Exemption form capital gains tax: SUCCESSION OF SOLE PROPRIETARY BUSINESS BY COMPANY.

[C.A. DEV KUMAR KOTHARI]

Relevant provisions and links:

Secion 47 (xiv) of the Income-tax Act, 1961.

Reconstruction of sole proprietary business:

A business may be carried as a sole proprietary concern. However, due to limitations of proprietor he may not be able to expand business. For expansion of business he may need more resources of different types. For expansion one may choose to enter into partnership arrangements with others. One may choose to form a company and combine resources of others. Succession of business by a company is also an important manner to reconstruct the business of sole proprietary concern. In case of succession one view is that there is no transfer but succession is by way of agreement to succeed the business on incorporation of company incorporated for the purpose of succession of business.

Succession of business by a company and exemption of capital gains:

We find a provision in clause (xiv) of section 47 of the Income-tax act, 1961 according to which in case of succession of business of a sole proprietary concern by a company the transfer of business is not considered as a transfer for the purpose of taxation of capital gains. To avail such exemption one need to make compliance of various conditions.

Conditions are simple and provide scope to expand business:

On reading of the said provision we find that the conditions are simple. There is condition that the sole proprietor of business which is succeeded should get consideration only in form of shares of company and he should hold at least 50% stake, in terms of voting rights, during five years from the date of succession of business. Thus the conditions are   not very tough. There is sufficient scope to pool together resources because 50% share capital can be raised from other persons also. The lock-in-period of five years is also not very long.

Illustrative  documents:

In this article some model documents/ clauses in documents specifically required for the purpose of succession and compliance with the said conditions are  suggested.

MEMORANDUM OF UNDERSTANDING FOR SUCCESSION OF PROPRIETORY CONCERN BY A COMPANY

Parties to MOU	Shri    SP     S/o              residing at …..      sole proprietor of M/s.   SPC       (sole proprietary concern) Carrying business at  …. And:  SP and SS (co-promoters of company  in process of incorporation  to be known as SPC P. Ltd, to succeed business of SPC. The promoters have obtained approval of the name of company to be incorporated.)
Purpose:	To succeed the business of  SPC by a company (  SPC P. LTD)  to be incorporated by the parties to the agreement by subscribing to the MOA and AOA of the successor company with the main objects inter alia to succeed and carry on business of SPC .
Date of succession	Immediately on incorporation of company (SPC P. Ltd) the business of  SPC (sole proprietary concern) shall be succeeded on as is where is basis and then entire business undertaking with all assets and liabilities shall belong to the company and steps shall be taken for recording of company as sole proprietor of SPC in place of SP.  From the date of incorporation, all business activities , transactions , dealings , changes in assets and liabilities of the  SPC shall be for and on account of and on behalf of  the company (SPC P. Ltd)  as  sole proprietor of the proprietary concern.
Physical verification and valuation of properties:	Physical verification and  confirmation  of all tangible and intangible  assets, properties , valuables, rights, privileges,  assets  of any kind as also all liabilities  shall be made and necessary adjustments shall be made in accounts as on the date of incorporation of company for the purpose of succession  and  shall be  valued  after due consideration of all business and financial aspects including present and future utility, any obsolescence, damages, wear and tear, self created assets etc. taxmanagementindia.com
Declaration of succession:	The succession of SPC by SPC P. Ltd will be by way of legal process on issue of Certificate of incorporation by the ROC. However, after such succession and after verification and valuation of all assets and ascertainment of number of shares to be issued, SP and directors of SCP P. Ltd shall execute a suitable declaration in this regard and that declaration shall incorporate broad terms and conditions for succession of business of SPC by SPC P. Ltd .
Issue of share	Shares shall be issued at such price (including premium) to subscribers and others associates as may be mutually decided keeping in mind objective of strong capital base of company.
Minimum shareholding of SP	SP shall be allotted and  he shall continue to hold at least 50% voting rights in SPC P. Ltd for a minimum period of five years from the date of succession of business by SPC P. Ltd. The other subscribers / promoters and shareholders shall also be bound by this condition.
Compliance of conditions of S.47 (xiv) of Income-tax Act,1961.	It is agreed by all parties that provisions of S. 47 (xiv) of the Income-tax act, 1961 shall be complied with  in all respect for succession of proprietary concern as well as during the lock-in-period/ restriction  period as laid down in the said provision. The company (SPC P. Ltd) shall also ensure such compliances and shall incorporate suitable provisions in its memorandum and articles of association to ensure compliance of conditions of the said provisions. In case any party causes breach of such conditions, then he shall indemnify loss caused due to such breach to other parties and SPC P. Ltd.
Disputes:	In case of any dispute, the matter shall be discussed and decided mutually, failing which the matter shall be referred to arbitration.

Main object in the Memorandum of Association of company:

[A]        THE MAIN OBJECTS TO BE PURSUED BY THE COMPANY ON ITS INCORPORATION ARE:

To  succeed  the business of  the sole proprietorship firm  of SP known by trade name as  “SPC”   by the company  and as a result of succession of the “SPC”, carry  on  all businesses carried by “SPC” such as  “to carry on the business of manufacturing, installation, commissioning, servicing, trading, marketing and to act as buyers, sellers, importers, exporters, merchants, indenters, brokers, agents, commission agents, assemblers, retailers, traders, stockiest, consultants and distributors of  ……. ” .

[B]       THE OBJECTS INCIDENTAL OR ANCILLARY TO THE ATTAINMENT OF THE MAIN OBJECTS OF THE COMPANY ARE:

1. To succeed and get  transferred all  asset of the firm including tangible and  intangible asset, self created assets, goodwill, with all  liabilities  of the sole  proprietorship firm, M/s SPC in favour of    the  immediately and with effect from the date of incorporation of company provided that-

(a)     all the assets and liabilities of the firm relating to the business immediately before the

        succession becomes the assets and liabilities of the company;

(b)     the proprietor of the firm , immediately before the succession, become the shareholder of the company .

(c)     the proprietor of the firm  do not receive any consideration or benefit , directly or indirectly , in any form or manner, other than by way of  allotment of shares in the company; and

(d)     the aggregate of the shareholding in the company of the proprietor of the firm  is not less than fifty percent of the total voting power of the company and  he continues to hold at least fifty percent of voting rights in the company for a minimum period of  five years from the date of succession (that is the date of incorporation).

(e)     The company and its directors  will have to comply with conditions of provisions of clause (xiv) of section  47  of the Income-tax Act, 1961. 

 Important specific clauses in the article of association:

         The directors of company jointly with SP shall make a declaration that the company has succeeded the business of M/s. Sole Proprietary Concern (SPC) on incorporation and with effect from the date of incorporation of company and that declaration shall also include the details of assets and liabilities succeeded and transferred in favor of the company  , the consideration to be discharged by issue of shares and other terms and conditions of succession, carrying business and all related aspects for effectively succeeding and carrying the business of SPC by company as its sole proprietor.

The company shall ensure that shareholding of SP shall not fall below 50% of total voting rights at any time during five years from the date of succession of business of SPC.

The company  and SP shall also ensure that all conditions of succession of business, as stipulated in the clause (xiv) of Section 47 of the Income-tax Act, 1961 are comply with during the period specified therein.    

Some relevant board Resolutions:

Extracts from the minutes of the Board Meeting of the company held on (the day of incorporation):

Succession of business of M/s. SPC:

The chairperson  informed that in terms of the Memorandum and Articles of Association of the company, the company has succeeded the business of M/s. SPC and has become sole proprietor of the said proprietary concern  with immediate effect from  the date of incorporation of the company that is          .2011. Accordingly  SP  has ceased to be sole proprietor of the said proprietary concern. The company succeeds the business of M/s. SPC  with all its assets and liabilities as on the beginning of the business hours of            2011.

SP  confirmed the same in his individual capacity as Ex-proprietor of M/s. SPC.  He also provided a copy of statement of affairs as on close of business hours on a day before the date of incorporation that is as on    . 2011  as per books of account and also list of assets and liabilities of the proprietary concern as on   …. 2011 including intangible assets, and self created assets described as goodwill in the said statement but representing various business assets of immense utility in carrying business of the concern.

The Chairman  informed the meeting that it is necessary to take inventory of all assets and liabilities of M/s. SPC  jointly by representative of company as  new sole proprietor and representatives of  SP  as Ex-proprietor of M/s. SPC.

It is also necessary to determine fair valuation of all assets and liabilities after considering utility of them while holding the same and using the same for carrying business of M/s. SPC . After discussion it was

“RESOLVED that  inventory of all assets and liabilities of M/s. SPC  be taken  jointly by representative of company as  new sole proprietor and representatives of  SP as Ex-proprietor of M/s. SPC.

Resolved that  fair valuation of all assets and liabilities of M/s. SPC be determined and negotiated after  due consideration of  utility of them while holding the same and using the same for carrying business of M/s. SPC.

Resolved that   Shri / Smt.  ……….  , Director / Officer   take necessary steps for the purpose and finalize the inventory and also valuation of all assets and liabilities after due consideration of conditions, utility and scope of use in future etc.  He/ She is also authorized to take help of technical team of M/s. SPC and any other professional persons as  He/ she may consider necessary in this regard for the purpose of valuation of assets and liabilities and negotiation  and finalization of the same.

Further Resolved that on determination of the net value of M/s. SPC , the consideration payable to  SP be determined and the same will be discharged only by way of issue of equity shares of the company in favor of  SP at such price (including premium)  as may be mutually negotiated keeping in mind the objective  to keep the capital base of the company stronger with low equity and  high reserves so that servicing of equity is easy and share command a better price.    

                                                                                                           

 DECLARATION

This declaration is made on   day of      , 2011,by and between parties namely (I)  Mr. SP  s/o Mr.  SPF  residing at                         , India, herein after referred to as SP or Ex-proprietor.

 

And M/s. “SPC Private Limited” (SPCPL), an Indian company, incorporated under the Companies Act, 1956, having its registered office at                India , hereinafter referred to as SPCPL or company.

 Whereas in terms of the Memorandum and Articles of Association of SPCPL, SPCPL has succeeded the business of M/s SPC  (Sole Proprietary concern) ,  and SPCL has  become the sole proprietor of M/s SPC  on incorporation of SPCL  with effect from      2011 (the date of incorporation)  and SP has  ceases to be sole Proprietor of M/s. Solace.

Whereas  for clarity and to avoid any confusion and doubts and to clearly establish rights and duties of concerned parties it is desirable to put into writing all relevant terms and conditions for succession of  business of M/s. SPC,  as follows:

1. That  SPCPL succeeds and  becomes sole proprietor of M/s. SPC   and  SP  ceases to be sole proprietor of M/s. SPC w.e.f.     2011 ( The date of incorporation).
2. That   all the assets and liabilities of M/s SPC have, becomes the assets and liabilities of  SPCPL as successor  and new sole proprietor of M/s SPC.
3. That SPCPL shall make allotment of shares in the company, to SP as the ex-proprietor of  M/s SPC  in consideration of the  succession of the business and all assets and liabilities of  M/s. SPC  by SPCPL.  SPCPL shall not pay any other consideration or provide any other benefit as any part of consideration to succeed M/s. SPC or for transfer of any assets of M/s. SPC.
4. That SP (ex-proprietor of M/s SPC) shall not demand and shall not  receive any consideration or benefit,  directly or indirectly, in any form or manner, other than by way of allotment of shares in the company  (SPCPL) for succession of  M/s SPC  as workout and detailed in this declaration.
5. SPCPL, and its directors  shall ensure that the shareholding of  SP  in SPCPL is not less than fifty percent of the total voting power in the company and his shareholding continue to remain as such for a minimum period of five years from the date of the succession of M/s. SPC  that is  from ….   2011 (date of incorporation) to             …. 2016.
6.  SP undertake and declare  that he shall not  engage himself  in any business which is similar to or is in competition to the business of M/s SPC for a minimum period of two years. 
7.  SPCPL as sole Proprietor of M/s SPC  can take all steps for  holding all assets , carrying business and SP shall assist in the same and for that purpose shall execute any documents for recording name of SPCPL as sole proprietor of M/s. SPC or for issuance of new certificates , licenses, registration etc. with any government authorities, parties, banks and others.
8.   During initial period and takeover process if any property , money or other things are received by SP in relation to business of M/s. SPC the same shall be belong to SPCPL and SP shall render account to SPCPL for all receipts and payments and transfer the same to SPCPL.
9. Inventory of assets, valuation and consideration thereof:

SPCPL and SP have jointly  made out inventory of all assets and liabilities of M/s SPC and valued the same as per Schedule  -I. Accordingly the net consideration payable on  succession of M/s. SPC   by SPCPL to SP is workout at Rs.          /- (Rs.   …  only) which shall be discharged by allotment of  … equity shares of Rs.10/- each having paid-up share capital of Rs.  …/- (Rs.    only) at   premium of Rs.  …. /-.

1. The above declarations shall constitute an agreement and understanding between parties to be affected in businesslike manner as per usual trade practices and practical requirements with a view  to achieve the purpose of the declaration cum agreement that is smooth succession and carrying of business of M/s. SPC by SPCPL as its new sole proprietor. In case of any dispute the matter shall be resolved by mutual dialogue and discussions, and in case of need by way of arbitration.

In witness whereof signed, sealed, declared and delivered by parties:

Witnesses to parties:                                           

                                                                  SP (Ex-sole proprietor of SPC)

                                                      Common Seal of SPC P. Ltd. Affixed and            

                                                     signed for and on behalf of company by:

                                                                             For SPC Private Limited                                                                                                                             

                                                                      (Director)      (Director)

                                                                         Authorised Signatory                                   

  Schedule-1

Details of Assets and Liabilities of M/s. SPC as on ….  ,2011, physically verified and taken over by SPCPL valued on consideration of users’ value and on as is where is basis :-

A S S E T S		AMOUNT		AMOUNT
Fixed assets:
Intangible Assets
CURRENT ASSETS :
Cash in hand Balance with banks: Stock - in –Trade: Finished goods, Other inventories VAT Receivable T.D.S Loans & Advances
Advance to Suppliers and service providers
Sundry Debtors
L I A B I L I T I E S	AMOUNT		AMOUNT
SECURED LOAN :
Bank Overdraft
CAR LOAN :
As per last Account
UNSECURED LOAN
Loans			644,323.00
CURRENT LIABILITIES &
PROVISIONS :
Sundry Creditors
Advance from Customers
Liabilities for Expenses (As per Sh– 2a)

                                                                 Rs.

Total of all Assets  of     SPC              

Less- Total Liabilities               

Net capital                                

(rounded off to Rs.     )

Name of Assets			Value taken as on
			.2011
A. C Machine
Computer / Printer
Furniture
Plant & Machinery
Car
Tools & Equipments
Total

                                              Schedule-1b

SCHEDULES	PARTICULARS	AMOUNT (RS.)
Schedules – 1b	LIABILITIES FOR EXPENSES :
	Audit Fees
	Business Promotion
	Consultancy Charges
	Freight Charges
	Performance Incentive
	Professional Fees
	Salary
	Bonus

                                                    Schedule-2

Consideration for succession of business  of M/s. Solace

Total number of equity shares allotted to Mr. SP    is  ….

Paid-up capital  per equity share                      Rs. 10   

Premium per equity share                                 Rs.

Total  value per equity share                            Rs. 

 Agreed total value of equity shares to be allotted to Mr. SP

  is Rs.  /-(Rs.            only).

                                                 Schedule-3         

                “SPC” (valuation of intangible assets) 

Taking over of all intangible assets of M/s SPC  by M/s. SPC  P. Ltd as sole proprietor from  SP ( ex- proprietor). And arriving at of agreed value based on utility of the same for carrying business of M/s. SPC.

Categories of assets:

No.	Particulars
1.	Details of  products	Annexure-1
	Absorbed technology for assembling and repair and maintenance of products.
5.	Dealers and their location	Annexure-II
6.	Copy rights of trade names,brands, logos, packet designs. Etc.	Annexure -III
7.	Tenancy rights
8.	Commercial information data base for: Marketing Procurements Services
9.	Website based data base
10.

Annexure-1

On the basis of the above information and details the valuation of the various intangible assets are as follows-

No.	Particulars		Valuation in Rs.
1.	Design , patterns, packing material , logos of  ten broad  products with different models.	Annexure-1	/-
2.	Absorbed technology and technical information  for assembling and repair and maintenance of products .		/-
5.	Distribution net work  including contractual rights with dealers	Annexure-II
6.	Copy right of Trade name and brands –Solace valued @ 5% of  expected     turnover of Rs.        crores.
7.	Commercial data ase
8.	Website based intangible assets.
	Total