Converting Your Business: Proprietorship, Firm, LLP and Company Conversions and Their Tax Conditions
Conversion lets a business change its legal form while keeping its assets, liabilities, contracts and history. Without care, though, a conversion can be treated as a transfer for income tax purposes, which triggers capital gains, and it can create stamp duty and GST costs. Here is a guide to the common routes.
The common conversion routes
| From → To | Legal route |
|---|---|
| Proprietorship → Private company | Business transfer to a newly incorporated company (succession) |
| Partnership firm → LLP | Section 55 and Schedule II of the LLP Act |
| Partnership firm → Company | Part I of Chapter XXI (Section 366) of the Companies Act |
| Private company → LLP | Section 56 and Schedule III of the LLP Act |
| OPC → Private / public company | Rule 6 of the Incorporation Rules (no conditions since 2021) |
| Private ↔ Public company | Section 14 / Section 18 – alteration of articles and fresh certificate |
Tax-neutrality conditions
The Income-tax Act exempts certain conversions from capital gains, subject to conditions. These were in clauses (xiii), (xiiib) and (xiv) of Section 47 of the 1961 Act and are carried into the 2025 Act. Broadly:
Proprietorship → Company
- all assets and liabilities of the business become those of the company
- the proprietor holds at least 50% of the voting power for five years after the succession
- the proprietor receives no consideration other than shares in the company
Firm → Company
- all assets and liabilities of the firm become those of the company
- all partners become shareholders in the same proportion as their capital accounts
- partners receive no consideration other than shares
- partners together hold at least 50% of the voting power for five years
Private company → LLP
- all assets and liabilities pass to the LLP, and all shareholders become partners in proportion to their shareholding
- shareholders receive no consideration other than a share in profit and capital contribution
- the company's total sales, turnover or gross receipts did not exceed ₹60 lakh in any of the three preceding years, and its total assets did not exceed ₹5 crore in any of those years
- no amount is paid to the partners out of the accumulated profits for three years
If a condition is breached later, the exemption is withdrawn and the gain is taxed in the year of breach.
Points that are easy to miss
- Stamp duty. Conversion under the LLP Act or Chapter XXI is generally treated as vesting by operation of law, not as a conveyance. A business transfer by a proprietor, however, can attract stamp duty on immovable property. The position varies by state.
- GST. Unutilised input tax credit can be transferred to the new entity through ITC-02, where the transfer includes a provision for transfer of liabilities. The new entity needs its own GST registration.
- Licences and registrations. IEC, FSSAI, Shop Act, trade licence, Udyam and professional registrations must be updated or re-obtained.
- Bank accounts and loans. Get the lender's consent in advance. Loan agreements usually restrict a change of constitution.
- Contracts. Check the assignment and change-of-control clauses in customer, vendor and lease agreements.
- Accumulated losses and depreciation – the rules on carrying them forward differ by type of conversion.
Sequencing a conversion
- Finalise the target structure and confirm that the tax conditions can be met for the required period.
- Get lender and key-counterparty consents.
- Prepare the financial statements as on the conversion date.
- File the conversion forms and obtain the certificate.
- Transfer registrations, credit and bank accounts, and notify customers and vendors.
The information in this article reflects the law as on the date of publication and is for general guidance only.