Income Tax Query 11: Income Tax in case of Reconstitution of Firm ~ Section 9B & 45(4) of the Income Tax Act, 1961

[A] Conditions Precedent

(1) Specified Person ~ Partner in Partnership Firm or LLP or Member of AOP or BOI

(2) Receives during the previous year

(3) Any Stock in Trade or Capital Asset or both

(4) From the Specified Entity ~ Partnership Firm or LLP or AOP or BOI

(5) In connection with ~

(a) Dissolution of the SE

(b) Reconstitution of the SE ~ Retirement of One or More SP, Admission of one or more SP, change in profit sharing ratio of one or more SP.

[B] Then – Consequences

(1). SE shall be DEEMED to have Transferred such Capital Asset or Stock in Trade or both, as the case may be, to the SP, in the previous year, in which such CA or SiT or both is Received by the SP.

(2) Any profits or gains arising from such deemed transfer shall be the Deemed Income of the SE in the PY in which such CA or SiT or both is Received by the SP.

(3) Such profits and gains arising from such deemed transfer shall be the chargeable under the head Profits & Gains from Business or Profession or under the head Income from Capital Gains.

(4) Fair Market Value of the CA or SiT or both on the date of Receipt by the SP shall be deemed to be the Full Value of Consideration to the SE.

(5) Section 45(4) provides the Computation of Capital Gains in case of Deemed Transfer of Capital Asset from SE to SP chargeable to Tax in the hands of SE.

(6) (A) = (B) + (C) – (D) where

(A) = Income from Capital Gains of SE

(B) = Value of any money received by the SP

(C) = FMV of the Capital Asset

(D) = Amount of Balance in the Capital A/c of the SP

(6) In order to avoid double taxation section 48 (iii) requires that the amount taxed under section 45(4) of the Act should be attributed to the remaining capital asset(s) of the specified entity, such that when these capital asset(s) get transferred in the future, the amount attributed to such capital asset(s) gets reduced from the full value of consideration.

(7) Rule 8AA(5) specifies that Capital Gain u/s 45(4) shall be :

1. deemed to be from transfer of Short-term capital asset, if it is attributed to – (a) short term capital asset (b) block of asset (c) self generated asset or self generate goodwill;
2. deemed to be from transfer of Long-term capital asset, if it is attributed to – (a) long term capital asset and (b) not covered by STCA abovee.

(8) Rule 8AB provides for Attribution of Income taxable u/s 45(4) to capital asset remaining with SE u/s 48(iii). under Rule 8AB(2) the amount taxable u/s 45(4) relates to revaluation of any capital asset or valuation of self -generated asset or self-generated goodwill, of the SE, the amount attributable to the capital asset remaining with the SE shall be the amount which bears to the amount charged under section 45(4) 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.

(9) The revaluation of an asset or valuation of self-generated asset or goodwill does not entitle the specified entity for depreciation on such increased value. 

Key Points:

1. Income on Deemed Transfer is chargeable to Income Tax in the hands of the SE – Partnership Firm or LLP or AOP or BOI.
2. Income of the Partner is Exempt u/s 10(2A) of the Income Tax Act, 1961.
3. In case No Asset – Capital Asset or Stock in Trade or Money is withdrawn by the SP (Partner / Member) then No Income is Deemed to Accrue to the SE.