperative that the value of transfer should be at net worth of the proprietary concern or at the balance value in the capital account of the proprietor.

2. Goods and Service Tax (GST)

As per Notification 12/2017, Services by way of transfer of a going concern, as a whole or an independent part thereof shall not attract GST. Additionally, the same was again clarified by way of an advance ruling by the Karnataka bench of AAR in the application filed by Rajashri Foods Pvt Ltd. Hence, in order to not attract GST, it is required that all the assets and liabilities of the sole proprietary concern be transferred to the company.

3. Stamp Duty

Transfer of title rights of all the properties from the proprietor to the company is required to be done in the course of conversion. Hence Stamp Duty and registration fees might be required to be paid on the transfer agreement based on the laws and at rates specified in the relevant stamp duty act of the respective state in which the transfer is taking place.

Note: All the information stated above are for reference purpose only. The Author and the firm do not take any liability for any mistake or misinterpretation in the article.