TAX ON TRANSFER OF ASSETS BY A PARTNERSHIP FIRM/AOP/BOI TO ITS PARTNER/MEMBER- SECTION 45(4)

Income on receipt of capital asset or stock in trade by specified person from specified entity [Section 9B]

9B. (1) Where a specified person receives during the previous year any capital asset or stock in trade or both from a specified entity in connection with the dissolution or reconstitution of such specified entity, then the specified entity shall be deemed to have transferred such capital asset or stock in trade or both, as the case may be, to the specified person in the year in which such capital asset or stock in trade or both are received by the specified person.

(2) Any profits and gains arising from such deemed transfer of capital asset or stock in trade or both, as the case may be, by the specified entity shall be—

(i) deemed to be the income of such specified entity of the previous year in which such capital asset or stock in trade or both were received by the specified person; and

(ii) chargeable to income-tax as income of such specified entity under the head "Profits and gains of business or profession" or under the head "Capital gains", in accordance with the provisions of this Act.

(3) For the purposes of this section, fair market value of the capital asset or stock in trade or both on the date of its receipt by the specified person shall be deemed to be the full value of the consideration received or accruing as a result of such deemed transfer of the capital asset or stock in trade or both by the specified entity.

(4) If any difficulty arises in giving effect to the provisions of this section and sub-section (4) of section 45, the Board may, with the approval of the Central Government, issue guidelines for the purposes of removing the difficulty.

(5) Every guideline issued by the Board under sub-section (4) shall, as soon as may be after it is issued, be laid before each House of Parliament, and shall be binding on the income-tax authorities and on the assessee.

Explanation.—For the purposes of this section,—

(i) "reconstitution of the specified entity" means, where—

(a) one or more of its partners or members, as the case may be, of such specified entity ceases to be partners or members; or

(b) one or more new partners or members, as the case may be, are admitted in such specified entity in such circumstances that one or more of the persons who were partners or members, as the case may be, of the specified entity, before the change, continue as partner or partners or member or members after the change; or

(c) all the partners or members, as the case may be, of such specified entity continue with a change in their respective share or in the shares of some of them;

(ii) "specified entity" means a firm or other association of persons or body of individuals (not being a company or a co-operative society);

(iii) "specified person" means a person, who is a partner of a firm or member of other association of persons or body of individuals (not being a company or a co-operative society) in any previous year.

Analysis of this section:

If a partner/member receives any capital asset or stock in trade from a partnership firm (reference to partnership firm shall also include AOP/BOI) during the previous year due to the dissolution or reconstitution of the firm, it is deemed that the firm has transferred such assets to the person in the same year.

The profits and gains arising from this deemed transfer by the partnership firm are considered the income of the firm in the previous year when the assets were received by the partner. Such income is chargeable to income tax either as business or profession income (in case of stock-in-trade) or as capital gains (in case of Capital Assets), according to the relevant provisions of the Income Tax Act.

For calculating the income, the fair market value of the assets on the date of their receipt by the partner is treated as the full value of consideration received or accrued due to the deemed transfer by the partnership firm.

In an explanation to this section meaning of reconstitution has been provided, and includes change in the profit-sharing ratio of the partners, however, such change without transfer of assets will not attract taxability under this section or under section 45(4).

All the provisions of this section are also applicable for the transfer of capital assets and stock in trade from AOP/BOI to its member(s).

Tax Implication on receipt of Capital Assets or Money on reconstitution of Partnership Firm/AOP/BOI:

Notwithstanding anything contained in sub-section (1), where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from such receipt by the specified person shall be chargeable to income-tax as income of such specified entity under the head "Capital gains" and shall be deemed to be the income of such specified entity of the previous year in which such money or capital asset or both were received by the specified person, and notwithstanding anything to the contrary contained in this Act, such profits or gains shall be determined in accordance with the following formula, namely:—

A = B + C – D

Where,

A = income chargeable to income-tax under this sub­section as income of the specified entity under the head "Capital gains";

B = value of any money received by the specified person from the specified entity on the date of such receipt;

C = the amount of fair market value of the capital asset received by the specified person from the specified entity on the date of such receipt; and

D = the amount of balance in the capital account (represented in any manner) of the specified person in the books of account of the specified entity at the time of its reconstitution:

Provided that if the value of "A" in the above formula is negative, its value shall be deemed to be zero:

Provided further that the balance in the capital account of the specified person in the books of account of the specified entity is to be calculated without taking into account the increase in the capital account of the specified person due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset.

Explanation 1.—For the purposes of this sub-section,—

(i) the expressions "reconstitution of the specified entity", "specified entity" and "specified person" shall have the meanings respectively assigned to them in section 9B;

(ii) "self-generated goodwill" and "self-generated asset" mean goodwill or asset, as the case may be, which has been acquired without incurring any cost for purchase or which has been generated during the course of the business or profession.

Explanation 2.—For the removal of doubts, it is clarified that when a capital asset is received by a specified person from a specified entity in connection with the reconstitution of such specified entity, the provisions of this sub-section shall operate in addition to the provisions of section 9B and the taxation under the said provisions thereof shall be worked out independently.

Analysis of this section:

1. This section is applicable only in case of reconstitution of Firm/AOP/BOI. This section applies in addition to section 9B.

2. As per provisions of this section, Capital Gain arising on the transfer of money and capital assets to a partner/member shall be charged to tax in the hands of Firm/AOP/BOI.

3. This Capital Gain arises when a partner/member is paid over and above his/her capital balance in the books of Firm/AOP/BOI.

4. The capital balance mentioned in (3) shall be adjusted by post-tax capital gain arising due to the implications of section 9B.

5. The post-tax capital gain mentioned in (4) shall be as per books of accounts and not as per income tax laws.

6. Also, the capital balance of such partner shall not include effect of revaluation.

7. Now, the difference between such capital balance and FMV of capital asset or money or both shall be taxable in hands of firm/AOP/BOI.

8. The capital gain arising u/s 45(4) will be attributable to remaining capital assets in books of firm/AOP/BOI in proportion to increase in value of remaining assets due to revaluation or recognition of an asset. However, if such capital gain is only due to increase in value of capital asset transferred to partner/member, no attribution is required.

9. The attribution as mentioned in (8), shall be considered when the remaining assets in hands of firm/AOP/BOI is transferred.

10. Reconstitution mentioned in this section have the same meaning as section 9B.

11. Capital gain mentioned in this section will be chargeable in the P.Y. of receipt of capital assets or money or both by partner.

12. If capital gain calculated as per this section is negative, it shall be considered as zero.

For better understanding of both the section discussed in this article, a detailed illustration is provided below:

There are three partners "A", "B" and "C" in a Firm "FR", having one third share each. Each partner has a capital balance of Rs. 100 lakh in the Firm. There is a piece of land "S" of book value of Rs. 30 lakh. There is patent "T" of written down value of Rs. 45 lakh. And there is cash of Rs. 225 lakh. The land was acquired by the Firm more than two years ago. The patent was acquired/developed/registered one year back.

Partner "A" wishes to exit. The Firm revalue its land and patent based on valuation report from a registered valuer, as defined in rule IIU of the Rules, and as per that valuation report fair market value of land "S" is Rs. 45 lakh and fair market value of patent "T" is Rs. 60 lakh. As per the valuation report there is also self-generated goodwill of Rs. 30 lakh. On the exit of partner "A", the firm decides to give him Rs. 75 lakh in money and land "S" to settle his capital balance.

In accordance with the provisions of section 9B of the Act, it would be deemed that the Firm " FR" has transferred land "S" to the partner "A" at its fair market value of Rs. 45 lakh. Let us assume that the indexed cost of acquisition of land "S" is Rs. 45 lakh.

Now on account of the deeming provisions of section 9B of the Act, it is deemed that the firm " FR" has transferred land "S" to partner "A" . However, since the sale consideration is equal to indexed cost of acquisition, there will not be any capital gains tax. For partner "A", the cost of acquisition of this land would be Rs. 45 lakh.

The net book profit Rs. 15 lakh (capital gains of Rs. 15 lakh without indexation) is to be credited in the capital account of each of the three partners, i.e. Rs. 5 lakh each. Thus partner "A" capital account would increase to Rs. 105 lakh. This exercise is required to be carried out since section 9B of the Act mandates that it is to be deemed that the firm "FR" has transferred the land "S" to partner "A". Thus, any gain in the books is to be apportioned to partners` capital accounts.

As against capital balance of Rs. 105 lakh, partner "A" has received Rs. 120 lakh (money of Rs. 75 Lakh plus land "S" of fair market value of Rs. 45 lakh). Thus Rs. 15 Lakh is required to be charged to tax under subsection (4) of section 45 of the Act

On account of clause (iii) of section 48 of the Act, read with rule 8AB of the Rules, this Rs. 15 lakh is to be attributed to the remaining capital assets of the firm " FR" on the basis of increase in the value due to revaluation of existing capital assets, or due to recognition of the value of self-generated goodwill, based on the valuation report of registered valuer. In this case as per this report the value of patent `T " has increased by Rs. 15 lakh and the self-generated goodwill value has been recognised at Rs. 30 lakh. Thus, one third of Rs. 15 lakh [i.e. Rs. 5 lakh (Rs. 15 gain as per section 45(4) x Rs. 15 gain increase in FMV of T/Rs. 15 gain increase in FMV of T + Rs. 30 on account of recognition of self-generated goodwill)] would be attributed to patent "T", while two third of Rs. 15 lakh [i.e. Rs. 10 lakh (Rs. 30 on account of recognition of self-generated goodwill x Rs. 30 on account of recognition of self-generated goodwill /Rs. 15 gain increase in FMV of T + Rs. 30 on account of recognition of self-generated goodwill)] would be attributed to self-generated goodwill. Rs. 5 lakh attributed to patent "T" shall not be added to the block of the assets and no depreciation shall be available on the same. When patent "T" gets transferred subsequently, this Rs. 5 Lakh attributed to it shall be reduced from the full value of the consideration received or accruing as a result of transfer of patent "T" by the firm " FR", and the net value shall be considered for reduction from the written down value of the intangible block under sub-clause ( c) of clause (6) of section 43 of the Act or for calculation of capital gains, as the case may be, under section 50 of the Act.. Let us say that Patent T is sold for Rs. 25 lakh. Rs. 5 lakh shall be reduced from Rs. 25 lakh and only net amount of Rs. 20 lakh shall be considered for reduction from the written down value of the intangible block under sub-clause (c) of clause (6) of section 43 of the Act or for calculation of capital gains, as the case may be, under section 50 of the Act. Similarly, when goodwill gets sold subsequently, Rs. 10 lakh would be reduced from its sales consideration under clause (iii) of section 48.