Key Takeaways: - Analysis of section 45(4), section 9B of the Income Tax Act and Rule 8AA and Rule 8AB of Income Tax Rules - Illustrations to understand the relevant impact - Critical Issues concerned with the provisions

1. REVAMPED TAXATION ON DISSOLUTION OR
RECONSTITUTION OF FIRM

2. Verbatim Analysis
Illustrations
Caveats
PRESENTATION SCHEMA

3. LEGENDS USED
CG Capital Gains
COA Cost of Acquisition
ICOA Indexed Cost of Acquisition
ITA Income Tax Act
LTCA Long Term Capital Asset
LTCG Long Term Capital Gains
STCA Short Term Capital Asset
WDV Written Down Value
WRT With Respect To

4. VERBATIM

5. SECTION 9B OF ITA
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.
*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.

6. SECTION 45(4) OF ITA
(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.

7. SECTION 48 OF ITA
The income chargeable under the head "Capital gains" shall be computed, by deducting from the full value of
the consideration received or accruing as a result of the transfer of the capital asset the following amounts,
namely :—
(i) expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement thereto;
(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:

8. ANALYSIS

9. STEPS TO BE FOLLOWED
7. Attribute the amount taxable under section 45(4) to the assets remaining with the firm
6. Compute capital gains as per section 45(4) (Note-2)
5. Credit the net income computed in the above step to partners capital account in the
profit-sharing ratio
4. Compute Net Income (Step 2- Step 3)
3. Compute tax on total income computed in the above step
2. Compute the partnership’s total income
1. Determine the capital gains or business income under section 9B (Note-1)

10. CONTD..
Note-1 Computation
of Capital Gains under
section 9B
Particulars Amount Remarks
Full value of Consideration XXX Fair Market value of capital
asset
Expenditure in connection with
transfer
(XXX)
Indexed Cost of acquisition (XXX)
The amount chargeable to tax as
income of Firm under section 45(4)
which is attributable to capital asset
being transferred by the firm [section
48(iii)].
(XXX)
Capital Gains XXX
Particulars Amount
Fair Market value of stock in trade
Cost of acquisition
Profits and gains of business or
profession
Note-1 Computation
of business income
under section 9B

11. CONTD..
Note-2
Computation of Capital gain under section 45(4)
A=B+C-D
A Income chargeable under the head "Capital
Gains"
B Money Received
C Fair market value of the capital asset received
D Balance in the capital account at the time of
reconstitution
Increase in capital account due to revaluation of
assets or self-generated goodwill or self-generated
assets shall be ignored.
The Capital gains chargeable under section 45(4)
shall be regarded as short term if it is attributed to
(Rule 8AA)
• capital asset which is short term capital asset at
the time of taxation under section 45(4) or
• capital asset forming part of block of asset; or
• capital asset being self-generated asset and self-
generated goodwill.

12. CONTD..
Note-3 (Rule 8AB)
Attribution of the amount taxable under section 45(4) to the Capital
assets remaining with the firm
Capital Gain under section 45(4) * Revaluation in the capital asset or self generated assets or
self generated goodwill
Revaluation in all the capital assets, self generated assets and self generated goodwill remaining
with the firm
 Attribution is not required, if
o Amount chargeable to tax under section 45(4) does not relate to revaluation of
any capital asset
o Amount chargeable to tax under section 45(4) relates only to the capital asset
received by the retiring partner.

13. ILLUSTRATION

14. ILLUSTRATION 1
Partner A wishes to exit
Revalued to ₹ 70 lakhs each
Revalued to ₹ 50 lakhs
₹ 11 lakhs
Firm X
Equal Partners, each having ₹10
lakhs capital balance
BV= ₹ 10 lakhs each
Holding period >2 yrs

15. APPLICATION OF SEC 9B
Revalued to ₹ 50 lakhs
Deemed transfer
Particulars ₹
Deemed FVC (FMV) 50 Lakhs
Less: ICOA (assumed) 15 Lakhs
LTCG 35 Lakhs
CG in the hands of the firm
CoA to partner
As contemplated by
erstwhile 45(4)

16. APPLICATION OF SECTION 45(4) OF
ITA
Particulars ₹
Profit from transfer of Land (₹ 50 lakhs - ₹ 10 lakhs) 40 lakhs
Less: Tax payable on CG as computed u/s 9B (7 lakhs)
Net book profits after tax 33 lakhs
Attribution of book profits to partners
Particulars A (₹) B (₹) C (₹)
Capital Balance prior to transfer 10 lakhs 10 lakhs 10 lakhs
Increase in net profit on reconstitution 11 lakhs 11 lakhs 11 lakhs
Revised Capital Account Balance 21 lakhs 21 lakhs 21 lakhs
Revised Capital Balance of each of the partners
Capital account balance of specified person to not include any increase due to revaluation or a self-generated asset

17. CAPITAL GAINS IN THE HANDS OF THE
FIRM
Particulars ₹
B Value of any money received by the specified person 11 Lakhs
C FMV of the capital asset received by the specified person (Revised
book value of land)
50 Lakhs
D Amount of balance in the capital account (represented in any manner)
of the specified person
21 Lakhs
A *LONG TERM Capital Gain chargeable u/s 45(4) (B+C-D) 40 Lakhs
1:1
This ₹40 lakh is to be attributed to the remaining assets
of the firm on the basis of increase in their value due to
revaluation – Sec 48 (iii) and Rule 8AB
₹20 lakhs
attributed
₹20 lakhs
attributed
*LTCG because they are attributed to lands, which are LTCA at the time of taxation u/s 45(4)
₹20 lakhs attributed to be reduced from sale
consideration when these assets are transferred later

18. TRANSFER OF REMAINING ASSET
Particulars ₹
FVC 80 Lakhs
Less: ICOA (assumed) (20 Lakhs)
Less: CG attributed to the asset (20 lakhs)
LTCG 40 lakhs
The capital gain arising upon subsequent transfer of the remaining assets are as follows

19. ILLUSTRATION 2
Partner A wishes to exit
Revalued to
₹ 60 lakhs
Revalued to ₹ 45 lakhs
₹ 75 lakhs
Firm X
Equal Partners, each having ₹100
lakhs capital balance
Land
BV= ₹ 30 lakhs
Holding period >2 yrs
₹ 225 lakhs
Patent
WDV= ₹ 45 lakhs
Holding period -1 yr
Self-generated
goodwill- ₹30 lakhs

20. APPLICATION OF SEC 9B
Revalued to ₹ 45 lakhs
Deemed transfer
Particulars ₹
FVC (deemed to be FMV) 45 Lakhs
Less: ICOA (assumed) 45 Lakhs
LTCG NIL
CG in the hands of the firm
CoA to partner
As contemplated by
erstwhile 45(4)

21. APPLICATION OF SECTION 45(4) OF
ITA
Particulars ₹
Profit from transfer of Land (₹ 45 lakhs - ₹ 30 lakhs) 15 lakhs
Less: Tax payable on CG as computed u/s 9B 0 lakhs
Net book profits after tax 15 lakhs
Attribution of book profits to partners
Particulars A (₹) B (₹) C (₹)
Capital Balance prior to transfer 100 lakhs 100 lakhs 100 lakhs
Increase in net profit on reconstitution 5 lakhs 5 lakhs 5 lakhs
Revised Capital Account Balance 105 lakhs 105 lakhs 105 lakhs
Revised Capital Balance of each of the partners
Capital account balance of specified person to not include any increase due to revaluation or a self-generated asset

22. CAPITAL GAINS IN THE HANDS OF THE
FIRM
Particulars ₹
B Value of any money received by the specified person 75 Lakhs
C FMV of the capital asset received by the specified person 45 Lakhs
D Amount of balance in the capital account (represented in any manner)
of the specified person
105 Lakhs
A *SHORT TERM Capital Gain chargeable u/s 45(4) (B+C-D) 15 Lakhs
1:2
(15L:30L)
This ₹15 lakh is to be attributed to the remaining assets of the firm on the
basis of increase in their value due to revaluation – Sec 48 (iii) and Rule 8AB
₹5 lakhs
attributed
₹10 lakhs
attributed
*LTCG because they are attributed to patent and self-generated goodwill, which are both STCA at the time of
taxation u/s 45(4)
Amount attributed to be reduced from sale
consideration when these assets are transferred later
The 1:2 ratio based on increase in revaluation of Patent and Goodwill

23. SUBSEQUENT TRANSFER OF PATENT
WDV of a block of patents ₹
Opening WDV 45 lakhs
Add: Actual Cost of Assets Acquired during the PY XX
Less: Moneys payable wrt assets sold or discarded or demolished or destroyed
during that PY (₹ 25 lakhs- ₹5 lakhs attributed)
20 Lakhs
Closing WDV XXX
Let us assume the patent is sold for ₹25 lakhs. The WDV of patents will be calculated as follows:
The WDV of Patent would remain 45 lakhs and would not be increased to 60 lakhs
due to revaluation during the year.
This is because, as per section 43(6)(c), the WDV of the block of assets shall be increased by actual cost of asset
acquired during the previous year. Further this clause does not allow any increase on account of revaluation.

24. CAVEATS

25. CAVEATS
No guidelines have been prescribed for computation of fair value under section 9B. Hence this
may result in litigations.
Deduction under section 48(iii) might not be available, if there is a tax neutral transfer of
remaining asset to which attribution is made
Deduction under section 48(iii) does not consider the time value of money
If the attribution is made to a self generated goodwill, it is unlikely that such goodwill will be
sold separately in the future. Hence, it’s uncertain whether the deduction under section 48(iii)
would be available in such case.

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