A sole proprietorship offers several advantages over other business entities, particularly for individuals starting a new venture with relatively lower risks. It is ideal for small to medium-sized businesses or professionals who prefer to work independently without involving others.
Many businesses typically begin as sole proprietorships. However, as the business grows, it may become necessary to change its structure and include one or more partners. When operations expand to a level where it becomes challenging for one person to manage both maintenance and growth effectively, bringing in a partner can enhance operational efficiency. Additionally, having multiple partners signals that the business has broader support.
For those seeking to scale their business smoothly and efficiently, transitioning from a sole proprietorship to a partnership is recommended. Such a conversion is feasible as long as the business meets the eligibility requirements for the new structure.
Drawbacks for a Sole Proprietorship Business
Lack of Successors – A sole proprietorship is operated, owned, and managed by a single individual. The passing over of rights to successors legally becomes complex because many licenses and registration were issued in the owner’s name to avoid transferability.
Limitations of Capital Resources – The sole proprietorship has essentially merged personal funds of the owner with those of the business. Therefore, no equity funding or additional partners for the business can be considered, which limits opportunities for financial growth.
Unlimited Liability – The proprietor is personally responsible for all debts of the business. Such a setup leaves the owner with boundless economic risk of needing to settle creditors’ claims from personal assets.
No Continuity – A sole proprietorship becomes dissolved with the demise or incapacity of its owner. Such a tie is against the business’s longevity and continuity.
Limited Financing – Sole proprietorships cannot raise funds by selling shares or business interest which limits them from accessing equity financing. Moreover, this, being closely tied to the owner, makes financial institutions reluctant to lend big sums of money to this business form.
Higher Tax Burden – A proprietorship being an individual such an organization pays on the slab basis, so, beyond the taxable income of ₹10,00,000, the tax burden of a proprietorship will be higher than that of a corporate firm and hence its tax burden will be higher.
Benefits of Converting to a Partnership Firm
1. Less Formalities and Legal Obligations-A partnership firm, compared with a limited company, involves fewer formality and legal requirements.
2. Simple Conversion of Business-The transition to a partnership firm from a Sole Proprietorship Registration is not much more than a new business initiation. The accumulated losses and unabsorbed depreciation that the sole proprietorship accrued are now set-off against the partnership firm. The worthwhile transition occurs under all received and assumed liabilities and all assets movable and immovable. Therefore, smooth transition.
3. Decision Making-Making decisions in a partnership is a shared job affected by all the partners. Each partner’s contribution helps foster a sense of shared ownership. The efforts so exerted generally ensure better strategies and innovations. On the other hand, in a sole proprietorship, everything is based on just one person’s effort and point of view.
4. Joint Responsibility-A partnership firm is made of a few persons under one roof who work for the same business goal. Partners share functions related to running and managing the business. The burden and liability are shared. Besides finance, knowledge, skills, and judgment are all pooled into work to improve it.
5. Tax Efficiency: Unlike limited companies, where income may be drawn through wages or dividends, partnerships provide flexibility in profit distribution. This structure enables partners to allocate profits in a manner that best suits their needs.
6 . Increased Partner’s Net Worth: Post-tax profits are distributed among the partners without additional tax burdens. Moreover, no capital gains tax is levied on transferring assets from a proprietorship to a partnership. Reduced tax liabilities effectively increase the partners’ take-home earnings, contributing to their overall net worth.
7. Flexible Capital Requirements: Partners can mutually decide on their respective investments in the firm, allowing for uneven capital contributions. There is no predefined limit on the amount of capital each partner can contribute, offering flexibility in business decisions and mutual agreement on withdrawals.
Procedure For Conversion
Step 1 – Draft a Partnership Deed
The Partnership Deed must include a declaration about the conversion of the proprietorship into a partnership firm.
Step 2 – File Returns for Both Proprietorship and Partnership Firm
Ensure all required returns are filed by both the proprietorship and the newly formed partnership firm.
Step 3 – Select and Align GST Registration Dates
The taxpayer must select the date for canceling the proprietorship’s GST registration and applying for the partnership’s GST registration. Both dates must be the same, as this will be the effective date for the partnership’s GST registration.
Step 4 – File GST Returns and Settle Pending Dues
The proprietorship must file all GST returns and settle any outstanding dues until the new GST registration date. The partnership firm must start filing GST returns from the date of its new GST registration.
Step 5 – Apply for GSTIN, PAN, and Open a Current Bank Account
Obtain a GST Identification Number (GSTIN) and PAN for the partnership firm. Then, open a current bank account in the name of the partnership.
Step 6 – Transfer the Business to the Partnership Firm
- The transfer of stock or other assets is exempt from GST.
- Transfer of a “going concern” is exempt under the CGST (Rate) Notification 12/2017.
- As per Schedule-2 of the CGST/SGST Act, transferring stock or other assets from an existing firm to a new firm during restructuring is not considered a supply of goods for business purposes, provided the old firm ceases to be taxable after the restructuring.
- CGST Exemption Schedule under Notification 12/2017 exempts services related to transferring a going concern. Thus, transferring a business as a whole or an independent part is not taxable under GST.
Step 7 – Transfer Unutilized ITC to the Partnership Firm
After filing all pending GST returns, the taxpayer can transfer any unutilized Input Tax Credit (ITC) to the partnership firm.
Step 8 – Cancel the GSTIN of the Proprietorship
File Form GST REG-16, citing the reason as “Changing the company’s legal framework,” and provide the new GST registration details of the partnership firm.
Documents Required
Proof of Business Address:
A copy of the electricity bill or telephone bill for the registered office address.
Identity Proof of Partners:
Self-attested copies of Aadhaar Card, Voter ID, Passport, or Driving License for all partners.
Self-attested copies of PAN cards for all partners.
Details of the Sole Proprietorship:
If the proprietorship business is registered under GST or has any other licenses, the relevant forms must be submitted to the respective authorities to update the business status.
Statement of Assets and Liabilities:
An updated statement of assets and liabilities certified by a Chartered Accountant.
Sole Proprietorship vs Partnership
| Parameters | Sole Proprietorship | Partnership |
| Ownership | Owned by a single individual. | as co-owners. It requires at least two partners and can have up to 50 partners. |
| Formation and Closure | Formation is simple with minimal paperwork, and closure is quick and informal due to single ownership. | Formation requires an agreement, and registration with the Registrar of Firms is optional. Closure is formal and needs mutual consent of partners. |
| Governing Law | No specific law governing sole proprietorships in India. | Governed by the Partnership Act, 1932. |
| Risk &Reward | Bears all risks and enjoys all rewards of the business. | Risks &rewards are shared among partners either equally or as per a pre-agreed ratio. |
| Credibility and Funding | Limited funds due to low credibility with banks and investors; expansion opportunities are restricted. | Higher credibility due to multiple contributors and shared capital, making it easier to raise funds. |
| Liability | The owner’s liability is unlimited, and personal assets may be used to settle business debts. | Partners’ liability is also unlimited, but it is shared jointly and severally. Partners may also be liable for each other’s unlawful acts. |
| Decision-Making | Decisions are made solely by the owner, ensuring flexibility and quick implementation. | Decisions are made collectively by the partners, which can lead to conflicts and slower implementation. |
| Taxation | Income is taxed as personal income of the owner, following the individual income tax slab rates under the Income Tax Act, 1961. | The partnership is taxed at a flat rate of 30% as a separate legal entity. Partners’ share of income is not taxed individually. |
| Business Continuity | The business ceases with the owner’s death or incapacity. | Entry, exit, or death of a partner dissolves the partnership but not the firm, allowing continuity. |
| Agreement | No agreement is required since there is only one owner. | Partners must enter into an agreement (oral or written) to define rights and duties. A written Partnership Deed is recommended. |
| Management | The owner manages the business but can hire employees for specific roles. | Management responsibilities are divided among partners, who collectively manage the business. |
| Secrecy | Easy to maintain secrecy since the owner is the sole decision-maker and holder of trade secrets. | Maintaining secrecy is challenging as trade secrets are shared among all partners. |
Conclusion
A partnership offers clear advantages to those entrepreneurs who wish to amplify their business without heavy obligations in regard to further corporate structures inclusive of incorporation and compliance costs. The owners may expand their business even further without having to part ways from the bone of the business. They will have the ability and opportunity to grow the business while maintaining a firm grip on ownership and administration. Furthermore, partnerships offer certain advantages over sole proprietorships concerning shared responsibilities and liabilities, making them a more balanced partner for various business operations.
