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Overview

Sole proprietorship is owned by an individual and he/she is personally liable for all the debts and responsibilities of the firm and the business. The business and the owner are not different; they hold single identity, which means that all the property possessed in the name of the firm belongs to the proprietor alone. It have many advantages and it has few limitations as well which can lead to situation where the conversion to the other identity may be required. A Sole Proprietorship is easy to start but can hamper your growth. After all, it’s difficult to build a big business as a single person. If one is looking to add partners to their business without any hassle or hindrance, then it is recommended to switch to a partnership.

There is no specific provision under the Goods and Services Tax (GST) Act on how to convert a proprietorship into a partnership. Still, there are various mentions in the Act on converting a proprietorship into partnership firm. It includes obtaining GST registration for partnership, transfer of unutilised Input Tax Credit (ITC) to partnership firm, and cancellation of proprietorship GST registration.

Prerequisites

It is important to create a partnership firm to convert the proprietorship into a Partnership Firm and then it is essential to obtain the partnership firm’s PAN, GST registration and bank accounts. To start with, partners have to write an agreement called “Partnership Deed”, which includes all the terms and conditions under which such partnership comes into force. As the legal forms of both type of entities are different, so, PAN number, GST Number, Bank Accounts of both entities will always be different from each other. PAN of individual person owing proprietorship firm serves itself as PAN of such firm. However, for partnership, PAN is different from the PAN of partners.

So to convert the proprietorship firm into a Partnership firm, firstly, it is required to incorporate a partnership firm and then arrange for PAN, GST number, Bank accounts of the Partnership firm.

Procedure

Firstly, it is required to write an agreement called “Partnership Deed” which shall describe all the terms and conditions on which such partnership comes into existence. Partnership deed must have following components:-

  • Name of Partners
  • Address of Partners
  • Name of Partnership Firm
  • Address of Partnership Firm
  • Objects of such firm
  • Capital Contribution % of all partners
  • Profit % of all partners
  • Other Terms and Conditions as mutually agreed.

After this, apply for PAN and TAN number with Income Tax department because PAN number is a mandatory requirement to apply for registration under GST.

Once PAN of partnership firm received, apply for registration under GST. Followings are the set of documents required for application under GST:-

  • PAN card of Firm
  • Partnership Deed
  • PAN card of all partners
  • Aadhar Card/Voter ID/Passport/Driving Licence of all partners on which address is correct and matches with address given in Partnership Deed.
  • Snap of all Partners
  • Authorisation Letter in the name of any one partner to make him/her authorised signatory for GST registration
  • Document evidencing address proof for business place(s) of firm.
  • Utility bill/Fard/Property Tax Receipt (latest of two months) of such business place
  • Copy of certificate of registration under any other act.

Once all above documents compiled, get registration number under GST for this Partnership firm.

Once GST number successfully generated, it is required to open a current account of the firm. After this, complete the process of seeding such Bank account details to GST registration.

Filing of Returns

While submitting the cancellation for GST registration of proprietorship, the taxpayer has to give the date from which the registration is to be cancelled. In addition, while applying for new GST registration of the partnership firm, the taxpayer has to submit the date on which liability to register arises. The taxpayer has to make sure that both the above dates are the same, and this will be the effective date for GST registration of partnership.

Transfer of Business

The transfer of stock or other assets while converting an existing proprietorship entity into a new partnership firm is exempted under GST, because such goods/assets are transferred for the continuance of the same business. This exemption has been specified in Schedule II of the CGST Act. This benefit is available when the existing firm ceases to be a taxable person after such conversion. However, it is also provided that, in case of conversion, existing firm should cease to be a taxable person at all. There should not be any activity in existing firm after transfer of all assets including stock into new entity.

Unutilized input tax credits

After completing the filing of the pending returns, the taxpayer can transfer the unutilised ITC to the partnership firm. Following are the steps for transferring unutilised ITC to the partnership firm:

(1) Proprietorship firm shall file in FORM GST ITC-02, along with a request for transfer of unutilized input tax credit lying in his electronic credit ledger to the partnership firm;

(2) The proprietorship firm shall also submit a copy of a certificate issued by a practicing chartered accountant or cost accountant certifying that the sale, merger, de-merger, amalgamation, lease or transfer of business has been done with a specific provision for the transfer of liabilities.

(3) The Partnership firm shall, on the common portal, accept the details so furnished by the proprietorship firm and, upon such acceptance, the un-utilized credit specified in FORM GST ITC-02 shall be credited to his electronic credit ledger.

(4) The inputs and capital goods so transferred shall be duly accounted for by the partnership firm in his books of account.

Transfer of Balance

There is no provision under the GST Act to transfer balance in electronic cash ledger from one entity to another entity. Hence, the taxpayer has to file the Form RFD-01 with a refund type of either “Refund of Excess Balance in Electronic Cash Ledger” or “Refund on Account of Any Other Reasons” to get the refund of balance in electronic cash ledger.

Cancellation of GST

Once the pending returns were filed, and all tax dues have been paid off, request for the cancellation of the GST registration in Form GST REG 16 citing reasons as ‘Changing the company’s legal framework’. It will also ask for the new partnership firm’s GST number.

Benefits

Shared Liabilities: The term Partnership, itself describes two or more individuals coming together for fulfilling some common objective. The partnerships referred here are of pure business nature. Therefore, the partners share the responsibility to work and manage the business. Partners share rights and liabilities in the business, dividing the burden of responsibilities among them. Not just money but resources, knowledge and judgment are also pooled in for improving the business.

With conversion, you do not need to start new business: With conversion, the accumulated loss and unabsorbed depreciation of Proprietorship is deemed adjusted as loss/ depreciation of the successor partnership firm. All the assets and liabilities of the firm immediately after the conversion are turned into the assets and liabilities of the partnership. All movable and immovable properties of the firm automatically vest in the partnership. Hence, the conversion is easy and hassle-free.

Partner net worth is Increased: There is a distribution of Post-Tax profits among the partners with no additional tax liability. No Capital Gains tax shall be charged on transfer of property from Proprietorship to Partnership firm. The reduction of tax liabilities indirectly increases the amount of money earned which results in an increase of net worth of all the partners.

No fixed capital investment required: The partners can internally decide on their individual investment in the firm and then divide the stakes accordingly, which gives them the flexibility to make decisions in the business. Uneven capital contribution between partners is permissible. There is no predefined limit on partners’ capital contribution, allowing the partners for putting in preferable amounts as capital and make decisions about the withdrawals mutually.

Conclusion

This is the whole process of converting a proprietorship firm into a partnership business. It should also be noted that the same procedures mentioned above apply in other cases, where one legal entity converts into another legal form. Such as converting a partnership firm into a proprietorship firm, a private limited/OPC/public limited or vice versa.

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