Many
entrepreneurs start their businesses as a sole proprietorship due to the low
compliance requirements. As the business and the revenues grow, there is a need
to separate the bank accounts and the tax filings of the sole proprietor and
that of the business. To achieve this separation a possible solution is to
convert the sole proprietorship into a private limited company. In this
article, we discuss how this conversion can be done and you as a shareholder
can avail of the provisions of law in this regard.
To
convert a sole proprietorship concern into a private limited company, an
agreement has to be executed between the sole proprietor and the private
limited company (once it is incorporated) for the sale of the business.
Further, such private limited company so incorporated must have “the takeover
of a sole proprietorship concern” as one of the objects in its Memorandum of
Association. Further, there are also certain other requirements and issues
related to this process as set forth below:
A.
Requirements under the Companies
Act:
Section
75 of the Companies Act, 1956, as amended (Companies Act) states that whenever
a company makes any allotment of its shares as fully or partly paid up
otherwise than in cash, to any person, then a written contract of sale, or a
contract for services or other consideration in respect of which that allotment
was made must be produced for inspection to the relevant Registrar of Companies
(RoC). Further, such company is also required to within thirty (30) days,
thereafter, file with the RoC within thirty (30) days, copies of all such
contracts and a return stating the number and nominal amount of shares so
allotted and the extent to which they are paid up along with the mode of
consideration.
B.
Exemption under the Income Tax Act:
Conversion
of a sole proprietorship into a private limited company entails a “transfer”
within the meaning of the Income Tax Act, 1961, as amended (Income Tax Act).
That is, the assets of the sole proprietorship concern are considered
transferred to the newly formed company, which makes the sole proprietor liable
to pay tax for any capital gains calculated on such transfer. However, there is
a provision under section 47(xiv) of the Incoem Tax Act, which lays down
certain conditions for exemption from any capital gains.
The
conditions are:
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;
The
shareholding of the sole proprietor in the company is not less than fifty per
cent (50%) of the total voting rights in the company and such shareholding
continues to so remain as such for a period of five years from the date of the
succession; and
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;
If
any of the conditions laid down above are not complied with (say the sole
proprietor sells his share in two years instead of holding on to the
shareholding for five years), the amount of profits or gains arising from the
transfer of such capital assets or intangible assets not charged earlier by
virtue of these conditions, shall be deemed to be the profits and gains chargeable
to tax of the successor company for the previous year in which the requirements
are not complied with.
So
therefore,
If
you are a sole proprietor who intends to convert his sole proprietorship into a
private limited company, and also allot shares to yourself, then it is
imperative that an agreement is entered into for such allotment and one of the
conditions in the agreement should state that your shareholding / voting rights
will not fall below fifty per cent (50%) in the next five years.
Source:
Yourstory.in
Very informative article.
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