Tax Implication Of Section 9B And 45(4) On Admission Of New Partner In Partnership Firm

 1.   Introduction

 

1.1. Finance Act 2021 has brought in new income-tax provisions related to reconstitution and dissolution of Partnership firms, Association of persons and Body of Individuals (not being a company or a co-operative society). For which a new section 9B is inserted under the Chapter II (Basis of Charge) and old section 45(4) is being substituted with the new one.

1.2. Owing to these new provisions, there has been paradigm shift in the manner of taxation on account of reconstitution or dissolution of the firms. Amended provisions of section 45(4) tax the Profit or Gain arising to partners, who are taking with them any asset or money or both from the firm at the time of reconstitution of the firm (erstwhile section 45(4) was covering the case of dissolution). Provisions of section 9B charge to tax the gain arising to the partner in the hands of the firm whenever partner/s take away Capital asset or Stock in trade or both as a result of reconstitution or dissolution of the firm.

 

1.3. Apparently, section 9B is not covering the cases where Money is being received by the partners at the time of dissolution (Could be because, money is generated out of transactions which are already taxed like sales, realization from debtors, sale of assets etc.).

 

1.4. It is imperative to understand that these provisions get triggered only when any asset, money or stock in trade is received by the partner at the time of reconstitution or dissolution of the firm. Otherwise, these provisions do not get triggered.

 

1.5. Further, section 48 is also amended by inserting clause (iii). As per memorandum to the Finance bill 2021 the intention behind inserting this clause is to mitigate the double taxation which might have happened in a situation where an asset which was revalued and for which income under the proposed sub-section (4A) of section 45 of the Act was brought to tax is transferred subsequently by the specified entity. (however, instead of proposed new sub-section 4A, existing sub-section (4) was substituted)

 

1.6. These amendments touch upon many nuances of reconstitution and dissolution of firm but the topic to be discussed here is particularly of reconstitution wherein one or more new partners are admitted in the firm.

 

2.    Relevant Provisions

 

2.1. Before moving on to the detailed discussion on various taxation aspects, it is imperative to refer exact provisions of section 9B and 45(4), same are reproduced as under,

 

2.2. Provisions of section 9B are reproduced herein under,

‘9B.  [Income on receipt of capital asset or stock in trade by specified person from specified entity.

 (1) 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.

(2) Any profits and gains arising from such deemed transfer of capital asset or stock in trade or both, as the case may be, by the specified entity shall be—

(i) 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

(ii) 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.

(3) 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.

(4) If any difficulty arises in giving effect to the provisions of this section and sub-section (4) of section 45, the Board may, with the approval of the Central Government, issue guidelines for the purposes of removing the difficulty.

(5) Every guideline issued by the Board under sub-section (4) shall, as soon as may be after it is issued, be laid before each House of Parliament, and shall be binding on the income-tax authorities and on the assessee.

Explanation.—For the purposes of this section,—   

(i) "reconstitution of the specified entity" means, where—

(a) one or more of its partners or members, as the case may be, of such specified entity ceases to be partners or members; or

(b) 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

(c) 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;

(ii) "specified entity" means a firm or other association of persons or body of individuals (not being a company or a co-operative society);

(iii) "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 co-operative society) in any previous year.’

 

2.3. Provisions of section 45(4) are reproduced herein under,

[(4) Notwithstanding anything contained in sub-section (1), where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from such receipt by the specified person shall be chargeable to income-tax as income of such 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 such money or capital asset or both were received by the specified person, and notwithstanding anything to the contrary contained in this Act, such profits or gains shall be determined in accordance with the following formula, namely:—

A = B + C - D

Where,

A = income chargeable to income-tax under this subsection as income of the specified entity 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 (represented in any manner) of the specified person in the books of account of the specified entity at the time of its reconstitution:

Provided that if the value of "A" in the above formula is negative, its value shall be deemed to be zero :

Provided further that the balance in the capital account of the specified person in the books of account of the specified entity is to be calculated 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.

Explanation 1.—For the purposes of this sub-section,—

(i) the expressions "reconstitution of the specified entity", "specified entity" and "specified person" shall have the meanings respectively assigned to them in section 9B;

(ii) "self-generated goodwill" and "self-generated asset" mean goodwill or asset, as the case may be, which has been acquired without incurring any cost for purchase or which has been generated during the course of the business or profession.

Explanation 2.—For the removal of doubts, it is clarified that when a capital asset is received by a specified person from a specified entity in connection with the reconstitution of such specified entity, the provisions of this sub-section shall operate in addition to the provisions of section 9B and the taxation under the said provisions thereof shall be worked out independently.]

 

2.4. While, as per clause 23 of section 2, Firm includes Limited Liability Partnership Firm.

 

3.    Discussion

 3.1. The meaning of reconstitution, as explained in section 9B, provides for three different scenarios which will be considered as ‘reconstitution’. Amongst which clause (b) provides for the situation where one or more new partners are admitted to the firm.

Clause ‘b’ is, as under,

(b) 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

3.2. Above clause can be dissected as under,

-      One or more new partners are admitted

-      In Specified Entity (i.e. Firm) and

-      Old Partners continues to be partner after such change (i.e. admission)

 

3.3. The moot question is, whether mere admission of new partner leads to taxation u/s 9B or section 45(4) ?

Generally, when a new partner is added, old partner may withdraw part of their share.

 

For example, A and B are partner with equal PSR in firm M/s PQR having capital balance of Rs.100 each and having 4 capital assets (E, F, G and H) of book value Rs.50 each (assume Long term). A new partner Mr. C would be joining the firm PQR for 1/3^rd share, so revaluation of assets is done at Rs.200/- each and Mr. A and Mr. B wishes to take away one capital asset each namely E and F.

 

3.4. Thus, in such situation where the continuing partners take away the assets (or money or stock in trade) provisions of section 9B and 45(4) will get triggered at the time of admission of partners. Basically, capital asset/money/Stock in trade should be received by partner IN CONNECTION with reconstitution/dissolution i.e. in cases where the capital accounts are credited at the time of admission of new partner and capital asset/money/stock in trade is withdrawn at a later date/ year then also Sec.9B r.w.s. 45(4) will be applicable application.

 

3.5. Further, it be noted that, provisions of section 45(4) are triggered when Capital asset or money or both are taken away by partners (i.e. received by the partners). While provisions of section 9B gets triggered when partner(s) receives Capital Asset or Stock in trade or both. Thus, in case of transfer of Capital Asset to specified person provisions of section 9B as well as 45(4) both gets attracted in the hands of specified entity.

 

3.6. Besides, if among the partners there is an understanding where consideration is paid without involving the Firm (i.e. out of books) and there is reconstitution where the Profit/ Loss/ Capital Ratio is changed then, though such situation is reconstitution it appears Sec.9B/ 45(4) gets no force of law.

                                                                                                                         

3.7. Proposition explained in Para 3.5 above is explained in the following chart dealing with different scenarios:

  

4.   Determination of amount of income 

4.1. As discussed above, whenever partner receives any capital asset/stock in trade/money and it leads to gains in the hands of receiving partner then such gains are deemed to be the income of the firm of the year in which such asset/Stock in trade/money is received by the partner in connection of reconstitution.

 

4.2. As per section 9B and 45(4), in case of Capital asset and stock in trade, the fair market value as on date of reconstitution will be the full value of consideration received or accruing to the firm as a result of such deemed transfer.

 

4.3. Section 9B creates the charge of tax but routes the taxability into respective heads of income. i.e. in case capital asset is transferred then taxability is to be determined under the head ‘Capital Gains’ whereas if stock in trade is transferred taxability is to be determined under the head ‘Profit and Gains from business or profession’. Though, section 9B is routing the taxability to respective heads, it fixes the full value of consideration to be the FMV.

 

4.4. Since, section 9B routes the transaction to respective head of income, the computation would also be done as per relevant provisions therein. That is, in case of Capital asset, Full Value of consideration will be FMV (as per section 9B), while cost of acquisition (including indexed cost of acquisition) and period of holding will be determined as it is done regularly.

 

4.5. While section 45(4) provides the mechanism of computing the gains arising in the hands of partner which is to be deemed as income of firm. A formula is provided in Section 45(4) to determine the gain. The formula, as provided under section 45(4), is ‘A= B + C – D’ , wherein B and C is the value of money and Fair market value of asset received by the partner while D refers to the capital balance of respective partner at the time of reconstitution.

 

4.6. Thus, taxable income u/s 45(4) would arise only in those cases where the aggregate of Value of Money and FMV of capital asset received by the partner exceeds the capital balance of the respective partner at the time of reconstitution.

 

4.7. Thus, in case capital asset is transferred, provisions of section 9B and section 45(4) both will get attracted (in case of reconstitution) and tax under both the sections would be computed and required to pay, if any.

 

4.8. For example,

In firm M/s PQR there are two partners namely Mr. A and Mr. B with equal PSR having capital balance of Rs.100 each and there are 4 capital assets being land (E, F, G and H) of book value Rs.50 each (assume Long term). A new partner Mr. C would be joining the firm PQR for 1/3^rd share, so revaluation of assets is done at Rs.200/- each, considering the report of registered valuer as mentioned in rule 11U(g). Further, Mr. A and Mr. B wishes to take away one capital asset each namely E and F respectively.

Above facts can be demonstrated as under,

 

Assets	Existing values	Revalued Values	Assets (land)	Existing values	Revalued Values
Mr. A	100	400	E (to be received by Mr. A)	50	200
Mr. B	100	400	F (to be received by Mr. B)	50	200
			G	50	200
			H	50	200
Total	200	800	Total	200	800

 

The taxation u/s 9B will be as under (similar for Mr. A and Mr. B),

Particulars	Amount in INR	Remarks, if any
Full Value of consideration	200	FMV of Capital Asset
Less: Indexed cost of Acquisition	75	Assumed
Capital Gain	125	Long Term Capital Gain
Thus, tax	25	20%, (assume no surcharge cess etc for ease of calculations)
Net Book profit after taxes	100	(total Rs.200 for both the Capital asset i.e. G and H)

 

Whereas, the taxation u/s 45(4) will be as under (for Mr. A and Mr. B individually),

A= B + C – D

Value of,

B= Zero (as no money is being received by the partners)

C= FMV of capital asset received by the partner = Rs.200 (as given in example)

D=Capital balance at the time of reconstitution= Rs.100

Thus, A= 0 + 200 – 100*

            = Rs.100/-

(*as per second proviso to 45(4), the balance in capital account of specified person is to be calculated without taking into account the increase in capital account due to revaluation of asset, thus Rs.100 is considered instead of Rs.200)

Tax calculation on this amount is discussed ahead in para 4.10.

4.9.    It be please noted that, as per section 45(4) capital balance AT THE TIME OF RECONSTITUTION has to be considered.

However, in the examples given in the guideline issued by CBDT on 2^nd July 2021 (14/2021), it has been demonstrated that after determining gains u/s 9B the amount of net book profit after paying taxes is to be transferred to the capital balances of the partners and such increased capital balance is to be considered for determining gains u/s 45(4). i.e., for the value of part ‘D’ of the formula.

In the instant example,

Gain as per section 9B is Rs.125/- therefore tax on Long term capital asset is Rs.25 (cess, surcharges etc. is not considered for sake of easy understanding). The net book profit from transfer of capital asset is Rs.100/- (after taxes). And since, partner A and B are taking away one asset each i.e. E and F, total net book profit for both the assets is Rs.200 (after taxes). So, this gain of Rs.200/- is to be transferred to the capital account of respective partners in their PSR. Thus, the capital balance of partner A and B would become Rs.200 each (Rs. 100 existing + Rs.100/- amount of net book profit transferred to respective capital account in PSR)

Accordingly, the calculation u/s 45(4) would now be as under (similar calculation for Mr. A and Mr. B both)

A          = 0 + 200 – 200 [ value of money + FMV of capital asset- capital balance]

                        = Rs. 0 .

Since, Mr. A and Mr. B are receiving asset E and F having same values, total taxable income u/s 45(4) would be Rs.0 (Rs.0 each for in case of Mr. A and Mr. B both).

Considering such examples in guideline, it would be interesting to imagine a case where reconstitution is done in year 1 and capital asset is taken in subsequent year. Whether capital balance AT THE TIME OF RECONSTITUON would be considered OR, as per the examples given in the guideline, the increased value of capital balance after crediting, to the respective capital account, the net book profit on transfer of capital asset, as per 9B)

 

4.10.  Type of Gain i.e. Long term or short term

4.10.1.  As per sub rule 5 of amended rule 8AA [as amended by the Income-tax Amendment(18^th amendment), rule 2021], the amount or part of the amount chargeable u/s 45(4) shall be deemed to be from

i. short term capital asset, if it is attributed to

a.    capital asset which is short term capital asset at the time of taxation of amount under subsection (4) of section 45; or

b.    capital asset forming part of block of asset; or

c.    capital asset being self-generated asset and self-generated goodwill as defined in clause (ii) of Explanation 1 to sub-section (4) of section 45; and

 

ii. long term capital asset or assets, if it is attributed to capital asset which is not covered by clause (i) and is long term capital asset at the time of taxation of amount under sub-section (4) of section 45

 

In above discussed example, the excess amount so determined (FMV of capital asset minus capital balance at time of reconstitution) is attributable to remaining capital assets i.e. Asset G and Asset H, which are also Long-term capital asset. (please refer para no. 4.11 and 4.12)

 

4.10.2.  Accordingly, the tax calculated u/s 45(4) will also be a long-term capital gain @ 20% i.e. Rs.20  [considering gain of Rs.100 u/s 45(4)  as mentioned at para 4.8 above]

 

4.10.3.  Further, it may be noted that the phrase ‘the amount or part of the amount’ used in sub rule (5) of rule 8AB, as mentioned above in para 4.10.1. above, is an interesting aspect.

 

4.10.4.  In above example, assume, Capital Asset ‘H’ is a short-term capital asset then, in that case the attribution of the excess amount (as determined through formula) would be added/ loaded on remaining capital Assets of the firm i.e. Capital Asset ‘G and H’ which are Long term capital asset and Short-Term Capital Asset respectively. Since, the increase in valuation of both the asset is equal (i.e. from book value of Rs.50 to revalued amount of Rs.200) the attribution will be done equally between Capital Asset G and H. Thus, the capital Gain tax in such case will be equal i.e. half will be Long term and the other half will be Short term capital gain.

 

4.11.  Attribution of tax paid u/s 45(4) as per newly inserted clause (iii) u/s 48

Further, as per newly inserted clause (iii) in section 48, the amount of income-tax chargeable u/s 45(4) is to be reduced from the full value of consideration of the assets transferred by the firm (specified entity). Relevant, provision is reproduced as under,

(iii) in case of value of any money or capital asset received by a specified person from a specified entity referred to in subsection (4) of section 45, the amount chargeable to income-tax as income of such specified entity under that sub-section which is attributable to the capital asset being transferred by the specified entity, calculated in the prescribed manner: 

 

4.12.  The manner of determining amount to be attributed to capital asset is prescribed by newly inserted rule no 8AB and explained in the guideline issued by CBDT on 2^nd July 2021 vide circular no.14/2021. Said rule provides that,

 

a.    Amount of tax shall be attributable to the REMAINING CAPITAL ASSETS (sub rule 2 of rule 8AB)

b.    Only if, such tax, on the aggregate of the value of money and the FMV of capital asset exceeding capital balance, RELATES to revaluation of any capital asset (sub rule 2 of rule 8AB)

c.    If such excess DOES NOT RELATES to revaluation of any capital asset then no attribution is to be done (sub rule 3 of rule 8AB)

d.    If such excess relates only to the capital asset received by partner then no attribution to be done (sub rule 4 of rule 8AB)

e.    Such tax SHALL RELATE to revaluation of any capital asset or valuation of self-generated goodwill, if revaluation is based on a valuation report obtained from a registered valuer as defined in clause (g) of rule 11U (explanation no.1 in rule 8AB)

f.    Amount of tax to be attributed shall be determined in proportion: increase in or recognition of value of that remaining asset to aggregate of increase in or recognition of value of all assets because of revaluation or valuation (sub rule 2 of rule 8AB)

 

4.13.  Accordingly, continuing with the example discussed at para no. 4.8 above, let us determine the value of attribution to be done as per section 48(iii):

 

a.    Tax chargeable u/s 45(4) = Rs.20 (for both the assets as mentioned at paragraph 4.10.2 above)

 

b.    Said tax of Rs.20 is to be attributed proportionately to remaining capital assets G and H in the proportion to their increase in the value due to revaluation. In the instant example, both the assets G and H have increased by Rs.150 each from book value of Rs.50 to revalued amount to Rs.200 each. Thus, the attribution of Rs.20 has to be equal i.e. Rs.10 each amongst capital asset G and H.

 

c.    Thus, whenever these two capital assets i.e. G and H are transferred, Rs.10 would be reduced from the full value of consideration. I.e. for example, Asset G is transferred in subsequent year for full value of consideration of Rs.350 then from this full value of consideration Rs. 80 (assumed to be indexed cost of acquisition) and Rs.10 [being attribution as per section. 48(iii)] would be reduced. Thus, net taxable capital gains would be Rs.260/-.

 

d.    Since, attribution is to be done on remaining capital assets, if there are no other capital assets remaining with the firm after distribution then there would not be any attribution.

 

5.   Conclusion:

 

5.1. In case where new partner is admitted, tax under section 9B and 45(4) would be determined only in case where any of the partner receives any capital asset/ stock in trade/ Money. That is to say, happening of reconstitution (including admission of new partner) just triggers provisions of section 9B and 45(4) but, taxation will arise only when capital asset/ stock in trade/money is received by the partner.

 

5.2. Further, provisions of section 45(4) charges to tax the Profit or Gain arising to partner/s, who receives any asset or money or both from the firm as a result of reconstitution of the firm, but the burden to pay tax on such gain is shifted on the firm (being deemed income). While, provisions of section 9B taxes the gains arising to the firm whenever partners take away Capital Asset or Stock in Trade or both as a result of reconstitution or dissolution of the firm.

 

6.   Frequently Asked Question

 6.1. If partner/s receive/s stock in trade, would it be taxed twice i.e. first as per section 9B and then under then head PGBP?

Ans. No, provisions of section 9B routes the taxation to relevant heads of income. Thus, in case stock in trade is received by partner, it would be taxed as income U/Sec.28 i.e. PGBP of the Firm.

 

6.2. If the amount of tax u/s 45(4) is attributed to capital assets being part of Block of asset then, whether said amount of attribution be added to carrying amount of WDV of the ‘block of asset’?

Ans. It appears the answer is ‘No’, since provisions of section 43(6) related with WDV and Actual cost have not undergone any change as of date. Thus, WDV won’t be adjusted by the value of attribution and accordingly depreciation would not be computed on the same.

 

6.3. Whether admission of minor to partner would have any separate implication?

Ans. Mere admission of new partner does not have any implication unless any capital asset/ stock in trade/ money is received by any partner in connection with such reconstitution. If, any partner receives any capital asset/money/ stock in trade then, taxation would be done according to the new scheme explained above.

 

6.4. Whether benefit of section 54EC would be available to the firm?

Ans. Since provision of section 9B states that the chargeability of tax on capital assets is under the head ‘Capital Gains’, the benefit of said provision would be available to the firm.

 

6.5. In case new partner pays consideration while joining the firm to the existing partners sans ‘Firm’ (i.e. outside the books of accounts) and reconstitution takes place then whether the provisions of section 9B and 45(4) are applicable?

Ans. It appears the answer is ‘No’. Provisions of section 9B and 45(4) are invoked only when any capital asset, stock in trade or money is transferred by the firm

 

6.6. In case of transfer of capital asset, whether benefit of indexation is available for determining gains u/ 45(4) or section 9(B) or both?

Ans. Provisions of section 9B charges tax on the gains arising due to transfer of capital asset  while the taxability is to be determined as per the provisions of head ‘Capital Gain’. Thus, for determining capital gains provisions of section 48 have to be applied. While, provisions of section 45(4) taxes the gains arising to the partner/s and not the transfer of asset, thus benefit of indexation may not be allowed while determining gains u/s 45(4).

6.7. Whether benefit of newly inserted clause (iii) u/s 48 is available to capital assets transferred at time of reconstitution/ dissolution or other remaining capital assets?

Ans. According to the newly inserted rule 8AB and the guideline issued u/s 9B on 02^nd July 2021 (14/2021) the attribution of taxes paid u/s 45(4) is to be done on REMAINING CAPITAL ASSETS i.e. Capital assets remaining after transfer of capital assets in connection with reconstitution.

Thanks and Regards,
Bhuvanesh V Kankani
B Com, CA, LLB
+91 9421847944

Disclaimer: This Article/ Write-up is entirely the personal opinion of the Author and should not be regarded or relied upon as legal advice by the Author. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although the Author has endeavored to provide correct information but the chances of error cannot be ruled out. Also, it be noted that above article/writeup is written considering the prevailing provisions of law, in case the the provisions change the Author is not bound to update the above article/writeup. No one should act on this information without appropriate professional advice. Author wont be held liable for any loss or delay.