Proprietorship to Private Company
Converting a proprietorship into a private limited company is a significant step for entrepreneurs seeking to expand their business and reap the benefits of a corporate structure. While a proprietorship offers simplicity and easy setup, transitioning to a private limited company provides advantages such as limited liability, improved access to funding, and enhanced market credibility. This article offers a concise guide for the Conversion of Proprietorship into Private Limited. We will explore the essential steps, legal requirements, and benefits business owners can expect. Whether you’re a sole proprietor looking to grow or an aspiring entrepreneur, this article offers valuable insights into the conversion process and its implications.
Proprietorship
A sole proprietorship/proprietorship is a business owned and operated by a single individual. A proprietorship has no legal distinction between the business and the owner. The proprietorship registration controls the business’s operations, decision-making, and profits.
- The owner is personally liable for all business debts, obligations, and liabilities in a proprietorship. This means that the owner’s assets are at risk in the event of business losses or legal claims against the business.
- Additionally, the proprietorship may have limited access to funding options compared to other business structures.
- It is famous for small-scale businesses and self-employed individuals, such as freelancers, consultants, and small retailers.
Private Limited Company
Business entities that shareholders privately own are known as private limited companies. It is a legal structure commonly chosen by small to medium-sized businesses. In a private limited company, the liability of shareholders is limited to their share capital contribution, which means their assets are safeguarded in case of any liabilities or debts incurred by the company. This limited liability provides financial security to the shareholders.
Private limited companies are characterized by having a minimum of two and a maximum of 200 shareholders.
Difference between the Proprietor and Private Limited Company
Before discussing the conversion, we will discuss the difference between a sole proprietor and a Private Limited Company.
Sr. No | Difference | Sole Proprietorship | Private Limited Company |
1 | Registration | Informal Registration | It is registered under the Companies Act, 2013 |
2 | Legal status | Is not a separate legal entity | Is a separate legal entity under the Companies Act,2013 |
3 | Transferability of shares | Not transferable | Shares are transferrable |
4 | Liability | Unlimited | Limited by the extent of shares |
5 | Members | One member only | Minimum two member Maximum 200 |
6 | Taxation | Income tax is the same for the proprietor and the proprietorship | The profits are taxed at 30% surcharges and cess as applicable |
7 | Compliance | – | Annual returns and annual accounts must be filed with the ROC every year. |
Law Governing the Conversion of Proprietorship into Private Limited
The conversion of a sole proprietorship to a Private Limited Company is governed by the Companies Act of 2013 and the Income Tax Act of 1961 in India.
- The Companies Act of 2013 provides the legal framework for corporate incorporation, governance, and operations in India. It specifies the procedures, requirements, and compliances for converting a sole proprietorship into a Private Limited Company.
- The Income Tax Act of 1961 governs the taxation aspects of businesses in India, including converting a sole proprietorship to a Private Limited Company. It outlines the tax implications, benefits, and obligations associated with the conversion.
Benefits of Conversion from Proprietorship to Private Limited Company
Converting a proprietorship into a private limited company offer several benefits that can positively impact the business and its operations. Some of the key advantages include:
- Limited Liability: Shareholders’ assets are safeguarded, and liability is limited to their investment, providing financial security and risk mitigation.
- Separate Legal Entity: A distinct legal entity with perpetual succession ensures stability, credibility, and continuity in ownership or management changes.
- Access to Capital and Funding: Private limited companies have better access to capital through share issuance, attracting investments for expansion and increased financial resources.
- Transferability of Ownership: Ownership is easily transferable through share transfers, facilitating business succession planning and opportunities for selling or exiting the business.
- Tax Benefits and Incentives: Eligibility for tax deductions, exemptions, and reduced rates leads to significant tax savings and improved profitability.
- Enhanced Business Image: Converting enhances stakeholders’ professionalism, credibility, and confidence, fostering better opportunities, collaborations, and partnerships.
- Better Governance and Compliance: Stricter regulations promote good corporate governance, financial transparency, and accountability, reducing legal and compliance risks.
Requirements for Conversion
Before initiating the conversion of a proprietorship into a private limited company, the proprietor must ensure compliance with the following requirements:
- Agreement: An agreement should be entered between the sole proprietor and the private limited company, outlining the terms and conditions of the conversion. This agreement may include details such as the transfer of assets and liabilities, valuation of the business, and other relevant words.
- Memorandum of Association (MOA): The MOA of the Private Limited Company must include an object clause that explicitly states the intention to take over a sole proprietorship concern. This inclusion ensures legal clarity regarding the conversion process.
- Transfer of Assets and Liabilities: All the assets and liabilities of the proprietorship firm must be transferred to the company. This transfer should be appropriately documented and recorded to ensure a smooth transition.
- Directorial Board and Shareholding: The sole proprietor should become a part of the directorial board of the private limited company. They must hold a minimum of 50% of the voting power in the company. It’s important to note that a company must have a minimum of two directors as per the incorporation rules.
- Minimum Share Capital: The incorporation rules of a private limited company mandate a minimum share capital requirement of Rs 1 00,000 (or the applicable currency equivalent). The proprietor must ensure compliance with this minimum capital requirement during the conversion process.
Prerequisites for Forming a Private Limited Company
To convert a proprietorship into a company, the process involves first forming it and then taking over the sole proprietorship by transferring its benefits and liabilities through a Memorandum of Association (MoA). Before applying for a certificate of incorporation, the following requirements should be fulfilled:
- Directors: At least two directors are required to form a private limited company. One of the directors can be the proprietor of the sole proprietorship, and the other can be a relative or friend. Having at least two individuals fulfilling the directorship requirement is essential.
- Director Identification Number (DIN): All directors of the private limited company must obtain a Director Identification Number as a prerequisite for incorporation. The DIN is a unique identification number assigned to individuals holding directorship positions in Indian companies.
- Shareholders: A minimum of two shareholders is necessary for the private limited company. The shareholders can be the same individuals as the directors. The owner of the sole proprietorship must be one of the directors of the private limited company.
Conditions for converting to a Sole Proprietorship
Before converting a sole proprietorship into a private limited company, the following conditions should be followed:
- Transfer of Assets and Liabilities: All the assets and liabilities of the proprietorship must be transferred entirely to the newly incorporated private limited company. This ensures that the business operations and obligations continue seamlessly under the new company structure.
- Shareholding and Voting Rights: Even after the conversion, the old sole proprietorship should hold a minimum of 50% of the shares in the new private limited company. This means the sole proprietorship retains significant control and influence over the company’s decision-making processes, holding 50% of the voting rights.
- Minimum Shareholding Period: The old sole proprietor should hold the shares in the new private limited company for a minimum of five years from the date of incorporation. This requirement ensures that the proprietor remains committed to the business and stabilizes the company’s ownership structure.
- Non-Monetary Consideration: The conversion from a sole proprietorship to a private limited company is not considered a sale but rather a conversion of the business structure. Therefore, there should not be any monetary consideration involved between the sole proprietorship and the private limited company.
Procedure for Conversion of Proprietorship to Company
The steps involved in the conversion of a proprietorship to a company are outlined below:
Slump Sale Formalities
The proprietor must complete the slump sale formalities, which involve transferring all the assets and liabilities of the proprietorship to the company.
Director Identification Number (DIN) and Digital Signature Certificate (DSC)
Obtain DIN and DSC for all the directors involved in the conversion process. DIN is a unique identification number assigned to directors, and DSC is used for secure digital transactions.
SPICE+ Form and Name Reservation
- Fill out the SPICE+ form, which combines name reservation, incorporation, and other registrations.
- Apply for the availability of the company name using the SPICE+ form (Form-1 section).
- Ensure the proposed name complies with the naming guidelines specified by the MCA.
Memorandum of Association (MOA) and Articles of Association (AOA)
Prepare the MOA and AOA, which outline the company’s objectives, rules, and regulations.
Incorporation Application
Apply for the incorporation of the company into the MCA. Submit all the relevant documents, including the MOA, AOA, identity proof, address proof, and other required forms and declarations.
Certificate of Incorporation
Upon successful application review and approval, MCA will issue a Certificate of Incorporation. This certificate legally establishes the company as a separate legal entity.
PAN and TAN Application
Apply for a new Permanent Account Number (PAN) and Tax Deduction and Collection Account Number (TAN) for the newly formed company.
Bank Details Modification
Update the bank details with the relevant financial institutions to reflect the conversion and ensure the company’s accounts are correctly set up.