Summarizing section 9B with Section 45(4) of Income Tax Act, 1961

Since the introduction of Section 9B of the Income tax Act (‘the Act’), there has been ample of discussions regarding double taxability of same income in the hands of Specified entity, in this regard this article is to give clarity in relation to same.

Applicability of Section 9B and Section 45(4) of the Act.

Section 9B is attracted when the Specified entity (Firm / AOP/ BOI) transfers capital asset or stock in trade to the specified person (Partner of firm/ Member of AOP/ Member of BOI) on event of dissolution or reconstitution of such specified entity;

Section 45(4) triggers when Specified entity transfers any capital asset or money to specified person on account of reconstitution of such specified entity;

Reconstitution shall cover the following events:

• Retirement/death of one or more partners; or
• Admission of new partners, provided at least one existing partner continues; or
• Change in respective profits shares of all or some of the partners.

Hence, it is clear that in case of dissolution of Specified entity only Section 9B would apply, however in case of reconstitution of the specified entity Section 9B as well as Section 45(4) will apply. It is also important to understand that during reconstitution of specified entity if stock in trade is transferred then only section 9B would come into picture as Section 45(4) does not include transfer by way of stock in trade.

Here one can argue that during reconstitution of the Specified Entity, if such entity transfers any capital assets to the Specified person, double taxability would trigger. Yes there is a double taxability but with benefits given u/s 48(iii) in form of cost of acquisition which is discussed later in this article.

Process to be followed when there is double taxability (Transfer of capital asset during reconstitution)

Step 1:  First compute capital gain for specified entity u/s 9B, capital gain shall be taxable in the hands of the specified entity during the year when capital asset is received by the   Specified person. For the purpose of Section 48 Full Value of Consideration (‘FVOC’) shall be Fair Market Value (‘FMV’) on the date of receipt by the Specified person, Cost of Acquisition would be just like any other asset as per Section 55 of the Act.

Step 2: After calculating tax as per Section 9B of the Act, distribute the profit [FMV u/s 9B –Book value of Asset – Tax u/s 9B] on such transfer of capital asset in profit sharing ratio of all Specified person (including retiring person). Subsequent to this distribution, capital balances of Specified persons would be increased.

Step 3: Now calculate capital gains tax u/s 45(4) of the Act by using following formula:

A= FMV of the asset received by the Specified person (same as considered for Section 9B in step 1)

B= value of Money received by Specified person

C= Capital balance post 9B calculation (enhanced capital balance as per step 3)

Capital gain would be A+B-C, if gains results in negative then capital gains would be deemed as zero. Gains would be either long term or short term in nature depending upon the period of holding as per Section 2(42A) of the Act, However as per Rule 8AA of the Income tax rule 1962, (‘the Rule’), if capital asset is forming part of block of asset or it is self-generated asset and self-generated goodwill then the gains would always be short term in nature.

If we conscientiously observe Step 1 and Step 3, there is double time taxability of the same capital asset transferred by Specified entity during reconstitution, first in Section 9B and then in Section 45(4). This dual taxability situation is however remedied by insertion of Section 48(iii) of the Act, which is described in Step 4 below.

Step 4: The capital gain calculated as per Section 45(4) of the Act in step 3 above, shall now be added to remaining other assets (other than capital asset transferred) of the specified entity, on the basis of increase in their value due to revaluation based on the valuation report of registered valuer. The addition to other assets would increase the cost of acquisition u/s 48 of the Act, while calculating capital gain on sale of such other assets.

However, if the other asset of the specified entity is the depreciable asset forming part of block of asset then such attributable amount shall not be added to the block of asset, but shall be netted off from the gross sale proceeds at the time of transfer of such other assets.

Other points

The specified entity shall on or before the due date of return of income u/s 139, furnish the details of amount attributed to capital asset remaining with the specified entity in Form No. 5C.