Taxation on Transfer of Capital Asset by Partner or by member of AOP/BOI & vice-se-versa

Taxation on Transfer of Capital Asset by Partner or by member of AOP/BOI & vice-se-versa

Introduction:

To understand the provision of taxation of capital gain on transfer of capital assets by the partner or by the member if the AOP/BOI and vice-se-versa, we need to understand the section 45(3) and 45(4) brought by the finance act 1987. The section 45(4) got substituted by the new section 45(4) and 9B by the finance act 2021.

1. Transfer by Partner or by the member of the AOP/BOI

a) Prior to the Finance Act, 1987 (Refer: CBDT in circular No. 495 dt. 22.09.87)

i) One of the devices used by assessees to evade tax on capital gains is to convert an asset held individually into an asset of the firm in which the individual is a partner.

ii) The decision of the Supreme Court in Kartikeya V. Sarabhai v. CIT [1985] 156 ITR 509 has set at rest the controversy as to whether such a conversion amounts to transfer. The Court held that such conversion fell outside the scope of capital gain taxation. The rationale advanced by the Court is, that the consideration for the transfer of the personal asset is indeterminate, being the right, which arises or accrues to the partner during the subsistence of the partnership to get his share of the profits from time to time and on dissolution of the partnership to get the value of his share from the net partnership assets.

b) As per section 48, for computation of the capital gain the full value consideration is required. As per the apex court judgment the full value of consideration is indeterminate, hence capital gain can’t be calculated and taxed.

c) Amendment by the Finance act, 1987

i) Due to the practical difficulties in evaluating the consideration for transfer in such cases the deeming provision of the act comes into the play.

ii) With a View to blocking this escape route for avoiding capital gains tax, the Finance Act, 1987 has inserted new sub-section (3) in section 45.

iii) The effect of this amendment is that profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partner’s income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital asset.

2. Transfer to Partner or by the member of the AOP/BOI

a) Prior to the Finance Act, 1987

i) The apex Court in Malabar Fisheries Co. vs. CIT (1979) 120 ITR 49 (SC) took the view that the firm has no separate legal right on its own in the partnership assets, but the partners have a joint or common right over the partnership assets.

ii) So, on retirement or dissolution, the partner received the assets, there is no transfer but the mutual adjustment of rights between the partners, hence not taxable.

b) Amendment by the Finance act, 1987

i) The Finance Act, 1987 has inserted new sub-section (4) in section 45 of the Income-tax Act, 1961.

ii) The effect is that profits and gains arising from the transfer of a capital asset by a firm to a partner on dissolution or otherwise shall be chargeable as the firm’s income in the previous year in which the transfer took place and for the purposes of computation of capital gains the fair market value of the asset on the date of transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer.

3. Assets are revalued or self-generated assets are recorded in the books of accounts and payment is made to partner or member

a) There was uncertainty regarding applicability of provisions of aforesaid sub­section to a situation where assets are revalued or self-generated assets are recorded in the books of accounts and payment is made to partner or member which is in excess of his capital contribution.

b) Amendment by the Finance act, 2021

i) Substitute the existing sub-section (4) of section 45 of the Act with a new sub-section (4) and also insert a new section 9B.

ii) New sub-section (4) of section 45 of the Act applies in a case where a specified person who receives during the previous year any capital asset at the time of dissolution or reconstitution of the specified entity. The capital asset represents the balance in the capital account of such specified person in the books of the specified entity at the time of its dissolution or reconstitution. In this situation, the profit and gains arising from the receipt of such capital asset by the specified person shall be chargeable to income-tax as income of the specified entity under the head-capital gains and shall be deemed to be the income of such specified entity of the previous year in which the capital asset was received by the specified person.

iii) Capital gain = Money Received by partner+ F.M.V of the assets receipt by the partner – capital balance of the partner (Excluding Revaluation of the assets or self-generated assets) at the time of reconstitution.

iv) New section 9B provides 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, then the specified entity shall be deemed to have transferred such capital asset or stock in trade or both, as the case may be, to the specified person in the year in which such capital asset or stock in trade or both are received by the specified person.

v) Deemed to be the income of such specified entity of the previous year in which such capital asset or stock in trade or both were received by the specified person; and

vi) Chargeable to income-tax as income of such specified entity under the head “Profits and gains of business or profession” or under the head “Capital gains”, in accordance with the provisions of this Act.

vii) For the purposes of this section, fair market value of the capital asset or stock in trade or both on the date of its receipt by the specified person shall be deemed to be the full value of the consideration received or accruing as a result of such deemed transfer of the capital asset or stock in trade or both by the specified entity.

c) The difference between the section 45(4) and 9B is that

i) Income arising to the partner u/s 45(4) but due to deeming fiction of the law its taxable in the hand of the firm.

ii) Income arising to firm shall be taxed u/s 9B of the act.

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Author: CA. Ajit Kumar K AJIT & Co. Chartered Accountant in Practice from Patna and can be contacted at [email protected].

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