Capital Gain on transfer of capital asset by a firm / AOP / BOI is governed by Sec. 9B and Section 45(4) of Income Tax Act, 2021 read with Rule 8AA(5) and Rule 8AB of Income Tax Rules, 1961.

Sec. 9B was introduced via Finance Act, 2021 while the same Finance Act also amended Sec. 45(4) by substituting the same. Rule 8AA(5) and Rule 8AB have been notified via Income Tax Amendment (18th Amendment) Rules, 2021 dated 2nd July 2021. Now, let’s first understand that what is Sec. 9B and Sec. 45(4) of the Income Tax Act, 1961 along with other related provisions.

Sec. 9B – It states that when a Firm / AOP/ BOI (hereafter they will be referred as ‘entity’) transfers any of its capital assets or stock in trade or both to any of its partners / members due to any reconstitution of the entity, then it shall be deemed to be income of the entity in the year of transfer. Few important points to be considered here are as under:

            a)      Full value of consideration – Fair Market value (FMV) of capital asset or stock in trade

            b)     Head of Income – “PGBP” for stock in trade transferred; “Capital Gains” for Capital assets transferred

Sec. 45(4) – It states that when an Firm / AOP / BOI transfers any money or capital asset or both to any of its partners / members due to any reconstitution of the entity, then it shall be deemed to be income of the entity under the head “Capital Gains” in the year of transfer.

The formula for calculating the amount of “Capital Gains” is as under:

Particulars

Amount

Money received

XXX

Add: FMV of capital asset received by the partner / member

XXX

Less: Balance in Capital Account (before considering any revaluation / self-generated goodwill)

(XXX)

Capital Gains u/s 45(4)

XXX

(Kindly note that this gain is in ADDITION to the gain amount calculated u/s 9B of Income Tax Act, 1961)

Clause (iii) of Sec. 48 – It provides for deduction of attributable amount of capital gain calculated u/s 45(4) from the Full Value of consideration of asset in the specified manner (manner is specified under Rule 8AB of Income Tax Rules, 1961)

For implementation of the abovementioned Sections, CBDT has made amendments in Income Tax Rules, 1962 via Income Tax Amendment (18th Amendment) Rules, 2021 dated 2nd July 2021.

Insertion of Rule 8AA(5) – It provides the basis of determining the Capital Gains u/s 45(4) to be Short Term Capital Gain (STCG) or Long Term Capital Gain (LTCG).

            1.      STCG – It shall be chargeable as STCG if it is attributed to:

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

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

c.      capital asset being self-generated asset and self-generated goodwill

            2.      LTCG – It shall be chargeable as LTCG if:

a.      It is not covered in 1. above; and

b.     Asset is Long term capital asset at the time of taxation of amount under section 45(4)

Insertion of Rule 8AB – Attribution of income taxable under sub-section (4) of section 45 to the capital assets remaining with the specified entity, under section 48

The manner and amount of attribution of capital gain is provided as under:

In case where Capital Gain u/s 45(4) relates to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill of the entity

Capital Gain u/s 45(4) shall be Attributable in the ratio of increase in / recognition of value of the remaining assets

In case where Capital Gain u/s 45(4) does not relate to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill of the entity

 No attribution

In case where Capital Gain u/s 45(4) relates only to capital asset transferred by the entity to its partner / member

No attribution

In case of the amount which is chargeable to income-tax as u/s 45(4)  under the head Capital gains, the specified entity shall furnish the details of amount attributed to capital asset remaining with the specified entity in new Form No. 5C. Form No. 5C shall be furnished electronically either under digital signature or through electronic verification code and shall be verified by the person who is authorized to verify the return of income of the specified entity under section 140.

Now, as we have gone through all the provisions relating to transfer of capital asset by a firm to its partner (or by AOP/BOI to its member), let’s clarify all the above provisions by using example:

(Note : This example is taken from Circular No. 14/2021 dated 2nd July 2021. For more examples kindly refer it by clicking on the link provided)

Example 3: There are three partners "A", "B" and "C" in a firm "FR", having one third share each. Each partner has a capital balance of ₹ 100 lakh in the firm. There is a piece of land "S" of book value of ₹30 lakh. There is patent "T" of written down value of ₹45 lakh. And there is cash of ₹225 lakh. The land was acquired by the firm more than two years ago. The patent was acquired/ developed/ registered one year back.

Partner "A" wishes to exit. The firm revalue its land and patent based on valuation report from a registered valuer, as defined in rule 11U of the Rules, and as per that valuation report fair market value of land "S" is 5 lakh and fair market value of patent "T" is ₹60 lakh. As per the valuation report there is also self-generated goodwill of ₹30 lakh. On the exit of partner "A", the firm decides to give him ₹75 lakh in money and land "S" to settle his capital balance.

In accordance with the provisions of section 9B of the Act, it would be deemed that the firm "FR" has transferred land "S" to the partner "A" at its fair market value of ₹45 lakh. Let us assume that the indexed cost of acquisition of land "S" is ₹45 lakh.

Now on account of the deeming provisions of section 9B of the Act, it is deemed that the firm "FR" has transferred land "S" to partner "A". However, since the sale consideration is equal to indexed cost of acquisition, there will not be any capital gain s tax. For partner "A", the cost of acquisition of this land would be ₹45 lakh.

The net book profit ₹15 lakh (capital gains ₹15 lakh without indexation) is to be credited in the capital account of each of the three partners, i.e. ₹5 lakh each. Thus partner "A" capital account would increase to ₹ 105 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 "S" to partner "A". Thus, any gain in the books is to be apportioned to partners' capital accounts.

As against capita l balance of ₹105 lakh, partner "A" has received ₹ 120 lakh (money of ₹75 Lakh plus land "S" of fair market value of ₹45 lakh). Thus ₹15 Lakh is required to be charged to tax under subsection (4) of section 45 of the Act.

On account of clause (iii) of section 48 of the Act, read with rule 8AB of the Rules and guidance note, this ₹15 lakh is to be attributed to the remaining capital assets of the firm " FR" on the basis of increase in the value due to revaluation of existing capital assets, or due to recognition of the value of self-generated goodwill, based on the valuation report of registered valuer.

In this case as per this report the value of patent 'T " has increased by ₹15 lakh and the self-generated goodwill value has been recognised at ₹30 lakh. Thus one third on ₹15 lakh (i.e. ₹5 lakh) would be attributed to patent "T", while two third of ₹15 lakh (i.e. ₹10 lakh) would be attributed to self-generated goodwill.

₹5 lakh attributed to patent "T" shall not be added to the block of the assets and no depreciation shall be available on the same. When patent "T" gets transferred subsequently, this ₹5 Lakh attributed shall be reduced from the full value of the consideration received or accruing as a result of transfer of patent "T" by the firm " FR", and the net value shall be considered for reduction from the written down value of the intangible block under sub-clause (c) of clause (6) of section 43 of the Act or for calculation of capital gains, as the case may be, under section 50 of the Act..

Let us say that Patent T is sold for ₹25 lakh. ₹5 lakh shall be reduced from ₹25 lakh and only net amount of ₹20 lakh shall be considered for reduction from the written down value of the intangible block under sub-clause (c) of clause (6) of section 43 of the Act or for calculation of capital gains, as the case may be, under section 50 of the Act.

Similarly when goodwill gets sold subsequently, ₹10 lakh would be reduced from its sales consideration under clause (iii) of section 48.

The amount of ₹15 lakh which is charged to tax under sub-section (4) of section 45 of the Act shall be charged as short term capital gains, as ₹15 lakh is attributed to the Patent "T" which is part of block of assets and ₹ 10 lakh is attributed to self-generated goodwill. In accordance with sub-rule (5) of Rule 8AA of the Rules, both of these are to be characterised as short term capital gains.


Feel free to contact in case of any query or consultation.