Taxability on transfer of Capital Assets/Stock-in-trade from specified entity to specified person
The Finance Act 2021, has inserted Section 9B, Section 48(iii) and substituted section 45(4) of the Income Tax Act. The deeming provisions shall be applicable from Assessment Year 2021-22.
For the purpose of this article, the term specified person and specified entity is in reference to the definition under section 9B of the Act, the definition has been reproduced as under:
Specified Person: 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.
Specified Entity: a firm or other association of persons or body of individuals (not being a company or a co-operative society);
Section 9B of the Act, stated that when any specified person receives any capital asset or stock in trade from the specified entity and that transfer is made only in connection with the reconstitution or dissolution of that specified entity, then the profit arisen on such transfer shall be taxable in the hands of specified entity under the income from business or profession or income from taxable gains. Furthermore, for the purpose of calculation of fair market value, the date of actual receipt of transfer will be deemed as income has arisen or deemed to be arisen.
The provision explains that the very essential of the section is that actual receipt and not a constructive receipt should take place during the previous year, i.e., if Partner’s Account is debited and asset account credited in the Books of Firm this will not be implemented. Further, for the purpose of the section it is not necessary that both the event of reconstitution/dissolution and transfer of assets be in the same previous year. Thus, if dissolution has taken place in Financial Year 19- 20 and assets are distributed in Financial Year 2021 this section will be applicable. So what is essential is the nexus between dissolution/reconstitution and distribution.
Section 45(4) of the Act has been substituted, the earlier provision was in context to the dissolution of the specified entity, the new provision takes into consideration the reconstitution of the specified entity rather than its dissolution for the purpose of taxability of capital gains on transfer of capital asset or stock in trade to the specified person.
For the purpose of method of calculation of income chargeable to tax in the hands of specified person (A), the addition shall be made to value of money received by specified person (B) and amount of fair market value of the capital asset received by the specified person (C) (as on date of receipt) which shall be subtracted by 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 (D).
Thus, the formula comes down to A= B+C-D.
Note: Both the provisions i.e., Section 9B and section 45(4) shall work independently
Earlier if stock-in-trade was distributed to the partner, partnership firms used to argue that no tax was payable by the firm under the erstwhile Section 45(4).
In Addl CIT Vs Mohanbhai Pamabhai  165 ITR 166 (SC) The Gujarat High Court, in the case of CIT Vs Mohanbhai Pamabhai  91 ITR 393 (Guj), held that when a partner retires from the firm and receives his share of an amount calculated on the value of the net partnership assets of the firm, there was no transfer of interests of the partner in the assets of the firm and no part of the amount received by him would be assessable as capital gains under section 45 of the Act.
The Department preferred an appeal to the Supreme Court against the aforesaid judgement of the Gujarat High Court.
The Supreme Court, in view of its earlier judgement, in the case of Sunil Siddharthbhai Vs CIT  156 ITR 509 (SC), dismissed the appeal of the Department and thus, the aforesaid judgement of the Gujarat High court was affirmed by the Supreme Court.
However, the new provision has reversed the position and has made it amply clear by providing that the same will be taxed under the head income from capital gains.
Further, the existing provisions did not provide that balance in the capital account of a partner shall represent capital assets. But the proposed amendment provides that the capital asset will represent the balance in a specified person’s capital account in the books of the specified entity at the time of its dissolution or reconstitution. It is also provided that in determining the capital account balance of the specified person, any increase on account of revaluation of any asset or due to self-generated goodwill or any other self-generated asset will be excluded. It is provided that so far as the cost of acquisition is concerned, it is to be ascertained in the usual manner. There was no such provision in the existing provisions.
Section 48(iii) of the Act has been newly inserted, for the purpose of taxability of income in the hands of specified person with respect to the said transfer of capital asset or stock in trade, the specified person shall receive deduction to the tune of the amount which has already been taxed in the hands of specified entity.
For example, if on transfer of capital asset of amounting X, tax to the amount of Y has been charged. The specified person while filing his return of income can claim a deduction of Y amount.
The Central Board of Direct taxation has issued circular_14_2021 which has issued guidelines for taxability of transfer of capital assets including block assets.
Block assets means a group of assets’ falling within a ‘class of assets’ comprising- tangible assets, being buildings, machinery, plant or furniture;
intangible assets, being know-how, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial rights of similar nature,
in respect of which the same percentage of depreciation is prescribed.
Earlier the provisions were ambiguous but with the issuance of the circular it has been clarified that the capital assets will include block assets and that written down value method under section 43 (6) (c) and section 50 (special provision for computation of capital gains in case of depreciable assets) shall also be taken into consideration for purpose of computation of income for such transfer of capital asset.
Rule 8AB as inserted by the above mentioned circular shall deem to include section 43 (6) (c) and section 50 wherever section 48 is mentioned.
(Authored by Ms. Anjali Jain, Advocate. The author can be contacted on firstname.lastname@example.org)