Taxation Aspects of Transfer of Property between Firms and Partners – Section 9B and 48(iii)

0

Taxation Aspects of Transfer of Property between Firms and Partners: With the combined aim to promote digitisation, minimizing litigations, and addressing the gaps in the tax on the transfer of money or property or stock-in-trade by a firm/AOP/BOI to its firm/members, the Government of India unleashed Budget 2021, which received assent from the President of India on 28th March 2021 along with some amendments in the original amendments proposed in Budget 2021.

Taxation Aspects of Transfer of Property between Firms and Partners

Finance Act, 2021 settled some important issues. One among those issues wastaxation of firms in the event of dissolution/reconstitution, given ample of favourable as well as contradictory judgements available.

Taxation Aspects of Transfer of Property between Firms and Partners - Section 9B and 48(iii)

The article throws light, in detail, on the issues and the implication of the amendments made to resolve those issues.

Section 45(4) of the Income Tax Act, 1961

Prior to substitution by Finance Act, 2021, as per Section 45(4) of the Income Tax Act, 1961, profit or gains arising on transfer of capital asset on the dissolution of a firm or other association of persons or body of individuals or otherwise, was chargeable to tax as the income of the firm, association of persons or body of individuals, of the previous year in which the said transfer took place.

Further, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing for the purpose of Section 48.

However, there has been a long drawn dispute on taxation of capital gain under section 45(4) and it involved lot of controversies and some of them are listed below

  1. Whether the expression “Dissolution of the firm/AOP/BOI or otherwise” as mentioned in Section 45(4) includes reconstitution also?
  2. Whether the provisions would be applicable in case where assets are revalued or self-generated assets are recorded in the books and payment made to partner is in excess of capital contribution?
  3. Whether money paid to partner would be taxable in the hands of the firm under section 45(4)?

All these issues have been addressed by Finance Act, 2021 with the insertion of Section 9B and 48(iii) and substituting Section 45(4) w.e.f. Assessment Year 2021-22.

Impact of the Amendments made by the Finance Act 2021, Section-wise

Important terms for the purpose of the Section 45(4)/9B of the Income Tax Act :

  1. Specified entity means a firm or other association of persons or body of individuals (not being a company or a co-operative society).
  2. 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 cooperative society) in any previous year.’
  3. “Reconstitution of the specified entity” means, where—
    1. one or more of its partners or members, as the case may be, of such specified entity ceases to be partners or members; or
    2. 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
    3. 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;

Section 9B- Income on receipt of capital asset or stock in trade by specified person from specified entity

At the time of Reconstitution or dissolution of specified entity-

  • If a specified person receives any capital asset or stock in trade or both,
  • then there shall be deemed transfer of capital asset or stock in trade or both in hands of the specified entity in the year in which such capital asset or stock in trade are received by specified person and
  • Fair Market value of the capital asset or stock in trade shall be deemed to be the full value of the consideration received or accrued and
  • shall be taxable under head “Capital Gain” or “Profits and Gains of Business and profession” in accordance with the provisions of the Act.

Computation of Gain arising from deemed transfer of stockin-trade under section 9B

Computation of Gain arising from deemed transfer of stockin-trade under section 9B read with Section 28 shall be as follows

Fair Market value of stock transferred shall be recorded as sale and forms part of the business profit within the provisions of Section 28 of the specified entity.

Computation of Capital Gain arising on deemed transfer of capital asset under section 9B read with Section 48 shall be as follows:

Fair Market value of the capital asset as Full value of the consideration received or accrued as a result of the transfer of the capital asset
Less: Indexed Cost / Cost of acquisition of the asset
Less: Indexed Cost / Cost of Improvement of the asset
Income taxable under head capital gain

It is pertinent to note that mere reconstitution or dissolution of a specified entity would not require the application of the provision of Section 9B. The provision becomes applicable when a specified person receives any capital asset or stock-in-trade at a time of reconstitution or dissolution of the specified entity. However, deemed taxability shall arise in the hands of the specified entity only.

Section 45(4)- Capital Gain on receipt of Money or Capital Asset by Specified Person in the hands of the Specified Entity

At the time of Reconstitution of specified entity, —

  • where a specified person receives any money or capital asset or both; —
  • then any profit and gains arising from such receipt of money or capital asset by specified person shall be deemed to be the income of the specified entity under the head “Capital Gains”; —
  • in the previous year in which such capital asset or money or both were received by the specified person and —
  • such profit or gains shall be calculated in accordance with the following formula

A = B+C-D

Where,

A = income chargeable to income-tax 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 of the specified person in the books of account of the specified entity at the time of its reconstitution without considering increase in the capital account of the specified person due to revaluation of any asset or due to selfgenerated goodwill or any other self-generated asset (if any). Where the value of A is negative, it shall be deemed to be nil.

For the purpose of this subsection

“Self-generated Goodwill” or “self-generated asset” means goodwill or asset which has been acquired without incurring any cost for purchase or which has been generated during the course of the business or profession.

Explanation

It has been clarified that when a capital asset is received by a specified person from the specified entity in connection with the reconstitution of specified entity, the provisions of this sub-section, i.e., 45(4) shall operate in addition to the provisions of Section 9B and the taxation under the said provisions thereof shall be worked out, independently.

Note- Section 45(4) comes only into the light at the time of reconstitution of a specified entity. It provides for taxability of profit and gains on receipt of capital asset or money in the hands of specified entity which is actually the income of specified person. Further, section 45(4) shall operate in addition to the provisions of Section 9B i.e. At the time of reconstitution, suppose if a specified entity transfers capital asset to its specified person then the same shall be taxable under section 9B as well as 45(4).

Section 48(iii)- Mode of computation of Capital Gain

Section 48 provides for the deduction at the time of calculating capital gain from the full value of consideration received as a result of transfer of capital asset. A new clause (iii) has been inserted vide Finance Act 2021 which provides for an additional deduction in respect of capital gain taxed under section 45(4), i.e., deduction shall be allowed in respect of amount chargeable to tax under section 45(4) from the full value of the consideration of the capital asset at the time of transfer, calculated in the prescribed manner. However, the method for the same is yet to be prescribed by CBDT.

Computation of Capital Gain as per amended Section 48 shall be as follows

Full value of consideration received or accrued as a result of the transfer of the capital asset
Less: Indexed Cost / Cost of acquisition of the asset
Less: Indexed Cost / Cost of Improvement of the asset
Less: Amount chargeable to tax under section 45(4) in the hands of specified entity which is attributable to capital asset being transferred
Income taxable under head capital gain

Note- It is important to note that additional deduction shall arise only in case of reconstitution as section 45(4) cover only the reconstitution aspect and to mitigate the impact of double taxation [i.e. taxability under section 9B and 45(4)], clause (iii) has been inserted.

Comparative Analysis of Section 45(4), 9B and 45(iii) of the Income Tax Act, 1961 —

Section 45(4) provides for taxability in the event of Reconstitution of specified entity whereas Section 9B provides for taxability in the event of reconstitution or dissolution of specified entity.

For example- At the time of Reconstitution of the firm, if a partner gets capital asset and stock in trade from the firm, there are two transactions involved. First one is relinquishment of his rights as a partner and second is transfer of money or asset by the firm.

Former transaction is dealt under the provisions of Section 45(4) and the latter in section 9B. However, in the former transaction income arises in the hands of the partner but as per section 45(4) it is deemed as income of the firm.

Thus, the firm would be assessed under section 9B for its own income and under section 45(4) for the income arising to the partner.

Further, in case of reconstitution of firm double taxability will arise once under section 9B and second under section 45(4). To remove the impact of such double taxation, clause (iii) has been inserted to the section 48 which provides for the deduction of the amount attributable to tax under section 45(4) from the full value of consideration received or accrued at the time of transfer of capital asset.

Concluding Remarks

Though the Finance Act, 2021 addressed several debated issues, few clarifications are further required from CBDT with respect to period of holding for capital asset classification for the purpose of Section 9B & 45(4), method of attribution under section48(iii), availability of deduction by virtue of Section 48(iii), bifurcation of amount attributable towards receipt of money and capital asset etc.

Further, the changes have been made applicable from the Assessment Year 2021-22, wherein if partner(s) or member(s) of the firms/AOP/BOI, reconstituted or dissolved during the concerned year received any capital asset, stock and/or money, then the firm/AOP/BOI are required to evaluate the implications of the said amendment.