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There is a lot of interpretations and confusion among the taxpayers and other stakeholders regarding the two newly inserted sections – Section 45(4) and Section 9B of Income Tax Act.

This article is confined to give the simplified interpretation of the above mentioned section which are related to transfer of Money, Capital asset or Stock in trade to Partners/Members from Firm/Association of Person(AOP)/ Body of Individuals(BOI).

Reason of introducing the amendment

The nation got a newly inserted Section 9B and a substitution of subsection 4 of section 45 through the Finance Act 2021.

Learning from the past , where assesses were evading the taxes through the medium of Firms, AOP and BOI , where capital assets held by such entities were transferred to Partners/Members on dissolution at book value. Although the old Section 45(4) provides for manner of taxation in case of transfer on dissolution or otherwise. But the same did not expressly cover Reconstitution and Retirement. (Refer CIT vs Kunnamkulam Mill Board ).

Thus, came the substitution of Subsection 4 and insertion of a new section 9B in Income Tax Act, 1961, through Finance Act 2021.

Section 45(4) – Capital Gain on transfer of a capital asset or Money by Firm/AOP/BOI to Partner/Member

1. Where partner/Member receives

2. During PY (Section is application from PY 20-21, AY 21-22)

3. Any Money or Capital Asset or Both

4. On Reconstitution ( Which include Retirement, Admission or Change in Share/Profit sharing ratio)

5. Then any profit or gain on such transaction will be chargeable in the hands of Firm/AOP/BOI

6. Under the head Capital gain in the PY in which the money or the capital assets or both are received by such Partner/Member.

Section 9B Capital Gain on transfer of a capital asset or Stock in Trade by Firm/AOP/BOI to Partner/Member

1. Where partner/Member receives

2. During PY (Section is application from PY 20-21, AY 21-22)

3. Any stock in trade or Capital Asset or Both

4. On Reconstitution ( Which include Retirement, Admission or Change in Share/Profit sharing ratio) or on dissolution.

5. Then any profit or gain on such transaction will be chargeable in the hands of Firm/AOP/BOI

6. Under the head Capital gain (in case the transfer is of capital asset) and Profit and Gain from Business and Profession(PGBP) (in case transfer is of Stock in Trade ) or Both in the PY in which the capital assets or Stock in trade or both are received by such Partner/Member.

Short Summary

Section 45(4) – Applicable on transfer of Capital Assets or any money or both

Section 9B- Applicable on transfer of Capital Assets or Stock in trade or both

Note: In case of transfer of Capital assets both the section is attracted in the hands of such Firm/AOP/BOI.

Computation Part

Now comes the interesting part. Lets start with the easy one first.

Section 9(B) : You are Computing PGBP or Capital gain or Both in the hands of Firm/AOP/BOI.

Section 45(4) and Section 9B of Income Tax Act Simplified

Step 1 Determine the Fair market value of the Capital asset/Stock in trade being transferred . and you just got the Full value of consideration.

Step 2 Reduce the determined Full value of consideration by the Cost of acquisition ( Cost of acquiring such Capital Asset/Stock in trade).

If the holding period of such capital asset makes it long term capital asset , indexation benefit will be given (Second proviso of Section 48)

Step 3 The Profit or Gain will be taxed under the head PGBP or CG or Both.

Its just the transfer of Stock in Trade? Your works done! Relax now!

NO!! Its Capital Asset? Brace yourself for next computation. As now Section 45(4) is also attracted.

Step -1 Determine the value of any money received by Partner and Fair Market value of Capital Assets. Add both to get Full value of consideration.

Step 2 You need Balance in the capital account of partner in the books of account of the firm at the time of reconstitution.

Do not forget to adjust the same with the share of partner in Post tax profit of the firm, on transfer of Capital asset under section 9B to such partner.

For example :

As per Section 9B

In a firm consisting of three equal partners having capital balance of ₹10 each, Land of FMV ₹50 (Book value ₹10) transferred to Partner. Assuming Indexed cost of Acquisition to be 15, Capital gain will be 50-15= 35 and the Capital Gain Tax on the same will be 35*20% = 7.

In the books of the firm simple accounting of the firm will give you pre tax profit of ₹40( 50-10) and the post tax profit of ₹ 33 (40-7).

This ₹33 when divided in between three equal partners, each partner will get the credit balance in their capital account of their share of ₹11.

Add this ₹11 in the initial credit balance (Say ₹10) in the capital account to get the Net credit balance in the capital account of the partner (₹10 + ₹11 = ₹21)

Step 3 Reduce such net credit balance from the full value of consideration determined in step 1 to get Capital Gain in the hands of Firm/AOP/BOI. If the value is negative , value shall be deemed to be Zero (0).

AND with this the computation part is over. One can take the reference of examples from CBDT Guidelines too to have a deeper understanding if the same.

Extra Notes

1. Is there any other significance of the Capital Gain calculated under Section 45(4)?.

Yes. The Capital Gain calculated under section 45(4) is in reality the share of increase in value of other remaining capital asset in the balance sheet of the firm at the time of reconstitution or dissolution and is paid to the partner as a compensation for such increase.

Such capital gain will be attributed to the remaining capital asset in the ratio of their increased value.

In future as the firm has already paid tax on such amount of share in the remaining capital asset, If any of the remaining capital asset is sold, such attributed amount will be reduced from the sale consideration while computing capital gain.

2. While computing the Capital balance of Partner for the purpose of Section 45(4) DO NOT consider increase due to

(a) Revaluation of any asset

(b) Self generated Goodwill or any other self generated asset.

3. In Section 45(4), Whether the gain is Short term capital gain or Long term capital gain?

In the following cases , the gain will be considered to be Short Term Capital Gain:-

– If the capital asset is Short term capital asset

– Self generated Goodwill or Other self generated capital assets.

– Capital asset forming part of block of asset.

*****

Disclaimer : This article is solely for educational purpose and cannot be construed as legal and professional opinion. It is based on the interpretation of the author and are not binding on any tax authority. Author is not responsible for any loss occurred to any person acting or refraining from acting as a result of any material in this article.

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