Hello friends, here we discussed the provision of transfer of capital asset to partner/member on dissolution or reconstitution of the specified entity [Section 45(4) and section 9B] [W.e.f A.Y. 2021-22].

1) SECTION 45(4) OF INCOME TAX ACT, 1961

Before Amendment, As per section 45(4), the profits or gains arising from the transfer of a capital asset to the partners/members by way of distribution on the dissolution of a firm or other association of persons or body of individuals (not being a company, or a cooperative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place. In such a case, there will be a capital gain to the firm/AOP, etc.

For the computation of capital gain, the fair market value of the asset on the date of such transfer shall be deemed to be the full value consideration received or accruing as a result of a transfer, instead of the value at which it is given to the partner/member.

Amendment made

Profit or gains from receipt of money or capital asset or both by the specified person from a specified entity on reconstitution of the specified entity shall be chargeable to income-tax as income of such specified entity under the head “Capital Gains” [Section 45(4)]

Notwithstanding anything contained in section 45(1), where a specified person receives during the previous year any money or capital asset or both from the specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from receipt of such money 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

Such profits or gains shall be determined by the following formula, namely:-

A=B+C-D

Where,

A= Income chargeable to income-tax under the sub-section as income of the specified entity under the head “capital gains”;

B= value of 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

♦ Self-Generated goodwill

♦ Self-generated asset

2) Income on Receipt of a capital asset or stock in trade by a specified person from the specified entity in connection with the dissolution or reconstitution of such specified entity. [Section 9B inserted w.e.f. A.Y. 2021-22]

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. [Section 9B (1)]

Any profits and gains arising from such deemed transfer by the specified entity shall be [Section 9B (2)] —

√ 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

√ 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 provision of this act.

For this section, the 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. [Section 9B (3)]

Explanation 1—- For both the sections, —-

i.  “Reconstitution of the specified entity” means, where—-

a) One or more of its partners or members, of such specified entity, ceases to be partners or members; or

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

c) All the partners or members, of such specified entity, continue with a change in their respective share or 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 cooperative 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 cooperative society) n any previous year.

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 reconstitution of such specified entity, the provision of section 45(4) shall operate in addition to the provision of section 9B and the taxation under the said provisions thereof shall be worked out independently.

  • Consequential amendment in Section 48

     The following clause has been inserted in section 48 w.e.f. A.Y.2021-22

In case of the value of money or capital asset received by a specified person from a specified entity referred to in section 45(4), the amount chargeable to income-tax as income of such specified entity under the said sub-section which is attributable to the capital asset being transferred by the specified entity, calculated in the prescribed manner shall be treated as part of the cost of acquisition in the hands of firm, to compute capital gain.

The government has issued Guidelines for the application of these sections which we will discuss further:

Guidelines under section 9B and subsection (4) of section 45 of the Income-tax Act, 1961

Circular No. 14 of 2021, Dated 02-07-2021

It is noticed that the amount taxed under sub-section (4) of section 45 of the Act is required to be attributed to the remaining capital assets of the specified entity so that when such capital assets get transferred in the future, the amount attributed to such capital asset gets reduced from the full value of the consideration and to that extent specified entity does not pay tax again on the same amount, it is further noticed that this attribution is given in the act only for the purposes of section 48 of the act. It may be seen that section 48 of the act only applies to capital assets that are not forming a block of assets.

For capital asset forming part of a block of assets, there is sub-clause (c) of clause (6) of section 43 of the act to determine written down value of the block of asset and section 50 of the act to determine the capital gains arising on transfer of such assets. It is clarified that Rule 8AB of the Income-tax Rules, 1962 notified vide notification no. 76 dated 02-07-2021 applies to capital assets forming part of a block of assets.

It is further clarified that in case the capital asset remaining with the specified entity is forming part of a block of asset, the amount attributed to such capital asset under rule 8AB of the rules shall be reduced from the full value of the consideration received or accruing as a result of subsequent transfer of such asset by the specified entity, and the net value of such consideration shall be considered for reduction from the written down value of such 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 understand the application of section 9B of the act and sub-section (4) of section 45 of the act with the help of examples:

Example1: There are 3 Partners A, B, and C in a firm “FR”

Particulars Partner A Partner B Partner C
% Share in Firm 1/3 1/3 1/3
Capital Balance in Firm 10.00Lakhs 10.00Lakhs 10.00Lakhs

 There are 3 pieces of land “S”, “T”, and “U” in that firm and there is no other capital asset in that firm. The book value of each of the land is Rs. 10Lakh. All these were acquired by the firm more than 2 years ago.

Partner “A” wishes to exit. The firm revalues its lands based on a valuation report from a registered valuer as defined in rule 11U of the Rules, and as per that valuation report fair market value of lands “S” and “T” is Rs 70Lakh each, while the fair market value of land “U” is Rs. 50Lakh. On the exit of partner “A”, the firm decides to give him Rs. 11 Lakh of money and land “U” to settle his capital balance. Assume the Indexed cost of acquisition of land “U” is Rs.15 Lakh.

Solution:  In accordance with the provisions of section 9B of the Act, it would be deemed that the firm “FR” has transferred the land “U” to the partner “A” at its fair market value of Rs. 50lakh and the Indexed cost of acquisition of land is Rs.15lakh. Now on account of deeming provision of section 9B of the Act, it is deemed that the firm “FR” has transferred the land “U” to partner “A”. Thus, an amount of Rs.50lakh less Rs.15lakh would be charged to tax in the hands of firm “FR” under the head “Capital Gains”. Hence the amount of Rs.35lakh is charged to long-term capital gain and let us assume that the tax is Rs.7 lakh (assume no surcharge or cess just for ease of calculation and illustration purposes).

This, net book profit after tax of Rs.33lakh [capital gains of Rs.40lakh( Revalue value of land Rs.50lakh less book value Rs.10lakh) without indexation less tax of Rs.7lakh] is to be credited in the capital account of each of three partners i.e. Rs.11lakh each. Thus partner “A” capital account would increase to Rs.21 lakh. As against a capital balance of Rs.21 lakh, partner “A” has received Rs.61 lakh (Rs.11 lakh of money plus land “U” of fair market value of Rs.50lakh). Thus Rs.40lakh (Money Rs.11lakh+ FMV of land given to “U” Rs.50lakh – Capital balance of “U” Rs.21lakh) is required to be charged to tax under sub-section (4) of section 45 of the Act. This shall be in addition to an amount of Rs. 35 lakh charged to tax under section 9B of the Act.

On account of clause (iii) of section 48 of the Act, read with rule 8AB of the Rules, this Rs.40lakh is to be attributed to the remaining assets of the firm “FR” on the basis of an increase in their value due to revaluation based on the valuation report of a registered valuer. In both cases, the value has increased by Rs.60lakh (Book value Rs.10lakh –FMV Rs.70lakh) each. Thus, out of Rs.40lakh, Rs.20lakh shall be attributed to land “S” and Rs.20lakh to land “T”. When either of these lands gets sold, this amount attributed to them would be reduced from sales consideration under clause (iii) of section 48 of the Act.

As per Sub-rule (5) of rule 8AA of the rules, the amount of Rs.40lakh which is charged to tax under sub-section (4) of section 45 of the Act shall be charged as long term capital gain because at the time of taxation of Rs.40lakh under Sub-section (4) of section 45 of the Act both land “S” and land “T” are long term capital assets.

Example 2: There are three partners “A”, “B” and “C” in a firm “FR”.

Particulars Partner A Partner B Partner C
% Share 1/3 1/3 1/3
Capital Balance in Firm 100.00lakh 100.00lakh 100.00lakh

There is a piece of land “S” of the book value of Rs.30lakh, there is patent “T” of written down value of Rs.45lakh and there is a cash of Rs.225lakh. 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 a valuation report from a registered valuer, as defined in rule 11U of the Rules, and as per that valuation report FMV of land “S” is Rs.45lakh and FMV of patent “T” is Rs.60lakh. As per the valuation report, there is also self-generated goodwill of Rs.30lakh. On the exit of partner “A”, the firm decides to give him Rs.75lakh in money and land “S” to settle his capital balance. Assume the indexed cost of acquisition of land “S” is Rs.45lakh.

Solution: On account of deeming provision of section 9B of the Act, it is deemed that the firm “FR” has transferred land “S” to partner “A” and that at its FMV of Rs.45 lakh. Since sales consideration is equal to the 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.45lakh.

The net book profit of Rs.15lakh (capital gains of Rs.15lakh without indexation i.e. FMV Rs.45lakh less Book value Rs.30lakh) is to be credited in the capital account of each of three partners, i.e. Rs.5lakh each. Thus partner “A” capital account would increase to Rs.105lakh.

As against a capital account of Rs.105lakh, partner “A” has received Rs.120lakh (money of Rs.75lakh + land “S” of FMV Rs.45lakh). Thus Rs.15lakh (75+45-105lakh) is required to be charged to tax under sub-section (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 and this guidance note, this Rs.15lakh is to be attributed to the remaining capital assets of the firm “FR” on the basis of an 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 a registered valuer. In this case, as per this report, the value of patent “T” has increased by Rs.15lakh, and self-generated goodwill value has been recognized at Rs.30lakh. Thus, 1/3 of Rs.15lakh (i.e. RS.5lakh) would be attributed to patent “T”, while 2/3 of RS.15lakh (i.e. Rs.10lakh) would be attributed to self-generated goodwill. Rs.5lakh 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. 5lakh attributed shall be reduced from the full value of the consideration received or accruing as a result of the transfer of patent “T” by the firm “FR”.

Let us say, that patent “T” is sold for Rs.25lakh, Rs.5lakh shall be reduced from Rs.25lakh and the only net amount of Rs.20lakh 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 gain as the case may be, under section 50 of the Act. Similarly, when goodwill gets sold subsequently, RS.10lakh would be reduced from its sales consideration under clause (iii) of section 48.

The amount of Rs. 15lakh which is charged to tax under sub-section (4) of section 45 of the Act shall be charged as short-term capital gains, as Rs.5lakh is attributed to the patent “T” which is part of a block of assets and Rs.10lakh is attributed to self-generated goodwill. As per sub-rule (5) of Rule 8AA of the Rules, both of these are to be characterized as short capital gains.

NOTE: For calculation of depreciation u/s 32 of the Act, the written down value of the block of asset “intangible” of which patent “T” is part, would remain Rs.45lakh and would not be increased to Rs. 60lakh due to revaluation during the year. Sub-section (1) of section 43 of the Act, defines “Actual cost” as the actual cost of the Assets to the assessee. In Revaluation, there is no actual cost to the assessee. So, there will be no depreciation on the revalued amount.

Further, section 32 of the Act does not allow depreciation on goodwill. If in the given example “Self-generated goodwill is replaced by “self-generated asset”, even then the depreciation will not be admissible on the amount of Rs.30lakh recognised in valuation and Since there is no actual cost to the assessee in the case of “self-generated asset”, depreciation is not allowable under section 32 of the Act on an asset whose actual cost is “NIL”.

*****

Disclaimer: The entire content of this document has been prepared based on relevant provisions and as per the information existing at the time of preparation. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided. I assume no responsibility; therefore users of this information are expected to refer to the relevant existing provisions of applicable laws. The user of the information agrees that the information is not professional advice and is subject to change without notice. I assume no responsibility for the consequences of the use of such information.

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Qualification: CA in Practice
Company: MAHAJAN JYOTI & ASSOCIATES
Location: GURDASPUR, Punjab, India
Member Since: 25 Sep 2020 | Total Posts: 3
I am a Practising Chartered Accountant for more than 4 years, having varied knowledge in the field of Direct Taxation, Indirect Taxation, Auditing & Accounting and Bank Audits. View Full Profile

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2 Comments

    1. JYOTI MAHAJAN says:

      Thank you so much Rajni Kant Verma. Comments like these boosts the morale to another level. Will surely come up with another article.
      🙂

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