For a long distribution of assets on dissolution or otherwise has been a cause of litigation and there were several judgements which were contrary to the other, giving taxpayers a gully to escape the wrath of tax on such distributions. To plug such leakages in revenue legislature vide Finance Act, 2021 inserted section 9B and substituted the erstwhile section 45(4) with a new one.
Now before you wonder which section will apply in which of the scenarios, it is brought to your attention that section 45(2) apply in addition to section 9B and therefore provision of both section shall where certain assets mentioned therein have been received by the specified person from a specified entity. Both sections shall operate independently of one another.
Also, even though the property is being transferred to the specified person it is the specified entity that shall bear the incidence of tax under these sections.
APPLICABILITY AND DEFINITIONS-
For these sections to apply there must be a reconstitution where in assets are received by the specified person from the specified entity. So let us begin by discussing what reconstitution means-
“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;
It is important to note that even though a change in profit sharing ratio is considered to be reconstitution but such change without transfer of assets from a specified entity to a specified person will not trigger taxation under these two aforementioned sections.
“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.
ASSETS WHICH ATTRACT THESE SECTIONS–
Section 9B- Capital Asset or Stock-in-Trade or Both
Section 45(4)- Capital Asset or Money or Both
CHARGEABILITY–
Section 9B- Income chargeable under the head Capital Gains (in case of Capital Assets) and under the head Profit and Gains from Business and Profession (in case of stock-in-trade)
Section 45(4)- Income on account of transfer of both money and capital assets chargeable under the head Capital Gains.
COMPUTATION OF INCOME-
Let us discuss what’s usually discussed in last at the very beginning and then slowly build upon that i.e., computation of income-
Section 9B-
Fair Market Value of Capital Assets/ Stock in Trade are to be considered-
Less: Cost of acquisition
Income chargeable under the head Capital Gains/ Profit and Gains from B & P
Capital Asset shall have the meaning as assigned to it under section 2(14). So for example rural agriculture which is not considered to be a capital asset is distributed then such transfer would not attract the wrath of Section 9B/ 45(4). Further, the benefit of indexation and the specified entity shall be entitled to take the fair market value as of 01.04.2001. In short, all benefits available under the chapter of Capital Gains become equally applicable to gains calculated under section 9B including available u/s 54EC and alike sections.
Section 45(4)-
Fair Market Value of Capital Assets transferred-
Add: Money received by specified person
Less: Capital Balance at the time of such transfer
Income chargeable under the head Capital Gains
It is important to note that capital balance should include post gains on the transfer of capital assets calculated u/s 9B. And the gain which arises consequent to the calculation under section 45(4) shall be attributed to remaining capital assets which have undergone revaluation or are recognised on account of such valuation and the same shall be allowed as deduction as per 48(iii) while calculating capital gain on such remaining capital assets. Details illustration is as under-
There are three partners “A”, “B” and “C” in a Firm “FR”, having one third share each. Each partner has a capital balance of ₹ 100 lakh in the Firm. There is a piece of land “S” of book value of ₹ 3O lakh. There is patent “T” of written down value of ₹ 45 lakh. And there is cash of ₹ 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 ₹ 45 lakh and fair market value of patent “T” is ₹ 60 lakh. As per the valuation report there is also self-generated goodwill of ₹ 30 lakh. On the exit of partner “A”, the firm decides to give him ~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 ~45 lakh. Let us assume that the indexed cost of acquisition of land “S” is ₹ 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 ₹ 45 lakh.
The net book profit ₹ 15 lakh (capital gains of ₹ 15 lakh without indexation) is to be credited in the capital account of each of the three partners, i.e. ₹ 5 lakh each. Thus partner “A” capital account would increase to ₹ I05 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 ₹ I 05 lakh, partner “A” has received ₹ 120 lakh (money of ₹ 75 Lakh plus land “S” of fair market value of ₹ 45 lakh). Thus ₹ 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 ₹ 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 ₹ 15 lakh and the self-generated goodwill value has been recognised at ₹ 30 lakh. Thus, one third of ₹ 15 lakh [i.e. ₹ 5 lakh (₹ 15 gain as per section 45(4) x ₹ 15 gain increase in FMV of T/₹ 15 gain increase in FMV of T + ₹ 30 on account of recognition of self-generated goodwill)] would be attributed to patent “T”, while two third of ₹ 15 lakh [i.e. ₹ 10 lakh (₹ 30 on account of recognition of self-generated goodwill x ₹ 30 on account of recognition of self-generated goodwill /₹ 15 gain increase in FMV of T + ₹ 30 on account of recognition of self-generated goodwill)] would be attributed to self-generated goodwill. ₹ 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 ₹ 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 ₹ 25 lakh. ₹ 5 lakh shall be reduced from ₹ 25 lakh and only net amount of ₹ 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, ₹ 10 lakh would be reduced from its sales consideration under clause (iii) of section 48.
The allocation is to be carried out in accordance with Rule 8AB which states as under-
“(2) Where the aggregate of the value of money and the fair market value of the capital asset received by the specified person from the specified entity, in excess of the balance in his capital account, chargeable to tax under sub-section (4) of section 45, relates to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill, of the specified entity, the amount attributable to the capital asset remaining with the specified entity for purpose of clause (iii) of section 48 shall be the amount which bears to the amount charged under sub-section (4) of section 45 the same proportion as the increase in, or recognition of, value of that asset because of revaluation or valuation bears to the aggregate of increase in, or recognition of, value of all assets because of the revaluation or valuation.”
The gains attributed to assets remaining with the specified entity have to be reported in Form 5C which has to be filed before the due date filling of return of income.
The amount of ₹ 15 lakh which is charged to tax under sub-section (4) of section 4S of the Act shall be charged as short term capital gains, as ₹ 5 lakh is attributed to the Patent “T” which is part of block of assets and ₹ 10 lakh is attributed to self-generated goodwill. In accordance with sub-rule (5) of Rule 8AA of the Rules, both of these are to be characterised as short-term capital gains.
Note: For the purpose of calculation of depreciation under section 32 of the Act, the written down value of the block of asset “intangible” of which Patent “T” is part, would remain ₹ 45 lakh and would not be increased to ₹ 60 lakh due to revaluation during the year. In this regard it may be highlighted that the following provisions are relevant in determining the amount on which depreciation is allowable under the Act:
- Explanation 2 of sub-section (I) of section 32 of the Act provides that the term “written down value of the block of assets” shall have the same meaning as in clause (c) of sub-section (6) of section 43 of the Act.
- Clause (c) of sub-section (6) of section 43 of the Act, with respect to block of assets, inter-alia, provides that the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year is to be increased by the actual cost of any asset falling within that block, acquired during the previous year. This clause does not allow any increase on account of revaluation. Therefore, any increase in value on revaluation will not have an impact on the block of asset but the gain u/s 45(4) which gets attributed to the specific asset in accordance with rule 8AB shall be reduced from full value of consideration at the time of its transfer in accordance with 48(iii).
- Sub-section (I) of section 43 of the Act which defines “Actual cost” as actual cost of the assets to the assessee. In revaluation, there is no actual cost to the assessee.
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 ₹ 30 lakh recognised in valuation. In this regard it may be highlighted that the above-mentioned provisions, in the immediate preceding paragraph, are also applicable to “self-generated asset” and since there is no actual cost to assessee in case of ” self-generated asset”, depreciation is not allowable under section 32 of the Act on an asset whose actual cost is nil.
In above lets say the Book Value, Fair Market Value and Indexed cost of acquisition of land “S” is as under-
Book Value (in ₹ in lakh) -20
Fair Market Value (in ₹ in lakh) -45
Indexed COA (in ₹ in lakh) -30
This gives us a capital gain of ₹ 15 lakh on which capital gain tax comes out to be ₹ 3 lakh (at 20%- ignoring cess and surcharge for ease of understanding). Thus, as a result of revaluation and consequent transfer there shall be post tax gain in books of ₹ 12 lakh i.e., ₹ 15 lakh (FMV-BV) – ₹3 lakh CG tax, which shall be divided equally among all partners therefore each partner’s capital account shall get credited by ₹ 4 lakh each. So now the “A” capital account shall be ₹ 104 lakh instead of ₹ 105 lakh.
It is important to note that capital balance for purpose of section 45(4) will not be increased by revaluations of patent and self-generated goodwill as. Only post tax gain on the assets deemed to be transferred shall be included in capital balance. Section 45(4) through its second proviso prohibits taking into account of revaluation of assets not deemed to be transferred.
(ABOVE ILLUSTRATION IS INSPIRED FROM CIRCULAR 14 OF 2021 AND HAVE BEEN SUITABLY MODIFIED FOR BETTER UNDERSTANDING.)
The rate of tax calculated on capital gain shall depend upon the gain being Long-Term or Short-Term and according shall be taxed u/s 111A/112/112A.
It is also pertinent to note that sections 9B and 45(4) mandate using of Fair Market Value whereas section 50C/43CA requires the use of Stamp Duty Value. In the opinion of the author, both are deeming provision, but section 9B/45(4) is specific to the case and therefore shall operate and Section 43CA/50C/50CA do not apply to situations covered by 9B/45(4).
The cost of Acquisition in the hand of a specified person shall be the Fair Market Value taken under section 9B/45(4) of the assets deemed to be transferred.
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