TAX PLANNING THROUGH CONVERSION OF

	A FIRM INTO A SOLE PROPRIETORSHIP
	With effect from Assessment year 1998-99 the tax on partnership firms is charged at the flat rate of 35 per cent without any exemption limit. Whereas the tax on individuals is charged on the basis of slabs and exemption is also available to the extent of total income of Rs.50,000 with effect from the assessment year 1999-2000. In view of this, it may be beneficial for a firm to be converted into a sole proprietorship concern. It will be particularly more advisable to do so where the partners also include women and minors, as it will be difficult to prove such partners as working partners for allowing any claim of Salary or remuneration to such partners.  Moreover those who feel problem in making compliance in respect of TDS formalities, may get respite by changing over to proprietorship business.
	TAX SAVING :
	The following comparative chart will indicate the amount of tax payable in case of firms and in case of individuals as well as the savings on conversion of constitution from firm to sole proprietorship :-
	Total Income Tax & S.C. payable for Asst Year 2001-2002 Tax saving by Individual by Firm Rs. Rs.1 Lac 9,900 38,500 28,600 Rs.1.5 Lacs 20,900 57,750 36,850 Rs.2 Lacs 37,400 77,000 39,600
	From the above chart, it is clear that the tax saving on conversion of a firm into proprietorship concern may be considerable amount. However, it will depend upon circumstances of each firm, as to how much the conversion will be beneficial considering the totality of circumstances like other factors necessitating the constitution as partnership, relationship between the present partners, other income of the partners etc.
	ALMOST NO BURDEN OF TDS FORMALITIES IN CASE OF SOLE PROPRIETORSHIP :
	The present trend of the Government is to expand the net of TDS on different kind of payments, which involves strict compliance in timely deducting the tax at source and then to deposit the same within the stipulated time in the account of the Central Government. The process does not stop here. One has also to issue TDS certificates as well as required to file the periodical returns of TDS. Any failure may attract not only interest but also heavy penalty and even rigorous imprisonment under section 276B and 276BB.
	However, an interesting point to note is that most of the provisions relating to TDS are not applicable to the sole proprietorship concerns. The relevant sections of the Income Tax Act, have specifically exempted individuals (sole proprietorship), from TDS provisions in respect of the following :
	i)	payments to contractors and sub-contractors (under section 194C),
	ii)	payments to advertising agencies, transporters and caterers (under section 194C),
	iii)	interest other than interest on securities (under section 194A),
	iv)	rent (under section 194-I) and
	v	fees for professional or technical services (under section 194J).
	It may however be mentioned that even in case of sole proprietorship the TDS provisions are applicable in respect of payment of salary, if the salary of any employee is taxable.
	Therefore, if a small or medium business concern is relieved of the intricacies of making deduction of TDS and other compliances in relation thereto, it will be of great help.
	THE PROCEDURE FOR CONVERSION OF A FIRM  INTO A PROPRIETORSHIP CONCERN :
	i)	The conversion may be achieved by entering into a deed of dissolution. In case of a firm consisting of only two partners, one partner may retire from the business leaving the same with the other partner, who may continue to run the business but as a sole proprietor. In case of a firm comprising more than two partners, all partners except one will have to retire.
	ii)	Intimation to the Assessing Officer : As required by section 176 (3) notice should be sent to the Assessing Officer within 15 days of the discontinuation of the business of the partnership firm.
	iii)	It is advisable to send intimation to the Registrar of firms also, if the firm was registered with the Registrar of firms. The Sales Tax Department as well as other departments should also be informed.
	SOME IMPORTANT POINTS -
	In case of dissolution of the firm for the purpose of converting it into a proprietorship, the following factors should be kept in mind :
	i)	Valuation of fixed and depreciable assets : As decided by the Supreme Court in A.L.A. firm v. C.I.T. (1991) 189 ITR 285 (SC), the fixed assets of the partnership firm have to be valued at the time of dissolution of the firm on the basis of fair market value. It may also be noted that as per section 50, the profit on transfer of depreciable assets will be treated as short-term capital gain.
	ii)	Valuation of stock-in-trade : In the Supreme Court judgment referred in (i) above it has also been held that so long as the firm continues, the asset continues to belong to the partnership at its book value and whatever fluctuations there may be in the value of assets, the benefit or loss of it would accrue only to the firm. But the situation is totally different in case of dissolution of the firm or where a partner retires. The settlement of accounts must be on real basis and not on notional basis, that means every asset of the partnership should be converted into money and the accounts of each partner should be settled on that basis. Therefore in case of conversion of a partnership into a sole proprietorship concern, the stock-in-trade and other assets are required to be valued at the fair market value prevailing at that time and the difference is to be treated as trading profit or loss for the year of conversion.
		To avoid the possible controversy in respect of valuation at the time of assessment, it is advisable to sell or otherwise transfer the stock and other assets a few days prior to the actual dissolution.
	APPLICATION OF SECTION 45(4) :
	As per the provisions of sec. 45 (4) of the Income Tax Act, in case of dissolution of a partnership, any profit or gain arising from the transfer of a capital asset by way of distribution is charged to tax as the income of the firm of the previous year, in which the transfer of the assets takes place. Further the fair market value of the asset on the date of distribution is deemed to be the full value of consideration received or accruing as a result of the transfer as per section 48. The question of estimation of fair market value of the assets being transferred to the sole proprietor or the retiring partner may result into litigation. Therefore, valuation can be made by the registered valuer, if possible.
	APPLICATION OF THE GIFT TAX ACT :
	If the asset is transferred before the date of dissolution at a value which is lower than the fair market value, the difference might be treated as deemed gift as per section 4(1)(a) of the Gift Tax Act. However it may be noted that gift tax has been abolished w.e.f. 1.10.1998.
	GOODWILL :
	The firm may be transferred to the sole proprietor along with its goodwill. However the goodwill may be valued in an appropriate manner and the amount shall be taxable as capital gain in the hands of the firm for the purpose of Income Tax.
	CONCLUSION :
	After carefully considering the benefits as well as implications, one should go for conversion of a firm into sole proprietorship, if it is considered useful in the given circumstances.
	Death and taxes are inevitable; at least death doesn't get worse every year - Unknown