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There can be many reasons for conversion of sole proprietary concerns or partnership firms into limited company.
Increasing size of operations, need to sharpen technological edge, obtaining benefits of economy of scale, limiting risks, etc. are some of the reasons that compel sole proprietary concerns or partnership firms to convert themselves into limited companies.
There are two methods:
One is conversion of proprietary/partnership firms into limited companies and
other method is registering a limited company and which takes over a proprietary/partnership firm.
First Method: For conversion of proprietary/partnership firms into limited companies, they need to fit into the definition of a joint stock company provided in section 566 of the Companies Act 1956.
The basic requirements for being treated as a joint stock company are:
* the firm should have a permanent paid-up or nominal share capital;
* such capital should be held as shares of fixed amount or held and transferable, as stock or partly shares or partly stock, and
* only the holders of the shares or stock should be members.
Section 566(2) states that "such a company (or association), when registered with limited liability under this Act, shall be deemed to be a company limited by shares". This clearly shows that the company or association continues and is, in addition deemed to be a company limited by shares. Had a new company been created upon registration, there was no need to deem it to be a company limited by shares. The need to 'deem' arises as the company so registered continues to be governed by its own laws and regulations under section 578 but is, in addition, given the status of having the liability of its members limited.
Stamp Duty:
Whether any stamp duty is payable upon conversion of proprietary/partnership firms into limited companies?
In Vali P Rao Vs Sri Ramanujan Ginning & Rice Factory (P) Ltd 60 Company cases 568 (AP) it was stated that "if the constitution of the partnership firm is changed …………there is no need of a separate conveyance of the property the firm". The vesting of property on registration under section 575 is clarificatory and such vesting of property is `for the estate and interest of the company therein'.
Section 575 of the Act makes it clear that there is an automatic vesting of property - both moveable and immovable - upon registration under Part IX. Since such vesting is under statute, no separate conveyancing is necessary. It has been held in Rama Sundari Ray Vs Syamendra Lal Ray (1939) ILR (Cal) 1, that `the section is mandatory and does not require the statutory transfer provided thereby to be accompanied by a registered instrument'.
Sales Tax/VAT:
Whether any sales tax/VAT is payable upon conversion of proprietary/partnership firms into limited companies?
When there is no transfer between two separate entities, the question of payment of sales tax does not arise. Many state sales tax laws also provide exemption on the sale of a business as a going concern from sales tax. Further, the sale of an industrial concern would not constitute goods and, if this logic is accepted, there would be no liability even if the scheme were to be considered as a transfer.
Capital Gain tax:
Whether any capital gain tax is payable upon conversion of proprietary/partnership firms into limited companies?
When a firm gets registered as a company there is a statutory vesting of properties and no transfer takes place between one distinct person and another - Ramasundari Ray Vs Syamendra Lal Ray & V P Rao Vs Ramanuja Ginning and Rice Factory (P) Ltd.
In the absence of such a transfer, the question of capital gains does not arise. The position would be the same even if the firm were to revalue its assets prior to registration.
Another question is whether registration results in the dissolution of the firm and whether the provisions of section 45(4) of the Income Tax Act would apply.
Section 45(4) provides: "The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer."
When no new organisation comes into existence and the firm continues, section 45(4) cannot apply. In any case there is only a statutory vesting of property and no distribution of capital assets consequent to dissolution.
Income Tax:
From the above discussion it is clear that no new organisation comes into existence. The firm continues but with certain additional rights and obligations. If this being so, one view is prevailing amongst professionals is that the firm, even after registration, would have to be treated as a `firm’ under the Income Tax Act till it re-registers itself under section 32 of the Companies Act, 1956.
The other possible alternative is that the firm gets treated as a company upon registration. However, for this to happen, the firm should fit into the definition of Indian Company provided in sections 2(17) [defines 'company'] and 2(26) [defines 'Indian company'] of the Income Tax Act, 1961. Section 2(26), inter-alia, defines an Indian Company as `a company formed and registered' under the Companies Act, 1956. It is apparent that while the firm is registered, it was not formed under the Companies Act.
The other view is that a firm when converted into a limited company, Registrar of Companies issues a certificate of registration pursuant to section 574 of the Companies Act and that section states that "the Registrar shall certify under his hand that the company (it includes firm) applying for registration is incorporated as a company under this Act.." Emphasis is on word 'incorporated'. It is same as company 'formed' under the Act. Section 574 is not using the term 'registered' under this Act. Further, words under section 574 are same as section 34 of the Companies Act (section 34 deals with issue of certificate of incorporation of newly formed company).
Thus, as per the later view, upon conversion of firm into limited company, provisions of the Income Tax Act shall apply to such converted company, as applicable to a company formed under the Companies Act.
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