Recently, The CBDT issues guidelines for taxpayers under section 9B. The new notification by CBDT sets new guidelines for taxing partnership firms in India. Therefore, everyone needs to know the new taxation rules to make the right decision while dissolving or reconstituting the company.
In this article, we will read about CBDT issues guidelines for Taxing Partnership Firms on its Reconstitution.
CBDT issues guidelines for Taxing Partnership Firms on its dissolving or Reconstitution
Finance Act, 2021 inserted a new section 98 in the Income-tax Act 1961 (from now on referred to as “the Act”). This section mandates that whenever a specified person receives any capital asset or stock in trade or both from a specified entity, during the previous year, in connection with 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, as the case may be, to the specified person (starting now referred to as “deemed transfer”).
This deemed transfer would be in the year in which such capital asset or stock in trade or both are received by the specified person. Any profits and gains arising from such deemed transfer are deemed to be the income of such specified entity of the previous year in which the specified person received such capital asset or stock in trade or both.
Further, it is 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,” following the provisions of this Act.
It has also been provided that the 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. The definitions of terms ” reconstitution of the specified entity,” “specified entity,” and “specified person” are provided in section 98 of the Act.
CBDT issues Guidelines under section 9B and sub-section (4) of section 45 of the Income-tax Act
Similarly, the Finance Act 2021 substituted sub-section (4) of section 45 of the Act. This newly substituted sub-section (4) now provides that where a specified person receives any money or capital asset or both from a specified entity, during the previous year, in connection with the reconstitution of such specified entity, then any profits or gains arising from receipt of such receipt by the specified person shall be chargeable to income-tax as income of the specified entity under the head “Capital gains.”
It has been further deemed that this income shall be the income of the specified entity of the previous year in which the specified person received such money or capital asset or both. A formula to calculate such profits and gains have also been provided in this subsection. The definitions of terms “reconstitution of the specified entity,” “specified entity,” and “specified person” shall be as provided in section 9B of the Act.
In contrast, the terms “self-generated goodwill” and “self-generated asset” have been defined in this sub-section. It has been further clarified that when a specified person receives a capital asset from a specified entity in connection with the reconstitution of such specified entity, the provisions of sub-section (4) of section 45 of the Act shall operate in addition to the provisions of section 9B of the Act and the taxation under the said provisions thereof shall be worked out independently. Section 9B and substituted sub-section (4) of section 45 apply for the 2021-22 and subsequent assessment years.
Sub-section (4) of section 9B of the Act provides that if any difficulty arises in giving effect to the provisions of this section and subsection (4) of section 45 of the Act, the Board may, with the approval of the Central Government, issue guidelines to remove the difficulty.
Furthermore, the CBDT has elaborated these guidelines through examples. Let’s understand these.
Example 1 – Guidelines for Taxing Partnership Firms on its Reconstitution
CBDT issues guidelines and also explains the notification through the examples. Let’s look at example no. 1.
Suppose, there are three partners, “A,” “B,” and “C” in a firm, “FR,” having one-third share each. Each partner has a capital balance of Rs.10 Lakh in the firm. “1–Here are three pieces of land “S,”T”,and”U” in that firm, and there is no other capital asset in that firm. Book value of each of the land is Rs. 10 lakh. All these three lands were acquired by the firm more than two years ago.
Partner “A” wishes to exit. The firm revalues its lands based on a valuation report from a registered valuer, as defined in rule 11U of the Rules. As per that valuation report, the fair market value of lands “S” and “T” is Rs 70 lakh each, while the fair market value of land “U” is Rs.50 lakh. On the exit of partner “A,” the firm decides to give him:11 lakh of money and land “U” to settle his capital balance.
Following the provisions of section 9B of the Act, it would be deemed that the firm “FR” has transferred land “U” to the partner “A” at its fair market value of Rs.50 lakh. Let us assume that the indexed cost of acquiring land “Ii” is Rs. 15 lakh.
Now on account of the deeming provisions of section 9B of the Act, it is deemed that the firm “FR” has transferred land “U” to partner “A.” Thus, an amount of Rs.50 lakh less Rs.15 lakh would be charged to tax in the hands of firm “FR” under the head “Capital gains.” For partner “A,” the cost of acquisition of this land would be Rs.50 lakh. Hence, the amount of Rs. 35 lakh is charged to long-term capital gains, and let us assume that the tax is Rs. 7 lakh(assume no surcharge or cess just for ease of calculation and illustration purposes).
This netbook profit after tax of Rs. 33 lakh (capital gains of Rs. 40 lakh without indexation less tax of Rs. 7 lakh) is to be credited in the capital account of each of the three partners, i.e., Rs. 21 lakh each. Thus partner “A” capital account would increase to Rs. 21 lakh. This exercise is required to be carried out since section 9B of the Act mandates that it is to be deemed that the firm “FR” has transferred the land “U” to partner “A” and the long-term capital gains of Rs. 35 lakh is chargeable to tax in the hands of the firm “FR.”
As against a capital balance of Rs. 21 lakh, partner “A” has received Rs. 61 lakh (Rs. 11 lakh of money plus land “U” of the fair market value of Rs. 50 lakh). Thus Rs. 40 lakh is required to be charged to tax under subsection (4) of section 45 of the Act. It shall be in addition to an amount of Rs. 35 lakh charged to tax under section 9B of the Act.
On account of clause (iii) of section 48 of the Act, read with rule 8AB of the Rules, this Rs. 40 lakh is to be attributed to the remaining assets of the firm “FR” based on an increase in their value due to revaluation based on the valuation report of the registered valuer. In this case, as per revaluation, only two capital assets remain; lands “S” and “T.” In both cases, the value has increased by Rs. 60 lakh each.
Thus, out of Rs. 40 lakh, Rs. 2.0 lakh shall be attributed to land “S” and Rs. 20 lakh to land “T.” When either of these lands gets sold, this amount attributed to them would be reduced from sales consideration under clause (iii) of section 48 of the Act.
The amount of Rs. 40 lakh, which is charged to tax under sub-section (4) of section 45 of the Act, shall be charged as long-term capital gains given sub-rule (5) of rule 8AA of the Rules, since the amount of Rs. 40 lakh is attributed to land “S” and land “T,” which are both long-term capital assets at Rs taxation. 40 lakh under sub-section (4) of section 45 of the Act.
In conclusion, the issue of CBDT guidelines will attract capital tax gain for the partners of partnership firm on the assets of the company when it’s dissolved or reconstituted.
Moreover, If you want any other guidance concerning ITR Filing, please feel free to talk to our business advisors at 8881-069-069.
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