Converting a Partnership Firm or Proprietorship into a Company or LLP

Many businesses in India start as a proprietorship or a partnership firm, because they're quick and cheap to set up. As the business grows, the owners' unlimited personal liability, and the difficulty of raising money or winning large contracts, start to matter. Converting into an LLP or a company solves both. This guide covers the routes for a partnership firm and a proprietorship, and how to keep the move tax-neutral.

Converting a Partnership Firm into an LLP

The LLP Act, 2008 lets a partnership firm convert into an LLP under Section 55 and the Second Schedule. It's a popular route for professional and services firms that want limited liability without a company's compliance.

Conditions

• All the partners of the firm become partners of the LLP, and no one else.
• The partners consent to the conversion.
• Any secured creditors whose charges are outstanding consent, or the charges are satisfied.

The process

1. Reserve the LLP's name through RUN-LLP, usually the firm's name followed by "LLP."
2. Prepare a statement of the firm's assets and liabilities, certified by a Chartered Accountant, and collect the partners' consents.
3. File the LLP's incorporation form together with Form 17, the application to convert.
4. Once the Registrar registers the LLP, the firm's assets, liabilities, contracts and proceedings vest in it, and the firm is treated as dissolved.
5. File the LLP agreement in Form 3 within 30 days, and inform the state Registrar of Firms of the conversion.

Converting a Partnership Firm into a Company

A partnership firm can register as a company under Part I of Chapter XXI of the Companies Act, 2013, usually as a Private Limited Company. The firm needs at least two partners for a private company.

1. The partners agree to the conversion, and approve the company's MoA and AoA.
2. A notice of the proposed registration is published in an English newspaper and a vernacular newspaper, inviting objections.
3. The company is incorporated through SPICe+, with Form URC-1 for registering the existing firm.
4. On registration, the firm's property and liabilities vest in the company, and the partners become its shareholders.

An LLP can register as a company through the same route, which is common for LLPs preparing to raise equity funding.

Moving a Proprietorship into a Company

A proprietorship isn't a separate legal entity, so there's no legal route to convert it. Instead:

1. Incorporate a new Private Limited Company, with the proprietor as a director and shareholder.
2. Sign a business transfer agreement under which the proprietor transfers the business, with its assets and liabilities, to the company.
3. The company issues shares to the proprietor as consideration.
4. Move contracts, licences, registrations and bank accounts across to the company.

Unlike a statutory conversion, nothing vests automatically. Contracts need to be assigned or novated, and each registration moved individually.

Keeping It Tax-Neutral

A conversion can be treated as a transfer of the business, which would attract capital gains tax. The Income-tax Act exempts it only if specific conditions are met. In broad terms:

• Firm to company: all the firm's assets and liabilities move to the company, the partners become shareholders in the same proportion as their capital accounts, they receive nothing other than shares, and together they hold at least 50% of the voting power for five years.
• Proprietorship to company: all the business's assets and liabilities move to the company, and the proprietor holds at least 50% of the voting power for five years, receiving nothing other than shares.

If a condition is broken during the lock-in period, the exemption can be withdrawn and the gain taxed. It's worth planning the structure with the conditions in mind from the start.

After the Conversion

• The new LLP or company gets its own PAN and TAN.
• Apply for a new GST registration, and move unused input tax credit across through ITC-02.
• Open bank accounts in the new entity's name.
• Update property records, licences and client contracts.

Getting Help

Think Filing handles conversions of partnership firms and proprietorships into LLPs and companies, from structuring the move to meet the tax conditions, through the filings, to setting up the new entity's registrations.