Conversion of Proprietary Concern & Partnership Firm in to Company

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Conversion of Proprietary Concern & Partnership Firm in to Company

Growth, Expansion & Diversification in the business coupled with lower rate of corporate tax often prompt the taxpayers to explore the possibility of converting proprietary & partnership firms into a company. There are few advantages which are not there when the business is carried out in a proprietary or a partnership firm. Some of the advantage of conversion could be,

  1. Limited liability of the shareholders
  2. Perpetual succession of the business entity
  3. Clear distinction of shareholding with the management
  4. Easy transferability & change in the ownership pattern
  5. Ownership of the immoveable property in the name of the company
  6. Lower tax rate of the companies
  7. Convenient & comfortable mode of Capital base widening
  8. Ease in expansion & Diversification.
  9. Better mode to raise the funds from bank, financial institutions, Private Equity & venture capitalist
  10. Ease in the sale of business without affecting the fund flow, etc

One of the most cheering parts is that conversion of proprietary firms or a partnership firm into a company is tax neutral i.e., no capital gain tax liability arises on such conversion. Shifting of capital asset or intangible asset on conversion of sole Proprietorship Concern or partnership firm in to a Company is not regarded as “Transfer” u/s 2(47) of the Income Tax Act – 1961 and hence not Capital Gain arises
However, there are certain riders which one need to comply so as to keep the conversion tax neutral, as under:

  1. I) Conversion of Sole Proprietary concern in to a Company [Section 47(xiv)]:
  2. 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;
  3. The shareholding of the sole proprietor in the company should not be less than 50% of the total voting power in the company and his shareholding continues to remain so for a period of 5 years from the date of the succession; and

iii.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;

  1. II) Conversion of Firm to Company[Section 47(xiii)]
  2. All the assets and liabilities of the firm [or of the association of persons or body of individuals] relating to the business immediately before the succession become the assets and liabilities of the company;
  3. All the partners of the firm immediately before the succession become the shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of succession;

iii.               The partners of the firm do 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; and

  1. Aggregate of the shareholding in the company of the partners of the firm should not be less than 50% , of the total voting power in the company and their shareholding continues to remain so for a period of 5 years from the date of the succession;

Withdrawals of Exemption from Capital Gain Taxation [Section 47A(3)]

Immunity from capital gain taxation is subject to the conditions enumerated as discussed above. However, if the conditions laid down above are not complied then the amount of profits or gains arising from the transfer of such capital asset or intangible asset shall be deemed to be the profits and gains chargeable to tax of the successor company for the previous year in the year of violation.

 

Benefit of carry forward of accumulated losses & unabsorbed Depreciation:

In addition to the relaxation from capital gain taxation, there is also a concession to carry forward & set off of accumulated loss & unabsorbed depreciation in the case of succession. Section 72A(6) of the Income Tax Act – 1961 provides that whereby, a firm is succeeded by a company or a proprietary concern is succeeded by a company , the accumulated loss and the unabsorbed depreciation of the predecessor firm or the proprietary concern, as the case may be, shall be deemed to be the loss or allowance for depreciation of the successor company of previous year in which business reorganization was effected and other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly.

However, if the conditions of succession as already discussed above are not complied with then the amount of set off of loss or allowance of depreciation made in any previous year in the hands of the successor company shall be deemed to be the income of the company. It shall be chargeable to tax in the year in which such conditions are violated.

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