Capital Gain arising in case of dissolution of partnership firm by way of transfer of a capital asset by way of distribution of capital asset to partners on dissolution or “otherwise” as Per S. 45(4) of Income Tax Act. As per S. 45(4) of the Income Tax Act where any partnership firm or AOP or BOI is dissolved and the Capital assets of the such firm or AOP or BOI are transferred by way of distribution of assets to the partners at the time of Dissolution in such case the gain arising from such transfer to the partners will be treated as capital gain and the firm will be liable for paying tax on it in the year of distribution of the assets.
For the purpose of S. 48 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 as a result of the transfer.
S. 45(4) of the Income-tax Act provides for taxation of the deemed capital gains arising on distribution of capital assets in the course of dissolution. The essential requirement for attracting this provision is that there is dissolution, and that in the course of such dissolution, capital assets are distributed.
Dissolution of the firm leads to the dissolution of partnership as between the partners but the partnership itself subsists, through only for the purpose of winding up it’s business and adjusting the rights of the partners inter se.
As is well-known in income-tax circles, there continues to be a lot of controversy about the interpretation of the provisions of S. 45(4) of the Income-Tax Act, 1961. U/s 45(4) of the Act, capital gains tax is sought to be charged on a firm in case of transfer of a capital asset and distribution of capital assets, on the dissolution of the firm or otherwise. The retirement of a partner from the firm is sought to be covered under the scope of the term “otherwise”, under the provisions of S. 45(4) of the Act.
- Recently, an Opinion was sought by a firm whether capital gains liability will arise in its hands in the event of the retirement of two of its partners from the firm.
- As the issue on which the Opinion was sought is not free from controversy, all the relevant aspects relating to the aforesaid issue were examined in detail.
- In other words, the Opinion sought was whether the firm, in question, will be liable to pay capital gains tax u/s 45(4) of the Act, as a result of the proposed retirement of two of its partners.
Keeping in view the aforesaid aspects, for the purpose of the Opinion sought, it will be necessary to discuss the following issues :
- The nature of relationship between a partnership firm and its partners, in regard to the assets of the partnership firm under the Indian Partnership Act, 1932.
- On the dissolution of a firm or on the retirement of a partner from the firm, there will not be a transfer of the assets of the firm.
- In the absence of the amendment of S. 2(47) of the Act, there will be no transfer of assets in the case of the dissolution of a firm or retirement of a partner from the firm.
Thus, the section since its introduction has been the subject matter of intense debate and discussion, as it threw open a large number of complex and unresolved issues including S. 2(47) of the Act which defines the term ‘transfer’ has not been amended to provide specifically for inclusion of the case of distribution of assets on dissolution. In view of that, a doubt has arisen relating to the enforceability of S. 45(4).The Section covers the cases of dissolution ‘or otherwise’. In view of that, a doubt has arisen about the applicability of S. 45(4) in cases of retirement and withdrawal of assets.
Whether S. 45(4) of the Act is attracted in case of retirement and admission of some partners even though the same firm continues.
The expression ‘otherwise’ as used in S. 45(4) of the Act has to be read with the words transfer of the capital assets. It becomes clear that even when a firm is in existence and there is a transfer of capital assets, it comes within expression ‘otherwise’. The word ‘otherwise’ takes into sweep not only cases of dissolution but also cases of subsisting partners of partnership transferring assets to a retiring partner.
Normally the partnership would stand dissolved on the death of a partner unless it is otherwise contracted for, but if it is found from the subsequent conduct of the parties that despite the death of partner, partnership business continued to function, then it would be taken that it continued by virtue of contractual relationship. The dissolution must be established from the circumstances leading clearly to such an inference.
The profits or gains are deemed to have arisen in the previous year in which the transfer takes place. The identification of the year of transfer becomes an issue in cases where the year of distribution happens to be different than the year of dissolution. The term ‘distribution’ is a legal and accounting concept which has given rise to a debate as to whether the Section will apply in a case where all the assets are taken away by one of the partners. An issue also has arisen as to whether the sale of capital assets to a partner could be treated as distribution of assets or not. A doubt has arisen about the entity in whose hands the deemed capital gain could be taxable, i.e., whether the gain would be taxed in the hands of the firm or in the hands of the group of partners as the firm has been dissolved and ceases to continue.
Normally, in cases of firms consisting of more than two partners, the death or insolvency of a partner would result in dissolution of the firm as per the provisions of the said Act. However, there would be no dissolution in a case where the partners have agreed to continue the partnership and the business even after death or insolvency, on certain terms and conditions. On compliance of such terms, the firm will be said to have continued. In such cases, there is a consensus of opinion that the provisions of S. 45(4) will not apply.
S.2(14), 2(47), 45(1) & 45(4) of IT Act, 1961—Capital gain—Profit received by the assessee partner on notional basis by deducting 40 per cent from two years average profit for the period of pendency of dissolution of the firm under the direction of the Court is to be treated as revenue receipt—B. Raghurama Prabhu Estate Executrix, Smt. M. Kaveri Bai vs. Jt. CIT (2011) 239 CTR 274 (Kar)
S. 45(4) of IT Act, 1961—Firm—The assessee is a partnership firm constituted under a partnership firm. One of the partners had disputed with the other partners and finally he was vacated from partnership. The allocation of the properties of the firm including goodwill was made in the accounts of the partners. On very next day, the new deed was executed and the remaining four partners continued to carry on the business without any break physically or operationally and the business of the firm continued without even a slight gap meaning thereby there was no distribution of assets to continuing partners. Therefore, there was no dissolution of the firm and there is no application of s. 45(4) and thus, there is no room for capital gains taxation—Purayannur Industries vs. ACIT (2009) 317 ITR 56 (ITAT-Cochin)
S. 2(47), 45(4), 47(ii) & 145 of IT Act, 1961—Capital gain—S. 45 gets attracted in the case of the transfer of capital asset by way of distribution of capital assets, inter alia, on the dissolution of a firm. When on reconstitution of a firm, new partners are admitted and one new partner took over entire assets and liabilities, it amounts to a transfer of assets on dissolution of a firm and therefore, S. 45(4) of the Act applicable. Thus valuing the closing stock on dissolution of firm at fair market rate is justified—ACIT vs. D. D. International (Global) (2009) 125 TTJ 112 (ITAT-Asr.)
S. 2(47), 45(3), 45(4) & 47(ii) of IT Act, 1961—Capital gain—S. 47 was introduced to take out certain transactions which otherwise are transfers of capital assets and otherwise taxable u/s 45 from being taxed. On the reintroduction of sub-s. (3) and (4) of S. 45 by the Finance Act, 1987, cl. (ii) of S. 47 has been expressly omitted removing the protective umbrella. Where in respect there is transfer of capital asset, by any mode and to ensure the gain being taxed u/s 47 has been amended. Therefore, continuing the business with the new partners who are introduced after retiring the old partners is a transfer of capital assets within the meaning of S. 2(47) attracting the capital transactions in terms of S. 45(4) of the Act—CIT vs. Gurunath Talkies (2009) 226 CTR 474 (Ker)
S. 45(4) of IT Act, 1961—Capital gain—Since there is neither dissolution of firm nor transfer of assets of the firm, but it is purely a case of conversion of firm into company, the provisions of S. 45(4) of the Act would not apply. For application of the provisions of S. 45(4), two conditions are required to be satisfied, viz. transfer by way of distribution of capital assets, and, secondly, such transfer should be on dissolution of the firm or otherwise. Once these twin conditions are satisfied, then for the purpose of computation of capital gains u/s 48, the market value on the date of the transfer shall be deemed to be the full value of the consideration received or accruing as a result of transfer. Where a firm becomes a limited company under Part IX of the Companies Act, 1956, S. 45(4) is not attracted as the first condition of transfer by way of distribution of capital asset is not satisfied—ITO vs. Gulabdas Printers (2010) 4 ITR (Trib) 264 (ITAT-Ahd)
S. 45(4) of IT Act, 1961—Capital gain—Distribution of land among partners on dissolution of the firm Whether—(1) the land belonged to the individual partners or to the firm?, (ii) the provisions of S. 45(4) are applicable on the facts of the case?, (iii) full value of the land is to be taken into account for computing the capital gains or only 12% of the full value of the land is to be taken into account for computing capital gains, and (iv) the value estimated by the valuation officer was correct or not? While allowing the appeal partly, the Income Tax Appellate Tribunal held that:—(i) the onus to prove that it belonged to the partners lied on the assessee. No such evidence has been produced and, therefore, it is held that the land belonged to the firm, (ii) the instant case is one of transfer of assets to the partners on dissolution of the firm. It is held that transaction is caught within the mischief of the provisions contained in S. 45(4), (iii) it is directed that only 62% of the value of the land should be considered for the purpose of computing capital gains under this section, and (iv) valuation is a matter of art and not science and, therefore, there is no arithmetical formula for the valuation of the land. Therefore, looking to overall facts of the case, the ends of justice would be met if the value of the lands on the date of dissolution is adopted at a round sum of Rs. 39 lakhs—Gandamal & Sons Vs. Assistant Commissioner or Income Tax (ITAT, Pune)
S. 45(4) of IT Act, 1961—Capital gain—In the event of distribution of assets on dissolution of partnership or otherwise, capital gain arises—ACIT vs. G. H. Reddy & Associates
As Per Section 45(4), of the Income Tax Act, 1961-
45(4). The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, 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 as a result of the transfer.
From the provisions of S. 45(4), it is quite clear that there are two primary requirements for the application of section 45(4) in a given situation, viz :
(i) There should be a transfer of a capital asset, and
(ii) There should be distribution of capital assets on the dissolution of a firm or otherwise.
In view of the aforesaid reasons, in the present context, it will also be necessary to refer to the definition of the word ‘transfer’, as defined u/s 2(47) of the Act.
2. In this Act, unless the context otherwise requires,—
(47) “transfer”, in relation to a capital asset, includes,—
(i) the sale, exchange or relinquishment of the asset ; or
(ii) the extinguishment of any rights therein ; or
(iii) the compulsory acquisition thereof under any law ; or
(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment ; or
(iva) the maturity or redemption of a zero coupon bond; or
(v) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882) ; or
(vi) any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.
Explanation 1.—For the purposes of sub-clauses (v) and (vi), “immovable property” shall have the same meaning as in clause (d) of section 269UA.
Explanation 2.—For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India.