Amalgamation of Sole Proprietorship with Company

Amalgamation of Sole Proprietorship with Company. Can you merge your sole proprietorship business with a company? The prohibition by law and possibilities for your business 
In the dynamic landscape of various structures of business ownership in India, the prospect of transitioning from a sole proprietorship is laden with opportunities and considerations. In this article, Compliance Calendar explores the legal framework, procedural nuances, and recent case laws that impose prohibition on amalgamation of sole proprietorship with a company
What makes a sole proprietorship business unique? 
A sole proprietorship business is a one man army, that is relatively simple and cost effective, compared to corporate ownerships like a company or partnership. 
As the business is owned by one person, the founder-owner enjoys complete control over the business, decision making and operations. The distinct advantages of a sole proprietorship business are as follows:

Tax benefits - A sole proprietorship is taxed in India based on individual tax slabs rates. Based on the latest Budget 2024-25, if the proprietor is less than 60 years old, income up to 2.5 lacs is exempted. The tax rate is 5% for income upto 5 lacs, 20% for income upto10 lacs. The highest slab of 30% is applicable for progressive income above 10 lacs. For small businesses, this typically reduces the overall liability of tax. Losses are allowed to be carried forward and deductions under Sections 10A, 10B, 80-IA, IAB etc. are also allowed.

Minimal compliance requirement - Unlike other business structures like corporations or partnerships, sole proprietorships have fewer regulatory compliance obligations. There is no legal requirement to hold annual meetings, maintain extensive records, or file separate tax returns for the business entity.

Confidentiality and Complete ownership over profits- As the sole owner, the proprietor can maintain confidentiality and closely guard business secrets. He/she is also singularly entitled to all the profits generated by the business. Since there is no sharing of profits with partners or shareholders, there is greater scope for creativity, bold decisions and reaping the rewards of it.

Ease of closure - In the event of discontinuing operations, winding up a sole proprietorship is relatively simple. The proprietor can cease business activities without the need for extensive legal procedures or formal dissolution processes required for other business entities.

Amalgamation of “a Sole Proprietorship Firm” with “a Company” is not permissible under the law.
Delhi High Court’s order on December 1, 2023 in SVS Marketing Sanitary ware Pvt. Ltd versus Kajaria  Bathware Private Ltd (Company Petition No. (IB)-322(ND)2023) 
Brief facts of the case- 
SVS Marketing Sanitary ware Private Limited (Applicant/'Operational Creditor') filed a petition under Section 9 of the Insolvency and Bankruptcy Code for debt owed due to unsold stock under the Distribution Agreement with the respondents - Kajaria Bathware Private Limited (“Respondent/Corporate Debtor”). 
A Distributorship Agreement dated 15.07.2016 was executed between the Respondent and Mr. Shibu M (proprietorship concern trading as "SVS Marketing"). This sole proprietorship was transferred to a private limited company, with the promoter of both being the same. 
Crucial question of law involved in the case - Whether assignment of debt owed by a sole proprietor to a company by way of an amalgamation agreement is valid? 
Order of the Delhi High Court 
A merger must involve two companies - The court noted that under Section 232 of the Companies Act, 2013, the parties that are eligible to seek a merger or amalgamation have to be two or more companies only. Specifically, Section 232(1)(a) uses the phrase “……a scheme for the reconstruction of company or companies involving merger or the amalgamation of any two or more companies” 
On this ground, the Delhi High Court has held that an amalgamation of a sole proprietorship firm with a Company is not permissible under law. 
The Delhi High Court also notes that a sole proprietorship has no legal entity of its own and is only known by the identity of its proprietor. When the proprietor becomes a member or shareholder of the company, the provisions of Section 230 are still available to the sole proprietor, for the purpose of Compromise and Arrangement, by filing a petition before NCLT. 
Thus, this ruling by Delhi HC in Kajaria Bathware Pvt Ltd has re-iterated the legal bar on merger of a sole proprietorship with the company.  
Navigating the transition - Conversion of Sole Proprietorship to a Private Limited Company 
While the overall benefits of operating as a sole proprietorship in India make it an attractive option for aspiring entrepreneurs, there are certain inherent risks unique to a sole proprietorship. These risks can be mitigated by converting a sole proprietorship into a private limited company. 
Limiting the liability of the proprietor - In the event of bankruptcy on part of the firm, the personal assets of the sole proprietor can be sold to discharge the debt. This is because the law does not view the identity of the individual as separate from the business. However, in a company form of business, the assets of promoters/directors are distinct and separate from those owned by the company. This ringfences the personal assets of those in charge of the business from any insolvency proceedings filed on behalf of the company. 
Transferability and Continued Existence - A company offers greater flexibility in case of transfer of shares owing to a change in ownership style and structure. This opens new possibilities of mergers and takeovers that are not available to a sole proprietor. Moreover, the death or departure of shareholders or directors does not affect the continuity of the company. This ensures greater stability and continuity of business operations, making it easier to attract long-term investors. 
Economic efficiency through raising capital and lower taxes for a growing business - A company can access investments through multiple sources that are not available to a sole proprietor. This includes angel investment, raising funds through venture capital, public issue and private placement of shares. Moreover, a lower corporate tax rate at around 22% is applicable for domestic companies. Additional tax benefits such as deductions under Chapter VI-A, minimum alternative tax and economic benefits of beneficial schemes such as Production Linked Incentive etc. are available exclusively to companies.  
Mandatory conditions for converting to a sole proprietorship 
In order to convert a business from a sole proprietorship to a private limited company form, the following conditions should mandatory be followed.

Transfer of all assets and liabilities of the proprietorship to the new private limited company. After the incorporation formalities are fulfilled, the assets and liabilities are transferred to the books of accounts of the new company.

Retention of ownership – the sole proprietor should retain a minimum of 50% shares in the new company and must hold these shares for a minimum of five years from the date of incorporation. Additionally, a minimum of two directors are required.

Not involve monetary consideration - There must not be any monetary consideration involved in this process. This is because the conversion from sole proprietorship to private limited company is not considered to be a sale of business.

Brief procedure involved in converting sole proprietorship to a private limited company

Obtain Director Identification Number and Digital Signature Certificate for all the directors involved in the conversion process. Additionally, copies of Aadhar card, PAN Card of the Directors are required.

Fill the SPICE+ form, which combines formalities of 13 services by three different ministries (Ministry of Corporate Affairs, Ministry of Labor, and Department of Revenue, Ministry of Finance) for name reservation, incorporation, PAN allocation etc. Using the AGILE PRO - S form, application for registration of GSTIN, ESIC and EPFO number, opening of bank account etc. can be completed.

Draft the Memorandum of Association and the Articles of Association that align with the company’s objectives, future prospects for growth and ultimate aim.

Apply for a new PAN (permanent account number) and TAN (tax deduction and collection account number) for the new company.

Minimum share capital of at least 1 lac is required to convert to a private limited company.

Details such as address of the company, number of subscribers to Memorandum of Association, stamp duty and other information will also be required by the Ministry of Corporate Affairs before conversion to a private company.

Under the purview of the Companies Act, 2013 the conversion of a sole proprietorship into a company embodies a strategic move aimed at leveraging greater fiscal and tax benefits, accessing resources, and expanding horizons. Compliance Calendar has advised diverse entrepreneurs on choosing the right business model, filing legal documents and accessing funding. Connect with our experts today for professional guidance on a smooth and successful conversion process to a private company.

Can you merge your sole proprietorship business with a company? The prohibition by law and possibilities for your business

In the dynamic landscape of various structures of business ownership in India, the prospect of transitioning from a sole proprietorship is laden with opportunities and considerations. In this article, Compliance Calendar explores the legal framework, procedural nuances, and recent case laws that impose prohibition on amalgamation of sole proprietorship with a company

What makes a sole proprietorship business unique?

A sole proprietorship business is a one man army, that is relatively simple and cost effective, compared to corporate ownerships like a company or partnership.

As the business is owned by one person, the founder-owner enjoys complete control over the business, decision making and operations. The distinct advantages of a sole proprietorship business are as follows:

Tax benefits - A sole proprietorship is taxed in India based on individual tax slabs rates. Based on the latest Budget 2024-25, if the proprietor is less than 60 years old, income up to 2.5 lacs is exempted. The tax rate is 5% for income upto 5 lacs, 20% for income upto10 lacs. The highest slab of 30% is applicable for progressive income above 10 lacs. For small businesses, this typically reduces the overall liability of tax. Losses are allowed to be carried forward and deductions under Sections 10A, 10B, 80-IA, IAB etc. are also allowed.

Minimal compliance requirement - Unlike other business structures like corporations or partnerships, sole proprietorships have fewer regulatory compliance obligations. There is no legal requirement to hold annual meetings, maintain extensive records, or file separate tax returns for the business entity.

Confidentiality and Complete ownership over profits- As the sole owner, the proprietor can maintain confidentiality and closely guard business secrets. He/she is also singularly entitled to all the profits generated by the business. Since there is no sharing of profits with partners or shareholders, there is greater scope for creativity, bold decisions and reaping the rewards of it.

Ease of closure - In the event of discontinuing operations, winding up a sole proprietorship is relatively simple. The proprietor can cease business activities without the need for extensive legal procedures or formal dissolution processes required for other business entities.

Amalgamation of “a Sole Proprietorship Firm” with “a Company” is not permissible under the law.

Delhi High Court’s order on December 1, 2023 in SVS Marketing Sanitary ware Pvt. Ltd versus Kajaria Bathware Private Ltd (Company Petition No. (IB)-322(ND)2023)

Brief facts of the case-

SVS Marketing Sanitary ware Private Limited (Applicant/'Operational Creditor') filed a petition under Section 9 of the Insolvency and Bankruptcy Code for debt owed due to unsold stock under the Distribution Agreement with the respondents - Kajaria Bathware Private Limited (“Respondent/Corporate Debtor”).

A Distributorship Agreement dated 15.07.2016 was executed between the Respondent and Mr. Shibu M (proprietorship concern trading as "SVS Marketing"). This sole proprietorship was transferred to a private limited company, with the promoter of both being the same.

Crucial question of law involved in the case - Whether assignment of debt owed by a sole proprietor to a company by way of an amalgamation agreement is valid?

Order of the Delhi High Court

A merger must involve two companies - The court noted that under Section 232 of the Companies Act, 2013, the parties that are eligible to seek a merger or amalgamation have to be two or more companies only. Specifically, Section 232(1)(a) uses the phrase “……a scheme for the reconstruction of company or companies involving merger or the amalgamation of any two or more companies”

On this ground, the Delhi High Court has held that an amalgamation of a sole proprietorship firm with a Company is not permissible under law.

The Delhi High Court also notes that a sole proprietorship has no legal entity of its own and is only known by the identity of its proprietor. When the proprietor becomes a member or shareholder of the company, the provisions of Section 230 are still available to the sole proprietor, for the purpose of Compromise and Arrangement, by filing a petition before NCLT.

Thus, this ruling by Delhi HC in Kajaria Bathware Pvt Ltd has re-iterated the legal bar on merger of a sole proprietorship with the company.

Navigating the transition - Conversion of Sole Proprietorship to a Private Limited Company

While the overall benefits of operating as a sole proprietorship in India make it an attractive option for aspiring entrepreneurs, there are certain inherent risks unique to a sole proprietorship. These risks can be mitigated by converting a sole proprietorship into a private limited company.

Limiting the liability of the proprietor - In the event of bankruptcy on part of the firm, the personal assets of the sole proprietor can be sold to discharge the debt. This is because the law does not view the identity of the individual as separate from the business. However, in a company form of business, the assets of promoters/directors are distinct and separate from those owned by the company. This ringfences the personal assets of those in charge of the business from any insolvency proceedings filed on behalf of the company.

Transferability and Continued Existence - A company offers greater flexibility in case of transfer of shares owing to a change in ownership style and structure. This opens new possibilities of mergers and takeovers that are not available to a sole proprietor. Moreover, the death or departure of shareholders or directors does not affect the continuity of the company. This ensures greater stability and continuity of business operations, making it easier to attract long-term investors.

Economic efficiency through raising capital and lower taxes for a growing business - A company can access investments through multiple sources that are not available to a sole proprietor. This includes angel investment, raising funds through venture capital, public issue and private placement of shares. Moreover, a lower corporate tax rate at around 22% is applicable for domestic companies. Additional tax benefits such as deductions under Chapter VI-A, minimum alternative tax and economic benefits of beneficial schemes such as Production Linked Incentive etc. are available exclusively to companies.

Mandatory conditions for converting to a sole proprietorship

In order to convert a business from a sole proprietorship to a private limited company form, the following conditions should mandatory be followed.

Transfer of all assets and liabilities of the proprietorship to the new private limited company. After the incorporation formalities are fulfilled, the assets and liabilities are transferred to the books of accounts of the new company.
Retention of ownership – the sole proprietor should retain a minimum of 50% shares in the new company and must hold these shares for a minimum of five years from the date of incorporation. Additionally, a minimum of two directors are required.
Not involve monetary consideration - There must not be any monetary consideration involved in this process. This is because the conversion from sole proprietorship to private limited company is not considered to be a sale of business.

Brief procedure involved in converting sole proprietorship to a private limited company

Obtain Director Identification Number and Digital Signature Certificate for all the directors involved in the conversion process. Additionally, copies of Aadhar card, PAN Card of the Directors are required.
Fill the SPICE+ form, which combines formalities of 13 services by three different ministries (Ministry of Corporate Affairs, Ministry of Labor, and Department of Revenue, Ministry of Finance) for name reservation, incorporation, PAN allocation etc. Using the AGILE PRO - S form, application for registration of GSTIN, ESIC and EPFO number, opening of bank account etc. can be completed.
Draft the Memorandum of Association and the Articles of Association that align with the company’s objectives, future prospects for growth and ultimate aim.
Apply for a new PAN (permanent account number) and TAN (tax deduction and collection account number) for the new company.
Minimum share capital of at least 1 lac is required to convert to a private limited company.
Details such as address of the company, number of subscribers to Memorandum of Association, stamp duty and other information will also be required by the Ministry of Corporate Affairs before conversion to a private company.