Introduction(Scenario):
In India, the scope of business opportunities is increasing every day and every person, doing a business, wants to expand it. Like in every business, the competition is also increasing and customer buys the products or services from the person in which they have a belief.
Now, since the company is having a separate legal business entity and it has to file many statutory forms to ROC, the customers would always prefer to buy the product from a company instead of from any proprietor. For Example, If I told you to buy a mobile phone from Reliance Digital or any local mobile shop, then you will prefer Reliance Digital. The reason is very simple because it has a brand and a separate entity in the eyes of law.
In other words, if any proprietor doing business on a small scale and wants to expand it, then he should convert this proprietorship to a private company and this is what we will discuss today in this article.
Benefits for the conversion from proprietorship to a private company:
- Transfer of Assets and liabilities: On conversion, all the assets and liability will automatically become the assets and liability of the company.
- Exemption from Tax(No Capital Gain): As per section 47 of the income tax act, there are certain transactions are defined which shall not be considered as transfer, hence on conversion, the assessee is not liable to pay Capital Gain Tax. Although, the exemption shall be given only after compliance of certain conditions which has been explained below in this article.
- Perpetual Succession(separate legal entity): As we already discussed above that the company is a separate legal entity. Another characteristic of a company is perpetual succession. It means, we always assumed that the company has an indefinite life and this also increases the confidence of the customer on the company.
- Carry forward and set off loss & unabsorbed depreciation: If the assessee is having a loss in proprietorship business then such loss can also be carried forward in the company for fresh 8 financial years after conversion from proprietorship to a private company.
Requirements for Conversion(Additional Requirements):
Before beginning the conversion of proprietorship into the company, the proprietor should ensure compliance with the following requirements:-
- Agreement: There should be an agreement that must specify the conversion of it.
- Memorandum Of Association(MOA): Its object( that is… newly formed company from Sole proprietorship to Pvt company) must state the ‘The Takeover of Sole Proprietorship Concern’
Conditions for exemption of capital gain on conversion of proprietorship to Private Company
As we discussed above that section 47 exempts the capital gain tax on the conversion of proprietorship to a Private Company. However, for exemption following conditions are required to be satisfied:
- Assets and liabilities: All the assets or liabilities of the proprietorship firm will become the assets of the private limited company immediately before conversion.
- Holding in the private company: The proprietor shall become the shareholder in the company and hold at least 50% shareholding in the new private limited company. In simple words, the assessee should have a minimum of 50% voting power in the company. Also, the proprietor has to maintain this 50% shareholding at least for the 5 years.
- No other consideration(benefits) should be received: The proprietor should not be received any consideration from the company directly or indirectly other than the allotment of shares.
To be Noted that:
- The benefit of the section is available for the proprietor assessee who is engaged in any business. If he is a professional then exemption shall not be available.
- if the company allots share to the relative of the proprietor and the above conditions are satisfied then also the exemption shall be available.
- The exemption shall be available for short terms as well as long term capital gains and it also includes the depreciable assets.
Note: Once the capital gain is satisfied but thereafter if the condition has not complied then the capital gain previously exempted shall be taxable in the hands of the company in the year of non-compliance.
Let’s understand the above conditions with an example:
Mr. A is a sole proprietor of a business and his net investment as on 31.03.2019 is Rs. 50 lakhs. On 01.04.2019 he formed a private company and transfer his business to the company for Rs. 70 lakhs for the issue of shares at 700000 share with 10 each.
| Particulars | Amount in Lakhs | |
| Sale consideration | 70 | |
| Less: | Cost of acquisition | 50 |
| Capital Gain | 20 |
Now, this capital gain shall be exempted if the conditions of Section 47 has been satisfied which are:
- Condition 1: He has transferred all the assets and liabilities of the proprietorship business to the assets and liabilities of the company immediately before the succession.
- Condition 2: He has acquired 4,00,000 lakh shares which are more than 50% of the total shareholding of the company.
- He has not received any other benefit or consideration from the company other than the allotment of shares of the company.
If Mr. A sold 100000 shares on FY 2020-21 then the shareholding will get reduced from 50% of the total holding before completion of 5 years hence, the capital gain exempted earlier of Rs. 20 lakhs shall be taxable in the hands of the company in the year of non-compliance i.e. 2020-21.
This is all about the taxation effect that the assessee has to consider at the time of conversion his proprietorship business into the private limited company. Now, we will discuss the steps for creation of a private company. Presently, there is no minimum requirement of share capital for the incorporation of a private company.
Following are the things that the assessee should have it before the creation of a private company
- Digital Signature
- Director I
- identification number (DIN)
- Reservation of Name
- Memorandum of Association
- Article of Association
- Declaration from a professional about the truth of the content
- Declaration from each subscriber of the memorandum of the company
- Directors consent in form DIR-12
- PAN Number (Permanent Account Number)
- GSTIN ( Goods and Services Tax Identification Number)
- EPFO ( Employees Provident Fund Organization)
- ESIC ( Employees State Insurance Corporation)
I know, this is a long list but you do not have to worry because under make in India, government has specified a new form SPICe INC-32 under which an assessee can file an application to ROC for the incorporation of the company and this form can be used for application of DIN or PAN or ESI or EPF number, etc. In simple words, with this form, you will be able to file an applications and obtain all the necessary numbers required for the incorporation of the company.
Note: Maximum 3 DIN number can be obtained from a SPICe form.
Contracts/Service Agreements/Leases
The contracts/service agreements/leases signed under the sole proprietorship business will have to be novated or even re-signed under the new entity.
Licenses/Permits
New licenses/permits are not transferable in most cases, therefore need to be re-applied from the government authority issuing the licenses/ permits.
Conclusion
In this article, we have cover
- The benefits for the conversion of proprietorship to a private company
- Conditions for the exemptions of capital gain tax on transfer under section 47 of the income tax act, 1961.
- Steps for the incorporation of the company
- A quick reference of new form SPICe INC-32 used for fast track registration of a company.