Many small business owners start out as sole proprietors of their firms. Sole proprietorship is the most common and simplest form of business structure. This form of business has its own advantages: easy formation, limited paperwork, small capital requirement, and minimum compliance requirements.
As the business starts spreading its roots, the next logical move would be to expand operations to accommodate large business needs. The experience acquired as a sole proprietor helps the entrepreneur to build a stronger foundation for his business when he chooses to transform it into a Private Limited Company.
Choosing to Register a Private Limited Company
As the revenues increase, many sole proprietors perceive the need to differentiate their personal accounts and tax filings from that of the business. There are several reasons why converting your sole proprietorship into a private limited company is a good idea.
The conversion allows you to enjoy the double benefits of keeping your goodwill and brand value intact while enjoying a legal existence. You are not only exempted from paying any stamp duty, but also from any capital gains tax on the property thus transferred.
Other key benefits include:
- Business expansion
- Better financing options
- Greater public visibility and acceptance
- Asset protection
- Managing risks
- Corporate tax benefits
The conversion process
The first step to converting your sole proprietorship firm into a private limited company is to incorporate a new private limited company.
At the time of the new Private Limited Company, it is appropriate to mention in the Memorandum of Association (MOA) that the company is a “takeover of a sole proprietorship concern.”
After the Company Formation, an agreement needs to be executed between the Company and the Proprietor for the takeover of the assets and liabilities of the proprietorship by the Company. The details of assets, liabilities and the consideration in exchange of such assets need to be specified in the agreement.
The agreement should be executed in a Stamp Paper of requisite value to make it a valid legal document.
As per the Income Tax Act, 1961, capital gains on such transfers are exempted if:
- All the assets and liabilities of the sole proprietorship, immediately before the conversion, are transferred to the company
- The proprietor’s shareholding is more than 50% of the total voting rights of the new company for a continuous period of not less than 5 years from the date of succession
- The proprietor receives shares in the Company only in exchange of the net assets of the business.
- In case any of these conditions are not complied with, the profits or transfer of assets shall attract capital gains tax.
Once the new private limited company comes into existence, the sole proprietorship can be duly terminated. The bank accounts in the name of the proprietary firm need to be formally closed and a new corporate account is to be opened for the Company.
Any contracts/ leases/ agreements signed by the proprietor need to be re-signed under the name of the newly incorporated company.
All tax and other registrations in the name of the Proprietorship need to be surrendered and new registrations should be obtained in the name of the Private Limited Company.
Nikita Bhatia is the co-founder of VenturEasy, an online platform for Company registration, book-keeping, accounting, tax consultancy and legal compliances in India. A Chartered Accountant and company secretary by profession, she has wide experience in the fields of audit, accountancy, taxation and corporate governance.