How to Convert a Proprietorship or Partnership Firm into a Private Limited Company

A business that started as a proprietorship or a partnership firm often reaches a stage where a company makes more sense: a bank or investor asks for it, a large customer prefers to deal with a company, or the owners want limited liability and a clear way to bring in new partners.

This article explains how a proprietorship or a partnership firm can become a private limited company, the routes available, and the points to take care of.

Why convert to a company?

• Limited liability for the owners
• Easier to raise funds from banks and investors
• Ownership can be divided and transferred through shares
• The business continues regardless of changes in owners
• Better standing with large customers, government tenders and foreign buyers

A company also has more compliance. If funding is not a priority, an LLP may be a simpler option. See LLP versus private limited company.

Converting a proprietorship

A proprietorship is not a separate legal entity, so there is no direct conversion. Instead:

1. Incorporate a new private limited company, with the proprietor as a shareholder and director, and at least one more shareholder and director. See the company registration process
2. Sign a business transfer agreement by which the proprietor transfers the business, including assets, liabilities, stock, contracts and goodwill, to the company
3. Issue shares to the proprietor as consideration for the business transferred
4. Move registrations, licences and bank accounts to the company’s name, or obtain fresh ones
5. Close the proprietorship’s registrations once the transfer is complete

Tax on transfer of a proprietorship

Under Section 47(xiv) of the Income-tax Act, the transfer is not treated as a taxable transfer for capital gains if:

• all assets and liabilities of the proprietorship become those of the company
• the proprietor holds at least 50% of the total voting power of the company for five years from the date of succession
• the proprietor does not receive any consideration other than shares in the company

If these conditions are broken later, the exemption can be withdrawn.

Converting a partnership firm

A partnership firm has two routes.

Route 1: registration as a company under Section 366

Section 366 of the Companies Act, 2013 allows a partnership firm to register as a company. The firm itself becomes the company, and its assets and liabilities vest in the company by law.

1. Partners pass a resolution approving the conversion and authorising partners to sign the papers
2. The firm should preferably be registered with the Registrar of Firms; the partnership deed and any amendment are attached
3. An advertisement is published in Form URC-2 in an English and a vernacular newspaper, inviting objections
4. The application is filed with the name reservation and the SPICe+ incorporation forms, along with Form URC-1 and the required declarations and affidavits
5. On approval, the certificate of incorporation is issued, and the partners become shareholders in proportion to their capital accounts

Route 2: new company and business transfer

The partners incorporate a new company and transfer the firm’s business to it by a business transfer agreement, with shares issued to the partners. This is similar to the proprietorship route and is used when the Section 366 route is not convenient.

Tax on conversion of a firm

Under Section 47(xiii) of the Income-tax Act, the conversion is not a taxable transfer if:

• all assets and liabilities of the firm become those of the company
• all the partners become shareholders in the same proportion as their capital accounts on the date of conversion
• the partners receive no consideration other than shares
• the partners together hold at least 50% of the voting power of the company for five years

A firm can also convert into an LLP under the LLP Act. See converting a partnership into an LLP.

Things to move to the company

Item	What to do
GST registration	Obtain a new GST registration for the company; transfer unused input tax credit through Form GST ITC-02 where the conditions are met. See GST registration process
Licences	Trade licence, FSSAI, drug licence, factory licence and similar licences are usually in the owner’s or firm’s name and need to be changed or obtained afresh
Bank accounts and loans	Open company accounts; existing loans need the lender’s consent to be taken over
Trademark	Assign the trademark to the company and record the change with the Trade Marks Registry. See assignment of trademark
Property	Transfer of land or buildings needs a registered document and attracts stamp duty; leases need the landlord’s consent
Employees	Move employees to the company with continuity of service, and update or obtain EPF and ESI registrations
Contracts	Customers and suppliers should be informed, and important contracts assigned or signed afresh
Udyam registration	Update or obtain afresh for the company

Points for businesses in Kerala

• Local body trade licences (panchayat, municipality or corporation) are in the owner’s name and need to be obtained in the company’s name
• Where the business runs from property owned by the proprietor or a partner, decide whether to transfer the property to the company or lease it to the company; transfer attracts stamp duty and registration fees
• For family firms, discuss how the shares will be held before conversion, since the capital account ratio decides the shareholding under the tax exemption
• A registered partnership firm under the Indian Partnership Act should inform the Registrar of Firms on dissolution or conversion. See partnership firm registration in Kerala

Frequently asked questions

Can a proprietorship be directly converted into a company?

No. A new company is incorporated and the business is transferred to it, with shares issued to the proprietor.

Do I need a second person?

A private limited company needs at least two shareholders and two directors. A single owner can instead form a One Person Company.

Will the company keep the firm’s GST number?

No. The company needs its own GST registration. Credit can be transferred where the conditions are met.

Is there capital gains tax on conversion?

Not if the conditions of Section 47(xiii) (firm) or Section 47(xiv) (proprietorship) are met and continue to be met for five years.

Can the old business name be used?

Usually yes, subject to name approval by the ROC under the naming rules.

ചുരുക്കം (Summary in Malayalam)

പ്രൊപ്രൈറ്റർഷിപ്പ് നേരിട്ട് കമ്പനിയാക്കി മാറ്റാൻ കഴിയില്ല; പുതിയ കമ്പനി രജിസ്റ്റർ ചെയ്ത് business transfer agreement വഴി ബിസിനസ് കമ്പനിക്ക് കൈമാറി, പ്രൊപ്രൈറ്റർക്ക് ഓഹരി നൽകുന്നു. പാർട്ണർഷിപ്പ് ഫേമിന് Section 366 പ്രകാരം URC-1 ഫയൽ ചെയ്ത് നേരിട്ട് കമ്പനിയായി രജിസ്റ്റർ ചെയ്യാം. Income-tax Act Section 47(xiii), 47(xiv) വ്യവസ്ഥകൾ പാലിച്ചാൽ capital gains നികുതി ബാധകമല്ല. GST, ലൈസൻസുകൾ, ബാങ്ക് അക്കൗണ്ട്, ട്രേഡ്മാർക്ക്, വസ്തു, ജീവനക്കാർ എന്നിവ കമ്പനിയുടെ പേരിലേക്ക് മാറ്റണം.

This article gives a general overview of the law and procedure under the Companies Act, 2013, the rules and related laws. Forms, fees, limits and procedures are revised from time to time; for accurate and current requirements, refer to the Act, the rules as amended and the official portals. The article is not advice on any particular case.