DO YOU KNOW THE CBDT GUIDELINES ON PARTNERSHIP FIRM TAXATION?

Introduction:

• Finance Act, 2021 inserted a new section 9B in the Income Tax Act, 1961.
• This section mandates that whenever a specified person receives any capital asset or stock in trade or both from a specified entity, during the dissolution or reconstitution of such specified entity, then it shall be deemed that the specified entity has transferred such capital asset or stock in trade or both to the specified person.

Specified entity: A Firm or other Association of persons (AOP) or Body of individuals (BOI) (Not being a company or co-operative society).

Specified Person: 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.

• Any profits and gains arising from such deemed transfer is 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.
• The value of the consideration is the fair market value of the capital asset or stock in trade or both, on the date of its receipt by the specified person.

DEEMED TRANSFER AND TAXED IN THE HANDS OF FIRM UNDER SEC 9B

SECTION 45(4)

• A formula to calculate such profits and gains has also been provided in this sub-section.
Income chargeable to tax under this section,

A = B + C - D

• Therefore, when a capital asset is received by a specified person from a specified entity in connection with the reconstitution, then provisions of section 45(4) of the Act shall operate in addition to the provisions of section 9B of the Act.
• CBDT issued guidelines to remove some difficulties in the section.

GUIDELINES

• The amount taxed under section 45(4) is required to be attributed to the remaining capital assets of the specified entity, so that when such capital assets get transferred in the future, the amount attributed to such capital assets get reduced from the full value of the consideration and to that extent the specified entity does not pay tax again on the same amount.
• It is clarified that this attribution applies to both capital assets not forming part of block of assets and capital assets forming part of block of assets.

Example: Following is the Balance Sheet of Firm “ABC” having partners A, B, C with equal profit-sharing ratio

All the three lands were acquired by the firm more than 3 years ago, thus, these are long term capital assets. Partner “A” wishes to exit from the firm. On his exit, the firm decides to give him Rs. 11 Lakh of money and land “R” to settle his capital balances. Indexed cost of acquisition of land “R” is Rs. 15 Lacs. Tax rate 20% on LTCG.

Application of Section: As per section 9B of the Act, it shall be deemed that the firm “ABC” has transferred land “R” to partner “A” at FMV Rs. 50 Lacs.

Therefore, Long Term capital Gain in the hands of firm “ABC” =50 Lacs – 15 lacs = 35 lacs*20% = 7 lakhs

Capital gain under Sec45(4) = 40*20% =8 lakhs

Thus, capital of each of the partners will be credited with Rs. 11 Lacs for the profit as calculated above.

As calculated above Rs.40 Lacs shall be chargeable under section 45(4). This shall be in addition to an amount of Rs. 35 Lacs charged to tax under section 9B.

According to guidelines, the above Rs. 40 Lacs is attributed to remaining assets of the firm “ABC” based on increase in their value due to revaluation.

In our example, both remaining assets “P” and “Q” have their values increased by Rs. 60 Lacs. Thus, Rs. 40 Lacs will be attributed to both “S” & “T” in i.e., Rs. 20 Lacs each.

When either of these lands are sold in future, the above amount as attributed to them Rs. 20 Lacs shall be reduced from sales consideration.

Detailed circular can be accessed Here