Conversion of Partnership to Company

People who initially started their businesses as partnership firms or sole proprietors should convert to form companies, LLPs or other entities this will help them to take their business to the next level. It helps in the overall growth, as it will make conducting business with other business associates more professional and a better experience. We are familiar with what a partnership business brings and the various flaws associated to it. However, the general public faces many problems during the conversion of a partnership to a company or LLP, this creates some myths and misconceptions regarding the conversion process. In this article we will basically try to address issues regarding these conversions and various capital gain exemption from conversion of partnership firm to company. Income tax issues: Section 47(xiii) Transfer of capital assets or intangible assets by a firm to a company where the firm is succeeded by a company in the business carried on by it or in the course of demutualization or corporatization of a recognized stock exchange in India where  an AOP/ BOI is succeeded by a company shall be treated as an exempt transfer if:

• All the assets and liabilities relating to the business is transferred.
• All the partners of the firm immediately before the succession become the shareholders of the company in the same proportion as their capital accounts on the date of succession.
• The partners of the firm shall 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.
• The shareholding in the company by the partners of the firm is not less than 50% of the voting power and their shareholding continues to be as such for a period of 5 years from the date of succession

Analysis 1)      It is understood that the partnership firm should be carrying on business and the successor company should succeed in that business. In the words the company should continue to carry on the business of the predecessor. However, no time limit has been prescribed for continuing the business. This would imply that, the benefit of exemption would not be available to an entity carrying on profession. 2)      Exemption is only to capital gains income and business income. If any current asset is transferred above book value or any other asset giving rise to business income, then such business income would not be exempt. The predecessor entity would be liable to tax on business income tax. 3)      All assets and liabilities relating to business have to be transferred. As result non business asset like investments need not be transferred. In other words investments held by the predecessor even if not transferred, the benefit of exemption would be available. Also the section does not prescribe that the assets should be transferred at book value. This would mean that asset may be transferred even above book value giving rise to capital gains which shall be exempt. 4)      Condition prescribed is that all the partners should become shareholders. The condition would stand satisfied whether equity or preference shares are allotted. However, in case of latter, the partners have to infuse funds separately to acquire 50% of the voting power. 5)      The partners of the predecessor entity should not receive any other benefit/ consideration other than allotment of shares, in connection with conversion. For example if any interest free loan if granted in course of conversion, the condition would stand breached. However, if such loan is granted after conversion the condition would stand satisfied. 6)      The shareholding of the partners – which consists of capital balances amount and 50% of the voting power should be maintained for a period of 5years from the date of succession. 7)      The partners in their discretion may acquire more than 50% equity stake. The condition stated above shall not apply to additional equity. In other words, equity above 50% may be transferred freely at anytime. Steps after incorporation Once the new company is formed, the takeover agreement would be entered between the partnership firm and the newly incorporated company. Convene a board meeting after giving notice to all the directors of the newly incorporated company immediately after incorporation. The company may issue shares or other securities to partners of the firm. Thanks for reading for this article. Please feel free to write to us, We want to hear it all!Suggestions? Complaints? Feedback? Requests?  at [info@taxmantra.com] or call us at +91 88208208 11. We would be more than happy to assist you.