How To Save Tax On Conversion of Proprietorship firm into a Company?
March 13, 2009 by taxworry · Leave a Comment
In this age of information technology, there are numerous self made entrepreneur who starts a web business himself or self. As the business grow, so is the chance of converting the proprietorship concern into a company so that others-Venture Capital firms or other people can bring in capital . The point every such entrepreneur must know that in the event that the proprietorship’s concern is converted into a company, there is transfer within the meaning of I T Ac .In other words, in case of such conversion, assets of proprietorship concern are considered transferred to the newly formed company . In such scenario, the proprietor is liable to tax for any capital gains computed on such transfer of assets.
However, there is a provision under section 47(xiv) which lays down certain conditions which if fulfilled, shall exempt any capital gains arising out of transfer of assets from proprietorship firm to the newly created company. This has been inserted to facilitate the entrepreneurship .
The conditions are
- The proprietor must have at least 50 % voting power in newly formed company.
- The minimum 50% voting power of the sole proprietor must be for next five years from the date of succession of proprietorship concern to company.
- All the assets of the proprietorship firm should be transferred to newly formed company.
- The sole proprietor does not receive any consideration or benefits directly or indirectly in any form other than the share of such company.
For ready reference the provision under I T Act is given below
47(xiv) where a sole proprietary concern is succeeded by a company in the business carried on by it as a result of which the sole proprietary concern sells or otherwise transfers any capital asset or intangible asset to the company :
Provided that—
(a) 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;
(b) the shareholding of the sole proprietor in the company is not less than fifty per cent of the total voting power in the company and his shareholding continues to remain as such for a period of five years from the date of the succession; and
(c) 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;
What happens if the conditions are not satisfied after some time?
The provision states that the sole proprietor whose proprietorship concern was converted into a company must hold at least 50% voting power for next five years. Therefore , he sells his share after one or two years or within five years, it is the company which will have to pay the tax on the capital gains in the year when conditions were not satisfied on the amount of capitals gains on which no tax was imposed earlier because the conditions were satisfied. This provision is given under section 47A(3) of the I T Act which is given below
Withdrawal of exemption in certain cases.47A. (3) Where any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 by virtue of conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 shall be deemed to be the profits and gains chargeable to tax of the successor company for the previous year in which the requirements of the proviso to clause (xiii) or the proviso to clause (xiv), as the case may be, are not complied with.
Therefore, every entrepreneur needs to hold the shares for first five years and not to receive any benefits from such newly formed company out of proprietorship concern.
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