All about tax on distribution of assets on dissolution or reconstitution of firm under Section 9B and 45(4) of the Income Tax Act, 1961
Budget 2021 changed the way the firms are taxed when they are dissolved or reconstituted and assets are distributed to the partners w.e.f 01.04.2021.
A new section 9B was introduced so as to create a deeming fiction of transfer of capital asset or stock in trade on distribution of assets on dissolution of a firm/AOP/BOI.
Also, the old section 45 (4) was amended to tax transactions when one or more specified persons receives a capital asset or stock or money on the reconstitution of the firm/AOP/BOI.
So, what are sections 9B and 45(4) of the Income Tax Act’1961?
Gist of Section 9B:
As mentioned earlier, new section 9B was introduced so as to create a deeming fiction of transfer of capital asset or stock on distribution of assets on dissolution/reconstitution of a firm/AOP/BOI. Therefore, on a dissolution/reconstitution of a specified entity when a partner or member receives assets of the firm, the receipt of the capital assets by the partners/members will be regarded as a transfer of capital assets by the firm to the partner and capital gains will be taxed on such transfer in the hands of the firm.
Similarly, when stock in trade is received by a partner or a member of AOP/BOI on dissolution, then such transfer of stock can be charged to tax under the head of ‘Income from Business Profession’ under section 28(1) read with section 9B in the hands of the firm.
Gist of Section 45(4):
Section 45(4) talks about receipt of a capital asset or money by a specified person i.e Partner of a firm or member of AOP/BOI on reconstitution of such entity. Such receipt can be taxed in the hands of the firm as capital gains.
The above section 45(4) gets triggered only when there is a reconstitution of a firm or AOP/BOI and the partners/members receive a capital asset or money in excess of the balance in their capital accounts.
Such excess receipt by the partners can be triggered when there is a revaluation of asset(s) of the firm/AOP/BOI.
Now we will try and explain these sections and their tax implications with the help of FAQs.
Q.1 When do sections 9B come into play?
Ans: Section 9B comes into effect 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.
Therefore, when a partner of a firm or member of AOP/BOI receives any capital asset or stock on the dissolution or reconstitution of the firm/AOP/BOI. This will be deemed as a transfer of asset and can be taxed if there is any profit on such transfer.
Similarly, as per section 45(4), 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”.
Therefore, as per section 45, when a partner of a firm or member of AOP/BOI receives any capital asset or money or both on reconstitution of the firm/AOP/BOI then any profit on such transfer shall be income of the firm/AOP/BOI under the head “Capital gains”.
Q.2Who is a specified entity and a specified person for the purposes of sections 9B and 45(4)?
Ans: “specified entity” means a firm or other association of persons or body of individuals (not being a company or a co-operative society);
“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.
Therefore, these sections apply only on dissolution or reconstitution of a firm or AOP or BOI. If there is winding up of a company or dissolution or reconstitution of a co-operative society or any other entity, then these sections do not apply.
Also, if any person other than a partner of a firm or member of AOP/BOI receives any capital assets, stock or money then these sections do not apply.
Q.3 What is the point of taxation in case of section 9B and section 45(4)?
Ans: The point of taxation for both section 9B and 45(4) is the receipt of Capital asset or money or stock. Therefore, income shall be chargeable to tax only in the year of receipt of the Capital asset or stock or money.
Therefore, even if there is a reconstitution of a firm/AOP/BOI and no assets have been distributed among the partners or members, there will be no tax implication of the same.
Mere reconstitution does not trigger section 9B or 45(4). Distribution of assets is a must.
However, in case of a dissolution since a deeming fiction is created therefore in case of a dissolution it will be deemed that the partners/members have received assets of the firm/AOP on the date of the dissolution as receipt includes constructive receipt.
However, mere credit to the capital account of partner is not a receipt.
Q.4 What is a reconstitution or dissolution of a firm/AOP/BOI?
Ans: As per section 9B, “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;
Dissolution
Dissolution of any firm or business is the process of winding up of business when the relationship between partners dissolves or terminates.
Also, dissolution means where any business or profession carried on by a firm/AOP/BOI has been discontinued or dissolved.
Dissolution can be intentional or by the operation of Law.
For example, If there are two partners in a firm and one of them dies or retires, in this case the firm has to be dissolved compulsorily by operation of law. If a new partner has to be introduced then it has to be a new partnership and the old one is compulsorily dissolved.
This will not be a case of reconstitution of firm.
Q.5 Can a firm transfer asset to the partners as firm and partners are the same?
Ans: In the eyes of the Law, the firm and the partners are same. Therefore, in order to tax the transfer of assets from the firm to its partners a deeming fiction was introduced in section 9B where any receipt of capital asset or stock in trade or both from the firm by its partner will be deemed to be a transfer of a capital asset or stock and will be taxable under the head Capital gains or business profession.
Q.6 What is the consideration for the purpose of taxation under both these sections?
Ans: In case a capital asset or stock is transferred, the full value of consideration will be the fair market value on the day of its receipt by the specified person.
Q.7 How will the gains or profit be calculated?
Ans: (a) When capital asset or stock is transferred as per section 9B i.e on dissolution or reconstitution of a specified entity, the taxable income will be calculated under the head ‘Capital Gains’ or ‘Business Profession’ normally. If the asset is Long term in nature the it will income under the head ‘long term capital gains’ and if the asset is short term then it would be under ‘short term capital gains’. Also, when stock is transferred any profits will be income under the head business profession.
(b) When money or a capital asset is transferred on a reconstitution of a specified entity as per section 45(4) the 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 meaning thereby that there will be no capital gains.
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.
Therefore, capital gains will be calculated on reconstitution if the amount or value of assets or both, received by the partner(s)/member(s) is more than the balance in the capital account or current account or called by any other name on the date of the receipt.
There will be no capital gains under section 45(4) if the value of money and assets received is equal to the balance of capital account of the specified person by whatever name called.
The excess received will be capital gains in the hands of the firm and will be due to either revaluation of any assets of the firm or self-generated goodwill or any other self-generated asset.
Q.8 What are the differences between sections 9B and 45(4)?
Ans: Section 9B applies to both dissolution as well as reconstitution whereas section 45(4) applies only in case of reconstitution.
Also, if the partner receives any capital or stock section 9B will be attracted. If money is received by the specified person on reconstitution, then section 45(4) is attracted as section 9B does not mention receipt of money.
Since stock or capital asset is mentioned under section 9B, the income under 9B can be taxable both under the head ‘Capital Gains’ or ‘Business Profession’ whereas section 45(4) taxes income under the head ‘Capital Gains’.
Therefore, on dissolution only section 9B is applicable but on reconstitution both sections 9B and 45(4) can be applicable.
Q.9 Whether section 9B of the Income-tax Act, 1961 applicable on cash payments?
No. Section 9B of the Income-tax Act, 1961 is only applicable on distribution of Capital Asset or Stock-in-Trade or both.
Q.10 Are sections 9B and 45(4) retrospective in nature?
Ans: No, sections 9B and 45(4) are not retrospective in nature and will be applicable from 01.04.2021 and onwards. Therefore, these will be applicable from AY 2021-22 onwards.
Q.11 How is Fair Market Value of the asset or stock in trade computed?
Ans: As per section 2(22B) of the Income-tax Act, 1961, “fair market value”, in relation to a capital asset, means—
(i) The price that the capital asset would ordinarily fetch on sale in the open market on the relevant date; and
(ii) where the price referred to in sub-clause (i) is not ascertainable, such price as may be determined in accordance with the rules made under this Act.
Further, CBDT Circular 14 of 2021 dated July 02, 2021, considers the Fair Market Value as arrived under Rule 11U of the Income-tax Rules, 1962 for the purpose of determining Profits and Gains under section 9B of the Income-tax Act, 1961.
Q.12 Whether sections 9B and 45(4) are applicable to distribution of assets without reconstitution or dissolution of the specified entity?
Ans: No. Sections 9B and 45(4) of the Income-tax Act, 1961 are only applicable on reconstitution or dissolution of the specified entity. Therefore, if any capital asset or stock-in-trade or money is distributed in absence of reconstitution or dissolution of the specified entity, these sections will not apply.
Q.13 Who is liable to pay tax under section 9B and 45(4) of the Income-tax Act, 1961?
Ans. Under both sections 9B and 45(4) of the Income-tax Act, 1961, the specified entity is liable to pay tax on the distribution of assets.
Q.14 Whether there will be tax implication on transfer of any asset which is not capital asset except money or stock in trade?
Ans: These apply only in case of transfer of capital asset or money or stock (as in the case of section 9B), therefore if any asset is transferred which is not a capital asset except money or stock in trade, sections 9B and 45(4) would not apply and there will be no tax implication. For example transfer of Rural agriculture land.
Q.15 How is Capital Gains on transfer of self-generated assets and self-generated goodwill as per section 9B of the Income-tax Act, 1961?
Ans: On reconstitution or dissolution of a specified entity, when a self-generated asset is distributed to a specified person, then the entire sum will be taxable as Capital Gains, taking the cost of acquisition as nil.
As per Rule 8AA of the Income-tax Rules, 1962, transfer of a self-generated asset or self-generated goodwill is deemed to be a Short-term Capital Asset for the purpose of computing Capital Gains under section 45(4) of the Income-tax Act, 1961.
Q.16 What if the assets are received by the legal heir of the deceased partner or member?
Ans: In the opinion of the author the definition of specified person means a partner of a firm or member of other association of persons or body of individuals. Legal heirs are not covered under this definition therefore sections 9B and 45(4) are not attracted in case assets are received by the legal heir.
Q.17 What would be the cost of acquisition in case of receipt of capital asset or stock by a specified person if they sell it further?
Ans: The Cost of acquisition of the specified person would be the fair market value at which the asset is received by the specified person.
Q.18 Whether exemptions under section 54ECwould be available to the specified entity?
Ans: There are different views on this, one view states that exemption u/s 54EC only comes into play when there is actual consideration receipt. Therefore, if asset is distributed to the partner there will is no actual receipt or consideration therefore 54EC would not be applicable but the plain reading of the section 54EC only requires investment of an amount of capital gains, therefore exemption under section 54EC maybe applicable in this case.
However, in case of dissolution of the firm since the firm cannot hold the Bonds in its own name since it is dissolved, exemption u/s 54EC will not be available.
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(The author is a Chartered Accountant and can be contacted at [email protected] or [email protected] or Mobile: +91-9953199493)
Author Bio
CA Prateek Anand has very well explained the both sections 9B and 45(4) of the Income-tax Act, 1961, and about the specified entity who is liable to pay tax on the distribution of assets /stock on dissolution of firm. Amendment 2021 are so complicated that create confusion lacking clarity on its proper treatment . It throws ample light .Thanks to author. At last One thing that I find missing , he should give some example on stock transfer, acquisition , capital assets transfer its effect on capital account of outgoing partners or partners taking over such stock or assets as the case may be in the event of dissolution or reconstitution , capital gain, tax calculation method etc etc to satisfy the concluding part to make the task easier for payers or consultants. Arvind Bhargava 9425157452