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Unit 14: Restructuring: Conversion and Slump Sale

14.1 Conversion of Sole Proprietary Business into Company Notes

Where a sole proprietary concern is converted into a company and as a result of such conversion,
the sole proprietary concern transfers any capital asset (whether tangible or intangible) to the
company, such transfer will not be charged to capital gains tax if the following conditions are
complied with:
(i) all the assets and liabilities of the sole proprietary concern immediately before its succession
should become the assets and liabilities of the company;

(ii) the shareholding of the sole proprietor in the company is not 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 succession;
(iii) the sole proprietor does not receive any consideration or benefit (whether directly or

indirectly) other than the shares allotted to him by the company section 47(xiv).
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.
!

Caution
1. To achieve this separation a possible solution is to convert the sole proprietorship
into a private limited company.
2. 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:

(i) 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).

Notes Such company is also required to within thirty (30) days, thereafter, fi le 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.

(ii) 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 Income Tax Act, which lays down certain conditions
for exemption from any capital gains.

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