TAX PLANNING BY CONVERSION OF FIRM INTO A COMPANY

	NECESSITY :
	Sometimes, in view of the expansion of the business, multiple increase in turnover and need for getting finances from the financial institutions or through public, it may be advisable to convert an existing business, which is being carried out in the status of a partnership firm into a company. In brief, the following are the benefits of doing the business as a company :
	i)	limited liability of the shareholders,
	ii)	widening of capital base,
	iii)	easy expansion and diversification,
	iv)	convenience in getting loan or finance from the banks and financial institutions,
	v)	change in shareholding and management possible without disrupting the business,
	vi)	if immovable property is held by company, the same can be transferred by mere transfer of shares and thus one may save stamp duty as well as avoid other complications,
	vii)	easy transfer of interest possible as the investment is in the form of shares, whereas in case of partnership reconstitution is required whenever any partner retires or a new partner joins.
	However, the decision of converting the firm into a company should be taken after considering all pros and cons.
	EXEMPTION FROM CAPITAL GAINS :
	The need of reorganisation of business by converting a proprietorship concern or a partnership firm into a limited company has been recognised and w.e.f. Asst. Year 1999-2000, in case of conversion of a proprietorship concern or a partnership firm into a company no capital gain shall arise if the following conditions are fulfilled :-
	1.	all assets and liabilities of the firm relating to the business immediately before the succession shall become the assets and liabilities of the company.
	2.	all the partners of the firm immediately before the succession become the shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of succession.
	3.	the partners of the firm do not receive any consideration or benefit, directly or indirectly in any form or manner other than by way of allotment of shares in the company.
	4.	the aggregate of the shareholding in the company of the partners of the firm is not less than 50% of the total voting power in the company and their shareholding continues to be as such for a period of 5 years from the date of succession.
	Similar conditions apply in case of conversion of a proprietorship concern into a company
	Further the brought forward business loss and unabsorbed depreciation in the hands of the partnership firm or proprietorship concern as the case may be shall be allowed to be set off by the company subject to the maximum limit of 8 years on fulfilment of the above mentioned conditions.
	However if a small partnership firm is to be amalgamated with the existing big company it will not be possible to comply with condition no. (4) given above. In such a case the partnership firm may be converted into a company under Part IX of the Companies Act and then the two companies have to be amalgamated.
	MODES OF CONVERSION :
	The following modes may be adopted for converting a firm into a company depending upon the suitability in the circumstances of the persons concerned:
	i)	Conversion by first making the company a partner in the firm and then making dissolution by retirement of all other partners except the Company.
	ii)	By outright sale of the firm as a going concern.
	iii)	By selling the assets of the partnership firm to the company at the specified price for each asset.
	iv)	By conversion of the firm into a company under the provisions of Part IX of The Companies Act, 1956.
	Some persons prefer to lease out the assets of the firm to the company incorporated for the purpose, without dissolving the firm. Out of the above, the first mode is quite simple and the modalities of converting a firm into a proprietorship may be followed. Here in this case the ultimate proprietor of such firm will be the Company in question and not any individual etc.
	But among all the modes, conversion through provisions of Part IX of The Companies Act is most beneficial, which is discussed hereinafter.
	CONVERSION THROUGH PART IX OF THE COMPANIES ACT :
	The conversion through provisions of Part IX of The Companies Act is most beneficial as neither registered instrument of transfer is necessary, nor transfer or extinguishment of right is involved in the process of such conversion. Hence no Capital Gain Tax, Gift Tax or Stamp Duty is attracted.
	Section 565 of The Companies Act, 1956 (corresponding to clause 46 of the Companies Bill 1993) provides that any entity constituted under any law may get itself registered as a company provided it has 7 or more members.
	Such registration affects automatic vesting and divesting i.e. the old firm is divested of the properties and the new company is vested with the properties.
	Part IX of The Companies Act, 1956 comprises sections 565 to 585, of which some important provisions are discussed hereunder:-
	According to the section 565(1)(b) of The Companies Act, 1956 a company formed in pursuance of any Act of Parliament or any other Indian law or being duly constituted according to law and consisting of 7 or more members may apply for registration under Part IX of The Companies Act, 1956. Indian Partnership Act, 1932 is naturally covered by “any other Indian law” occurring in this clause(b).
	The heading of section 565 is “Companies capable of being registered”. In other words section 565 speaks of or contemplates registration of a “Company”. Ordinarily speaking, the word “Company” here as per section 3 of the Companies Act should mean a company registered under The Companies Act. It means that what is to be registered should be a company. The pertinent question is then whether a partnership firm is a company within the meaning of section 565(1)(b) capable of being registered under Part IX . In this connection Andhra Pradesh High Court in the case of Vali Pattabhirama Rao v. Sri Ramanuja Ginning and Rice Factory Pvt. Ltd. 60 Company Cases 568 [1986] (AP) has observed the word “Company” occurring in section 565 of The Companies Act, 1956 (corresponding to section 253(1)(ii) of the 1913 Act) which permits any company otherwise duly constitued according to law consisting of 7 or more members to be registered as a company. A partnership must be one such. This is made clear by the provisions of section 255 of the 1913 Act (corresponding to section 568 of the 1956 Act) whereunder a deed of partnership has to be filed before the Registrar prior to seeking the registration. Hence, a partnership which was treated as a company for the purpose of The Companies Act can be registered under Part 8 of the 1913 Act (Part 9 of the 1956 Act) and the vesting is provided by section 263 of the 1913 Act (corresponding to section 575 of the 1956 Act).
	PRIMARY REQUIREMENTS FOR CONVERSION :
	The primary requirement of conversion is that the Partnership must be validly constituted under the law.
	There should be minimum of 7 partners in the Partnership Firm which intends to convert itself into a company taking shelter under the provisions of Part IX of The Companies Act, 1956. Therefore when the number of partners is less than 7 then the partnership should be first constituted by inducting fresh partners, so that the total number of partners rises to seven. In this connection it is clarified that a minor admitted to the benefits of the partnership is not to be regarded as a member for the purposes of section 11 of The Companies Act. Therefore ,when the number of the partners is to be counted for making it 7, it is necessary to exclude the minors admitted to the benefits of the partnership. Of course other entities eligible to become partners can be counted as members.
	PROCEDURE FOR CONVERSION:
	For the purpose of conversion under Part IX of The Companies Act, the following steps should be taken :-
	Step -1- Re-organisation of the firm
	The first step towards converting a firm into a company under Part IX is re-organisation of the firm on the lines of a joint stock company. The following steps needs consideration :-
	1.	The firm should have atleast seven partners.
	2.	It should have a permanent paid-up or nominal capital of fixed amount divided into shares of fixed amount.
	3.	The partners should be holders of these shares as members of the joint stock company with each member holding specific number and amount of shares.
	4.	A deed of partnership evidencing existing partnership of seven partners on normal lines and registered with the registrar of firms is necessary.
	5.	A deed of Co-partnery/Partnership should be drawn showing number of shares, percentage of shares and paid-up capital held by each partner as a member of the joint stock company alongwith other necessary clauses like making Memorandum and Articles of Association a part of the instrument as also balance sheet of the firm made out on a date not more than six clear days before delivery of documents for registration.
	Step -2- Name Approval
	The firm should obtain approval of the name with which it wishes to register itself following usual procedure of filing Form No. 1A prescribed under the Companies Act. The intention of registering the firm under chapter IX of Companies Act should be mentioned in Form No. 1A and a copy of the partnership deed is also required to be enclosed.
	Step-3- Preparing Memorandum and Articles of Association
	Memorandum and Articles of Association should be prepared incorporating certain special clauses like inclusion of co-parcenery deed, balance sheet, paid-up capital of the members, vesting of the assets and liabilities of the firm in the company etc. and should be got printed. All the partners/members should sign the same in usual fashion.
	Step-4-Prepration of other forms
	Apart from the usual Form nos. 1, 18 and 32, the following forms should be prepared:
	1.	The application for registration in Form no. 37
	2.	List of members of the company with names, address, occupation, number of shares held and its distinctive numbers made upto a date not more than six clear days before delivery of the documents for registration. The relevant Form is Form no. 39.
	3.	In Form no. 40, a statement specifying certain particulars like nominal share capital, number of shares taken etc. is required to be given.
	4.	Copy of the resolution by members giving their assent for registration of the joint stock company as a company with limited liability under the Companies Act, 1956 in Form 41.
	Step-5-Filing of the documents
	The following documents are required to be filed for registration along with necessary fees :
	1.	Memorandum and Articles of Association duly stamped and signed.
	2.	Forms no. 1, 18, 32, 38, 40 and 41.
	3.	A certified copy of the instrument of co-partnership.
	4.	A copy of the balance sheet and profit and loss account made up to a date not more than six clear days before filing of the documents for registration duly certified.
	5.	A copy of the resolution assenting for registration signed by all the members.
	6.	Copy of the name approval letter.
	7.	Power of attorney to carry out correction etc.
	Step-6- Power of Registrar to call for evidence
	The Registrar of Companies may call for such evidence as he may think necessary to satisfy himself about the genuineness of the joint stock company. For example, he may call for a normal deed of partnership and a copy of the registration with the registrar of firms.
	Step-7-Certificate of Incorporation
	After all the formalities like rectification of the documents etc. are completed, the Registrar of Companies shall give certificate of incorporation of the company under Part IX of the Companies Act, 1956.
	LEGAL IMPLICATIONS OF REGISTRATION UNDER PART IX :
	All the provisions of The Companies Act,1956 shall apply to the company and the members, contributories and creditors thereof, in the same manner in all respects as if it had been formed under The Companies Act, 1956, subject to the following :-
	a)	Table A in Schedule I shall not apply unless and except in so far as it is adopted by Special Resolution.
	b)	The provisions of The Companies Act, 1956 relating to the numbering of shares shall not apply to any Joint-Stock Company whose shares are not numbered.
	c)	Subject to the provisions of this section, the company shall not have power to alter any provision contained in any Act of Parliament or other Indian Law relating to the Company.
	d)	Winding Up :- In the event of the company being wound up, every person shall be a contributory, in respect of the debts and liabilities of the company, contracted before registration, who is liable to pay or contribute to the payment of any debt or liability of the Company contracted before registration, or to pay or contribute to the payment of any sum for the adjustment of the rights of the members among themselves in respect of any such debt or liability, or to pay or contribute to the payment of the costs, charges and expenses of winding up of the company, so far as it relates to such debts or liabilities as aforesaid. In the event of the company being wound up, every contributory shall be liable to contribute to the assets of the company in the course of the winding up, all sums due from him in respect of any such liability as aforesaid; and in the event of the death or insolvency of any contributory, the provision of The Companies Act with respect to the legal representatives of deceased with respect to the assignees of insolvent contributories, as the case may be, shall apply.
	e)	The Instrument of the partnership becomes the Memorandum and Articles of Association of the incorporated company.
		Subject to the provision of this section, a company registered in pursuance of this Part may , by special resolution , alter the form of its constitution by substituting a memorandum and articles for a deed of settlement.
		A printed copy of the memorandum and articles shall be substituted for the printed copy of the altered memorandum required to be filed with the Registrar. On the registration of the alteration being certified by the Registrar, the substituted memorandum and articles shall apply to the company in the same manner as if it were a company registered under The Companies Act with that memorandum and those articles, and the company’s deed of settlement shall cease to apply to the company.
	f)	Section 575 of The Companies Act provides for the vesting of the property in the incorporated company pursuant to registration. It reads as under:
		All property, movable and immovable (including actionable claims), belonging to or vested in a company on the date of its registration in pursuance of this part, shall, on such registration, pass to and vest in the company as incorporated under this Act.
		The registration of a company in pursuance of this part shall not affect its rights or liabilities in respect of any debt or obligation incurred,or any contract entered into, by, to, with, or on behalf of, the company before registration.
		According to section 32 A(5)(a) of the I.T.Act, where the asset in respect of which investment allowance had been granted to assessee, is sold or otherwise transferred to the person before expiry of a period of eight years from the end of the previous year in which the asset was acquired or installed, then the same will be withdrawn by resorting to rectification proceedings under sec. 155(4A). The statutory vesting of the asset under same person in the erstwhile company continues to exist in the converted form of the company even after the vesting as no sale is involved. Therefore, there shall not be any question of withdrawal of the investment allowance under section 32A (5)(a) of The I.T.Act. It would, however be necessary that the converted company should, for the purpose of section 32A, step in the shoes of erstwhile partnership firm and should satisfy all the conditions under section 32A. These are that the asset should not be transferred before expiry of the prescribed period of 8 years and the required reserves should be created and also utilised.
	g)	That apart, according to provisions of sec.32A(7) where a partnership firm is converted into a Private Limited Company and if it has unabsorbed investment allowance of past years yet to be absorbed, it can get the same absorbed provided the conditions prescribed under section 32A(7) of the Income Tax Act are satisfied. The conditions are :
		i)	The entire property of the firm relating to the business immediately before the succession by conversion into a limited company becomes the property of the company.
		ii)	Similarly the entire liabilities of the firm related to the business immediately before succession by conversion becomes the liabilities of the company.
		iii)	All the shareholders of the company were also partners of the firm immediately before its succession by conversion into a company.
		If the above conditions are satisfied, the investment allowance is not lost on conversion. The condition of all the shareholders of the company being the partners of the firm immediately before succession is to be fulfilled only at the point of time of conversion. If this requirement is satisfied once, it is immaterial if there is a subsequent change in the shareholding of the company because, inspite of such change, the investment allowance which has already been granted to the firm, will not be lost to it. Therefore, where there is unabsorbed investment allowance in the hands of the firm, care should be taken that the conversion is covered by section 32A(7) of the I.T. Act.
	CONCLUSION :
	The benefits of a company as well as the various modes of converting a firm into a company have been discussed in the foregoing paragraphs. After careful consideration, if it is felt that change-over to company is beneficial, one should go for the same adopting the most convenient mode of conversion.