Finance Act 2021 has heralded new legislation to restraint the use of Partnership FORM of Organization, for tax planning. To this end, legislation has incorporated new section (9B) and re-casted existing section (45(4)) under Income Tax Statue. These provisions are applicable from Assessment year beginning from 1st April, 2021
In the ensuing write-up, I have tried to explained the said provisions, along with illustration and expounded many unsettled question expected to arise on implementation of new provisions
Taxability on Reconstitution of Partnership Firm- Amendment by Finance Act 2021.
Section 9B
1. Following event (Specified event) took place in the Partnership firm/AOP/BOI (FIRM)
a) Dissolution
b) Change in Profit Sharing ratio
c) Retirement of Partner
d) New Person is admitted as a partner in FIRM
2. Partner/Member (specified person) of Firm, AOP or BOI received Capital asset or stock in trade from FIRM in connection with specified Event.
3. In above conditions are satisfied, then FIRM is deemed to have TRANSFERED such capital Asset or stock in trade to specified Person
4. There arise Profit or gains on such transfer to be computed on the basis of Sales consideration (Stock in trade or Capital Asset) to be taken at FMV of the asset on the date of transfer.
5. Such Profit or gains shall be chargeable to tax in the hands of FIRM under the hands PGBP or Capital gains, in accordance with the provision of Act,
6. If any difficulty arises in giving effect to provision of section 9B, CBDT is empowered to issue guidelines for removing the difficulty.
Section 45(4)
1. Section override Section 45(1)
2. There is either change in profit Sharing ratio, retirement or admission (Reconstitution) of Partner in FIRM (Dissolution not Covered)
3. Partner receives Capital asset or Money from FIRM in connection with re-constitution.
4. On receipt of capital Asset or money, Profit & gains arises to such partner.
5. Such Profit & gain
a) Shall be chargeable to Income Tax under the head “ Capital gains” and
b) Shall be deemed to be income of the FIRM in the previous year in which money or capital asset is received by partner
6. Profit & Gains will be computed as under:
a) Money received + FMV of Capital Asset Received less Balance in capital Account of such partner at the time of reconstitution (without taking into account the increase in the capital account of the specified person due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset.)
b) If above working results in negative amount, then gain shall be considered as ZERO
Amendment in section 48
1. In calculating capital gain u/s 45(1) pursuant to section 9B, the Capital gain will be computed as under;-
a) FMV of Capital Asset transferred to Partner
b) Less: Cost/Indexed cost of Acquisition/Improvement
c) Less: Capital gain chargeable to tax u/s 45(4) on transfer of Capital Asset to Partner
Taxability – Summary
|
Group |
Transaction |
Section 45(4) |
Section 9B |
|
Reconstitution of firm (Change in PSR, Admission or Retirement of Partner) |
Receipt of Money by Partner |
Taxability will be computed |
No Taxability |
|
Receipt of Capital Asset (from firm’s perspective) by Partner |
Taxability will be first computed |
Then, taxability will be computed in pursuance of section 9B under section 45(1) & 48 |
|
|
Receipt of Stock in Trade |
No Taxability |
Taxability will be computed in pursuance of section 9B , as per provisions applicable for PGBP |
|
|
Dissolution of FIRM |
Receipt of Money |
NOT Applicable |
Not taxable |
|
Receipt of Capital Asset |
Taxability will be computed in pursuance of section 9B under section 45(1). |
||
|
Receipt of Stock in Trade |
Taxability will be computed in pursuance of section 9B , as per provisions applicable for PGBP |
The above provision can be illustrated with Example
A. Transfer of Capital Asset on retirement of Partner
1. There are 3 partners (A,B & C) each having Capital of Rs. 3 lacs on 31-03-2021
2. There are 3 capital assets X- Rs. 4 lacs, Y – Rs. 4 lacs and Z – Rs. 1 lacs. All Assets acquired on 01-04-2017
3. A retires and he was given Asset Z, having FMV of Rs. 10 lacs
Tax Implications
i) Taxability U/s 45(4) – {FMV of Asset- Capital Balance) – Rs. 7 lacs ( 10-3).
ii) Taxability pursuant to section 9B and will be taxable u/s 45(1)
FMV of Capital Asset Rs. 10,00,000
Less: Indexed Cost of Acquisition Rs. 1,10,661 (1,00,000 x 301/272)
Less: Capital u/s 45(4) Rs. 7,00,000
Long Term Capital Gain Rs. 1,89,339
B. Transfer of Stock in trade on retirement of Partner
1. There are 3 partners (A,B & C) each having Capital of Rs. 3 lacs as on 31-03-2021.
2. A retires and he was given stock in trade (Book value – Rs. 2 lacs), having FMV of Rs. 10 lacs
Tax Implications
i) Taxability pursuant to section 9B and will be taxable u/s 28
FMV of Stock in Trade Rs. 10,00,000
Less: Book value Rs. 2,00,000
PGBP Rs. 8,00,000
Unresolved Issues
1. Nature of Capital gain (Long term and Short term) u/s 45(4)
a) Section 45(4) is departure from Normal Capital Gain taxation rules. Capital gain arises on transfer of Capital Asset
b) U/s 45(4), receipt of money or Capital Asset (FMV) by partner in excess of balance in his capital Account, is chargeable to tax under the capital gains and such capital gains though accrue to partner, but same is taxable in the hands of FIRM. Law does not deem any transfer of Capital Asset u/s 45(4) and gain arising in pursuant thereto.
c) In the absence of transfer of Capital Asset, there cannot be Short term or long term capital gain, as same is dependent upon the holding period of capital asset before its transfer.
d) Thus Section envisage special capital gain and following implication draw from thereupon
i) Setting of bough forward loss - If Partner has bought forward Long term Loss under the head Capital gain, whether it can be set-off against the special capital gains. Long term capital loss can be set-off against Long term capital gain only. In the absence of nature of special capital gain, this point needs clarification.
ii) Place of Accrual of Capital Gains- Capital gain on transfer of Capital Asset situated in India is deemed as accrue or arise in India u/s 9. In case of special capital gain, there is no transfer of Capital gain. In the absence of specific provision, as regard place of accrual of special capital gain, the taxability of same in the hands of Non-resident is questionable
2. Implication of Double taxation in the hands of FIRM
a) Under Section 45(4), money paid to retiring partner in excess of balance in his account is deemed as Capital gain. The excess amount, generally, represents unrealized appreciation in the value of Firm’s asset as on the date of retirement.
b) Though unrealized gain is made taxable in the hands of FIRM, but there is no corresponding provision for increase in the value of asset in the hands of FIRM
c) Explained as under:-
i) Suppose there are 3 partners (A,B,C), each having capital balance of Rs. 2 lacs and C retires.
ii) One capital Asset (X) (book value – Rs. 3 lacs) is having market value of Rs. 12 lacs. C will be credited with his share of appreciation – Rs. 3 lacs ( 9 lacs x 1/3)
iii) C capital account stands at Rs. 5 lacs ( 2+3) and Rs. 3 lacs is profit accruing to C and will be made taxable in the hands of FIRM as capital gain.
iv) Suppose immediately after C’s retirement, FIRM sold capital asset (X) at Rs. 12 lacs and made capital gain (STCG) of Rs 9 lacs ( 12-3). But out of Rs. 9 lacs, Rs. 3 lacs has already been taxable in the hands of FIRM on C’s retirement and same is again made taxable on actual capital gain.
v) There needs to be provision for enhancement in the COST OF ACQUISITION of capital assets, whose unrealized gain is being made taxable in the hands of retiring partner earlier.
3. Implication of Double Taxation in the hands of retiring partner
a) Under Section 9B, on receipt of capital asset by retiring partner, taxability is casted on the FIRM on the basis of FMV of Capital Asset. But there is no corresponding provision for cost of Acquisition (COA) to be taken as FMV, in the hands of retiring partner
b) Explained as under
a) Suppose C, having Capital balance of Rs. 2 lacs, was given Capital Asset (book value- Rs. 3 lacs) having FMV at Rs. 9 lacs
b) The FIRM will be made taxable on aggregate of capital gain (9B+45(4)) of Rs. 7 lacs ( 1+6).
c) The partner has been given Capital Asset at Rs. 3 lacs, but firm is being made taxable on the basis of FMV of capital Asset i.e Rs. 9 lacs
d) As per existing provision of section 48, COA in the hands of partner will be taken at Rs. 5 lacs, which should have been Rs. 9 lacs.
e) Thus in the absence of explicit provision u/s 55 for FMV being COA in the hands of retiring partner, there will be double taxation, when he will sell such asset in future.
4. Complexity in Computation Mechanism.
a) Under new taxability provision, Capital gain on transfer of Capita Asset to retiring partner is first computed u/s 45(4) and then same is allowed as deduction, while computing Capital gain envisage in section 9B
b) If retiring Partner is given both money and Capital asset on retirement, then there is no provision to determine the capital gain accruing on transfer of Capital Asset.
c) Explained as under
i) Suppose Partner C (having Capital Balance – Rs. 2 lacs) retires. He is given money of Rs. 3 lacs and Capital Asset (book value- Rs. 4 lacs) – Rs. 10 lacs (FMV)
ii) The Taxable Capital under section 45(4) and 9B will be work out as under:-
|
Particulars |
Section 45(4) |
Section 9B |
|
Money Paid to Partner |
3,00,000 |
|
|
FMV of Capital Assets |
10,00,000 |
|
|
Less: Balance in Capital Account |
2,00,000 |
|
|
Capital Gain u/s 45(4) |
11,00,000 |
|
|
FMV of Capital Asset |
|
10,00,000 |
|
Less; Book Value of Capital Asset |
|
4,00,000 |
|
Less: Capital Gain on transfer of Capital Asset made taxable u/s 45(4). It Cannot be worked out, since capital gains u/s 45(4) has been worked out on the basis of aggregate Consideration comprising payment of money and FMV of Asset. There is no provision to work out capital gain u/s 45(4) proportionate to receipt of capital asset by Partner |
|
???????? |
5. Deemed transfer u/s 9B- Weakness in Strengthening taxability
a) Section 9B provides that if there is dissolution of firm or reconstitution in the firm, receipt of capital asset or stock in trade is DEEMED as transfer and gain arising in pursuant thereto will be taxable under the head Capital gains or PGBP. Same hold u/s 45(4).
b) It implies that if partner receives capital asset or stock in trade during tenue of partnership or without there being reconstitution in FIRM, then such transaction will not be considered as transfer, as u/s 9B deeming transfer arising on dissolution or reconstitution of FIRM only.
c) This aspect could render entire taxability u/s 9B & 45(4) ineffectual, explained as under
i) Suppose there are 3 partner, each having Capital balance of Rs. 2 lacs. Asset (Book value- Rs. 6 lacs) of the firm has market value of Rs. 27 lacs.
ii) Firm carried out revaluation of Assets and credited the revaluation gain of Rs. 21 lacs, in equal proportion (7 lacs each). Now capital balance of each partner stands at Rs. 9 lacs ( 2+7).
iii) Suppose C receive an asset of Rs 9 lacs (FMV) again his capital balance. There will not be any taxability either u/s 9B or Section 45(4), as C has not retired
iv) Suppose after 1 year of this transaction, C retires. Now on this retirement there is no taxability, as no capital asset is being transfer on retirement, which has already been done earlier during C tenure as Partner
d) This loophole needs to be curbed in order to strengthen the revised taxability u/s 9B and 45(4).
6. Whether deemed Transfer u/s 9B is specific or General
a) Section 9B provides receipt of Capital Asset or stock in trade by Partner on reconstitution or dissolution of firm as Transfer
b) The Point of consideration is whether such transaction is transfer for computing taxable income as envisage in section 9B ONLY or it is transfer for all other intent under Act, enunciated as under
i) If there is transfer of Immovable property in excess of Rs. 50 lacs to partner on retirement, whether partner will be required to deduct TDS u/s 194IB?
ii) If the FMV of Capital Asset transfer on retirement is less than FMV envisage u/s 56(2)(x), whether partner will also be taxable u/s 56(2)(x) for excess of FMV u/s 56(2)(x) and section 9B.
7. FMV of Stock in Trade u/s 9B- Whether treated as Turnover ??
a) Under Section 9B, receipt of stock in trade on retirement of partner is treated as Transfer of stock in trade and firm is being taxable on the basis of FMV of stock in trade.
b) Question for consideration is, whether such transfer of stock in trade at FMV, is treated as TURNOVER, as many provision under the Act is contingent upon level of turnover, explained as under:-
i) Tax Audit is dependent upon Turnover
ii) TDS u/s 194Q is dependent upon Turnover
iii) TCS u/s 206C is also partly dependent upon Turnover
I hope that government will suitably consider the above points and will issue guidelines in the due course to resolve the unsettled aspects in implementation of Section 9B and section 45(4)
