Converting a sole proprietorship into a company: three routes and their consequences
Converting a sole proprietorship into a limited or joint stock company: transfer of the business as a whole (ITL 81), sale of assets and contribution in kind; tax, VAT, fees, SGK, employment contracts and licences; a choice table and steps.
Owners of growing sole proprietorships start to think about moving to a company after a certain point: for reasons such as the corporate tax rate, limiting liability, taking on partners and a corporate image. This move can be made in three different ways, and each has different tax consequences.
First, to assess whether the move suits you: Sole proprietorship or limited company?
Three routes
| 1. Transfer as a whole | 2. Sale of assets | 3. Contribution in kind | |
|---|---|---|---|
| How? | The sole proprietorship is transferred with its assets and liabilities to a capital company; the owner receives shares equal to the equity in the transfer balance sheet | A new company is formed; stock, fixtures and vehicles are sold to the company with invoices | Specific assets (vehicle, machinery, real estate) are contributed to the company as capital |
| Condition | Balance sheet basis; book values | None | Expert valuation |
| Taxation of gain | If the conditions are met, the gain from the transfer is not taxed | Gain on sale is taxed in the sole proprietorship | Treated as a disposal of the asset; the increase in value may be taxed |
| VAT | Exempt | Charged; the company deducts it | As a rule, charged |
| Debts and receivables | Pass to the company | Remain with the sole proprietorship | Remain with the sole proprietorship |
| Suitable when | On the balance sheet basis, and the whole business is moving | On the business ledger basis or for businesses with few assets | Moving specific valuable assets |
1. Transfer as a whole
Under the Income Tax Law, if a sole proprietorship keeping books on the balance sheet basis is transferred as a whole, with its assets and liabilities, to a capital company and the owner receives shares equal to the equity in the transfer balance sheet, the gain from the transfer is not calculated and not taxed. The conditions include:
- The acquiring company takes over the transferred assets at their book values,
- The transfer is made as a whole, covering all the assets and liabilities of the business,
- The transfer in exchange for shares is documented.
This transfer is exempt from VAT; no VAT is charged on invoices issued during the transfer. Documents relating to the transfer can also benefit from stamp duty and fee exemptions under certain conditions.
2. Sale of assets
This is the most common route for small businesses keeping books on the business ledger basis. A new company is formed, the sole proprietorship sells its stock and fixtures to the company with invoices and closes its tax registration. The sale price must be set at arm's length value; a sale below value may be adjusted in a tax audit. The company deducts the VAT it pays.
3. Contribution in kind
Specific assets (e.g. a vehicle or real estate) can be contributed to the new company as capital. This requires a valuation report by a court-appointed expert. A contribution in kind counts as a disposal of the asset by the sole proprietorship; taxation of the increase in value and the VAT treatment are assessed separately.
Non-tax steps
| Subject | To do |
|---|---|
| Employees | Under the rules on transfer of a workplace, employment contracts pass to the company; length of service is preserved. The transferor remains liable, together with the transferee, for a certain period for debts arising before the transfer. The SGK workplace file is rearranged for the company. |
| Licences and permits | The workplace licence and sectoral permits are obtained in the new company's name: Workplace licence |
| Contracts | Lease, supply, customer and bank contracts are renewed in the company's name; the landlord's consent may be required for transferring the lease. |
| e-Documents | e-Invoice, e-Archive and, if needed, e-Ledger applications are made for the company; the sole proprietorship's e-document registration is closed. |
| Trademark and domain name | Trademarks and domain names registered in the individual's name are transferred to the company. |
| Bağ-Kur | The sole proprietor's Bağ-Kur registration continues through the company partnership: SGK status of company partners |
Recommended order
- Set out the current position (book-keeping basis, assets, debts, employees).
- Decide which route is suitable.
- Form the company: Limited company formation · Formation cost
- Carry out and document the transfer, sale or capital transactions.
- File the sole proprietorship's cessation and closing returns.
The date of the move also matters for the tax brackets within the year; in a move made mid-year, the income the sole proprietorship earned that year is declared on the annual return: Annual income tax return
Legal basis: Income Tax Law No. 193 art. 81 and repeated art. 80; VAT Law No. 3065 art. 17/4-c; Labour Law No. 4857 art. 6; Turkish Commercial Code No. 6102 arts. 127 and 343.