You start a business as a proprietorship. After sometime, the business starts growing, which brings the need to change the constitution of the business from proprietorship to a company due to various factors such as: Need of capital for further expansion of business, saving in income tax through reduced tax rate etc.

There are number of procedural & legal aspects you need to consider before you could initiate the conversion

1) How would the conversion take place?

2) Will it be taxable under GST?

3) What would be impact of conversion under Income tax?

4) What conditions needs to be met to keep the conversion from being taxable under GST & Income tax?

5) Would we be required to close the proprietorship business?

6) What would happen to unutilized balance of Input tax credit

In this article, we aim to address the above questions to provide a clarity on how to have a successful conversion:

1) How would the conversion take place?

Since the proprietorship business is to be transferred to a Private limited company, we need to do the following:

a) Incorporate a Private limited company

b) Obtain it’s GSTIN

c) Open a bank account & apply for commencement of business.

Now, that we have a new company incorporated, it will takeover the business of proprietorship for which we need to enter agreement of sale of business.

2) Will it be taxable under GST?

No, if certain conditions are satisfied. Under the GST act, where a business is transferred to another business as a going concern, it will not be considered as a Supply and thus such transfer will not be taxable under GST.

3) Will it be taxable under Income tax?

No, if certain conditions are satisfied. Under income tax act, where a sole proprietorship is succeeded by a company, it would not be considered as a transfer & thus wouldn’t attract capital gain tax

4) What conditions needs to be met to keep the conversion from being taxable under GST & Income tax?

Following conditions needs to be met:

a) Business should be transferred as a going concern i.e., entire business (including all assets & liabilities) should be transferred

b) Existing business should cease to be a taxable person.

c) The shareholding of the sole proprietor in the new company should not be less than 50% & it shall remain as such for a period of 5 years.

d) 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 Private Limited Company

5) Would we be required to close the proprietorship business?

Yes, the existing proprietorship firm needs to be closed to complete the conversion. The GSTIN of the proprietorship firm will have to be applied for cancellation.
The proprietorship firm should file all GST returns & pay all pending taxes

6) What would happen to unutilized balance of Input tax credit?

If there is unutilized Input Tax Credit at the time of conversion, the such ITC is allowed to be transferred into the new entity for which the proprietorship will be required to file form ITC-02

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Disclaimer: The above post is only for the purpose of academic discussion and should not be construed as any legal opinion in any matter whatsoever.

The author is a CA in practice at Delhi and can be contacted at: E-mail: [email protected], Mobile: +91-9811741451

Author Bio

Qualification: CA in Practice
Company: Abhinandan Sethia & Associates
Location: west delhi, Delhi, India
Member Since: 26 May 2018 | Total Posts: 46
I am a Practicing Chartered Accountant with over 6 years of professional service experience. My professional services experience include specialization in #GST compliance #Risk based Internal Audits #Risk Management, #business process reviews, #Fraud Investigations etc. among other services View Full Profile

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