You are currently viewing Can a Sole Proprietorship be Converted into a Partnership Firm?

Can a Sole Proprietorship be Converted into a Partnership Firm?

Loading

A sole proprietorship is simple to establish but not ideal for expansion. A partnership is best if you wish to expand and bring on new partners without any bother or obstacles.

A sole proprietorship is a business solely owned by one natural person and in which there is no separation of the owner’s rights from those of the company. The business owner engages in his or her activity without establishing a separate legal entity.

“Partnership” refers to a relationship between individuals who have decided to split the earnings from a business that is operated by all of them acting collectively or by any one of them.

Key Takeaways

  1. Sole proprietorships lack expansion potential, making partnership conversion a suitable option for growth and bringing in new partners.
  2. One individual owns a sole proprietorship, while a partnership involves collectively sharing business earnings.
  3. Reasons to convert include fewer legal obligations, shared management responsibilities, enhanced privacy, tax efficiency, attracting partners and raising capital.
  4. Sole proprietorship drawbacks include limitations on ownership transfer, personal liability, lack of continuity, difficulty in obtaining funds, and higher tax incidence.
  5. The conversion process involves drafting a partnership deed, declaring the transfer, choosing a name, establishing a mutual agency, specifying investment details, and optionally registering the partnership.
  6. Tax implications include changes in tax liabilities and accounting procedures after conversion.
  7. Partnerships may have joint and several liabilities, individual and collective responsibilities, and obligations such as providing accurate information and maximizing common interests.

Reasons to Convert from Sole Proprietorship to Partnership

Benefits of partnership firm

  • Less formal and with fewer legal obligations: A commercial partnership is much less formal than a limited company.
  • Share and share alike: The task of managing a firm falls entirely on the shoulders of a lone proprietor, whereas partnerships gain from companionship and support from one another.
  • More privacy: A partnership might maintain complete secrecy regarding its business dealings. 
  • Tax efficiency: In a partnership, you take profit rather than a wage through PAYE or dividend payments. Partnerships provide the greatest flexibility because of this. The profits can be distributed however you like.

Drawbacks of a sole proprietorship

  • Proprietorship management: An individual owns and runs a sole proprietorship. In a proprietorship, it can be difficult to pass over ownership of a running business to one’s legal successors because many licenses and registrations are held in the proprietor’s name and cannot be transferred.
  • Proprietorship capital: The capital of a sole proprietorship firm and the proprietor’s money is the same in a sole proprietorship firm. The proprietorship and proprietorship funds are, therefore, equivalent. Additionally, sole proprietorships are unable to solicit equity funding or add partners.
  • Proprietorship liability: The sole proprietorship business’s liabilities are held individually accountable by the owner. Due to this, the proprietor could incur indefinite company obligations.
  • Business continuity: A proprietorship business lacks continuity because the owner’s death or incapacitation constitutes legal termination. Therefore, the longevity or continuity of a sole proprietorship company is constrained.
  • Difficulty in obtaining funds: A sole owner is prohibited from selling stock or business interests, preventing the entity from acquiring equity financing. Furthermore, because a proprietorship firm’s existence is dependent on its owner, banks are hesitant to lend significant quantities of money to them. 
  • Higher tax incidence: Ownership businesses are taxed similarly to individuals. As a result, a proprietorship firm’s income tax rate depends on slabs. Additionally, a proprietorship firm’s income tax rate is greater than a company’s tax rate for taxable income of more than Rs. 10 lakhs.

Steps to Convert a Sole Proprietorship Firm to a Partnership Firm

Required documents

  • Business proof: Electricity bill or telephone bill of the registered office address
  • ID proof: Self-attested copy of the Aadhaar card, voter ID, passport, or driving license of all partners.
    A self-attested copy of the PAN card of all partners.
  • Details about the sole proprietor’s business: Forms for changing the status of the business must be submitted to the relevant departments if the proprietorship firm has a goods and services tax (GST) license or any other registrations.
  • Statement of assets and liabilities: Updated statement of assets and liabilities certified by a chartered accountant.

Conversion procedure

Drafting of partnership deed

Writing the partnership deed for the business is the first step in transforming a sole proprietorship into a partnership. The foundation of the company and the partnership will be established through this.

The partnership’s beginning date, also known as the partners’ induction information, must be stated in the deed.

Declaration of transfer

The declaration of transfer deed is distinct from the normal partnership document. The proprietorship business will be mentioned multiple times, and the move to a partnership firm will be announced.

By law, deeds must include certain information, including the date the sole proprietorship was established, the proprietor’s name, the type of business, and other specifics like service tax registration and value-added tax. In this situation, you must disclose the TIN and service tax number.

Choosing name

Any name is acceptable for the partners to choose for their partnership firm. The government enforces no pre-established set of guidelines for naming the company. The only thing to remember is that the name chosen must not be similar to another company’s name or imply any affiliation with a federal or state agency.

Mutual agency between partners

This means that each partner will be held accountable for the other partners’ decisions. As a result, in a mutual agency, each partner represents the principals or agents of the other partners.

Minor:  A minor cannot be made a party to a contract or a legitimate business partner. However, if necessary, a minor might be added to the partnership to share in the gains and avoid liability in the event of a loss.

Investment details

This is one of the most crucial decisions, so you should make it carefully. The deed must specify how much capital each partner will contribute, how profits and losses will be split, and what will happen to one or more partners after retirement.

The deed must also include a detailed description of every change anticipated due to the addition of the new company partners. It also covers any modification to the firm’s registered address information.

Registration

Partnership registration is not a must. The government advises that the deed be recorded nonetheless. By registering the deed, the partners will be entitled to initiate lawsuits on their behalf or behalf of the partnership firm.

After the document is approved by all partners and attested to, the sole proprietorship is dissolved. The collaboration agreement also enters into force.

Partnership firm registration

Tax implications of conversion

Changes in tax liabilities

No capital gains tax shall be levied on the transfer of property from a sole proprietorship to a partnership firm. The decrease in tax obligations indirectly raises income, raising all partners’ net worth.

Accounting procedures after conversion

Except that each partner has a separate capital and drawing account, partnership accounting is the same as proprietorship accounting. Except that total owners’ equity is equal to the sum of the partners’ capital accounts, the basic accounting equation (assets = liabilities + owner’s equity) remains unaltered.

Liabilities and obligations of partners

In a partnership, joint and several liabilities refer to the degree of accountability each participant has assumed, particularly in the event of a dispute. Both partners are responsible for a joint-liability partnership. However, a numerous-liability partnership restricts the degree of responsibility one partner bears for the activities of the other partners.

There are other partnerships with joint and several responsibilities, in which each partner is accountable for their deeds but is also liable if another partner fails to fulfil their obligation. Therefore, they may be sued jointly or separately.

Individual and collective responsibilities

The Indian Partnership Act 1932 stipulates key obligations for partners in its sections.

Responsibilities of partners

1. Giving true accounts and complete information: The partner’s responsible for giving both true accounts and complete information.

2. Covering up for any loss brought on by the fraud: If there is any loss brought on by the deception of a partner in the firm’s operations that affects the firm or any of its partners, in that situation, the dishonest partner is obligated to make up for the loss suffered by the company or the other partners.

3. Maximizing common interests: Conducting business in the partners’ best interests is each partner’s most important responsibility.

4. Accounting for any personal profits made by partners: If partners make any money off of business dealings with the company or the firm’s name or other assets, they are responsible for accounting for those profits and must pay them to the company.

Conclusion

While a proprietorship has benefits like ease of creation, control, flexibility, and direct profits, it also has drawbacks like unlimited liability, scarce resources, insufficient skills and competence, and potential issues with company continuity. When determining the best business structure for their venture, aspiring entrepreneurs should consider these criteria.

A reputable service provider, Govche India Pvt. Ltd.’s web portal Kanakkupillai.com, may help with company registration in India. Their professionals can help you through the procedure and guarantee that you comply with the law thanks to their experience and understanding of business registrations.

Given the preceding, we hope that this blog will be useful to all curious visitors who are interested in learning how a sole proprietorship could be changed into a partnership firm.

Kanakkupillai

Kanakkupillai is your reliable partner for every step of your business journey in India. We offer reasonable and expert assistance to ensure legal compliance, covering business registration, tax compliance, accounting and bookkeeping, and intellectual property protection. Let us help you navigate the complex legal and regulatory requirements so you can focus on growing your business. Contact us today to learn more.