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Partner's Share

Sunali (Learner) (1317 Points)

10 December 2010

Can a partner transfer his share in firm to an outsider? What will be the taxability in this case?

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CA Tarkeshwar (job) (77 Points)
Replied 11 December 2010

dear friend

When a person acquires share in partenership firm by introducing capital, he does not aquire any capital asset under the meaning of capital asset as defined in section 2(14) of the income tax act, 1961

As per Section 2(14), "Capital asset" is defined to include property of any kind, whether fixed or circulating, movable or immovable, tangible or intangible. some assets are however, excluded from the definition of "capital assets"

share in partenership firm can not be the property of any kind so as to deal therein, So the transfer of share in partenership firm is just realisation of his capital contribution with goodwill. therefore the transfer of share in partenership firm is not attract capital gain tax

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Sunali (Learner) (1317 Points)
Replied 11 December 2010

Thanks Tarkeshwar. The point I am confused is, if all the partners want to transfer their respective shares to some other persons, can they do so ? What if they receive more than their capital shares as standing on the date of transfer..?

Parshu (CA Final) (84 Points)
Replied 11 December 2010

If a partner transfers his share in the firm(assumed wholly) he is said to be retiring from the firm.No Capital Gain tax is attracted since it is refund of own capital employed.The increase is only because of interest,remuneration & share of Profit,which is taxed (except share) in relevant assessment year.

As regards the transfer of whole Partnership firm to another Concern Deemed Capital Gains tax is attracted

The Bombay High Court in CIT v Texspin Engineering and Manufacturing Co. (supra) pointed out that for the deeming provision of section 45(4) to be attracted treating gains on transfer of dissolution to be capital gains, two conditions are to satisfied. There has to be transfer by way of distribution of capital assets. Secondly, such transfer should be on dissolution of the firm or otherwise. If these conditions are complied with, the market value of such assets on the date of transfer is deemed to be the full value of consideration for the transfer. The Court held that these conditions were not attracted. The assets merely vested in the company without there being any distribution at all, as legally understood. The Court pointed out that vesting of property in the company is different from distribution which was necessary to attract section 45(4). Distribution is something totally different. Since the first condition itself was not attracted, section 45(4) was not applicable

Sunali (Learner) (1317 Points)
Replied 11 December 2010

Thanks Parshu.

But the issue still stands. Suppose Mr. A and Mr. B running a firm, have their capital shares (including interest, salary, goodwill etc.) Rs. 300000 and Rs, 500000 respectively as on the date of transfer of their firm to Mr. D and Mr. E. On transfer, Mr. A and Mr. B receives Rs. 350000 and Rs. 550000. Now, will this excess Rs. 50000/- be taxable..???

Parshu (CA Final) (84 Points)
Replied 11 December 2010

As per the Tribunal decision Dy. CIT Vs G.K.Enterprises (2003) 79 TTJ 02 (Mad), there is no capital gain tax u/s 45(4) in the case of retirement of a partner from a firm.

The Kerala High Court in the case of CIT Vs Kunnamkulam Mills Board (2002) 257 ITR 544 (Ker) held that, the retirement of partner from the firm after receiving their credit balances will not be covered u/s 45(4) of the Income-tax Act. In this case the assets have been revalued and the amounts were credited in the partners account. The partners have received larger amounts on their retirement from the firm.

The decision rendered by the Bombay High Court in CIT Vs A.N. Naik Associates and another (2004) 265 ITR 346 (Bom), will create yet another confusion about the word “ otherwise” in Section 45(4). As per this decision, if the retiring partner receives any property during the subsistence of the firm even without dissolution, Section 45(4) will attract and the firm is liable to pay capital gain tax.

In another case, it was held that, as per sec 45(4) which itself, is a charging Section, so there is no need for a separate amendment in the definition of capital asset. As per the decision rendered in Swamy Studio Vs ITO 66 ITD 276 (Mad) the tribunal held that “ Section 45(4) is a separate code by itself, providing for a levy of capital gain tax, on distribution of assets among the partners on dissolution of the firm

From the above it can be made clear that, it is the capital asset of the firm transferred to other concern which determines Capital Gain Tax to the firm and not the amount of money received by the partners on dissolution.

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CA Tarkeshwar (job) (77 Points)
Replied 13 December 2010

dear friend

transfer of share by all partner to outsiders amounts to dissolution (or otherwise) of the existing firm.

As per section 45(4) The profit or gains arising from transfer of capital assets by way of distribution of capital asset on dissolution of firm shall be chargeable to tax as the income of the firm. for the purpose of computation u/s 48, The Fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received by the firm.

again transfer of share by mr. A and Mr. B means transfer of assets got by them from the dissolution of the existing firm. therefore, it is transfer of capital asset and chargeable to tax under capital gains in the hands of partners on the amount received by them (i.e Rs. 350000 and Rs. 550000 ) after deducting cost of aquision being the fair market value of asset distributed to them . this would be STCG

I think the explanation help to sunali, but the answer is given by my own logic and interpretation of section 45(4). and you must follow the above case laws refered by paeshu

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Sunali (Learner) (1317 Points)
Replied 13 December 2010

Thanks friends,

So, what I have concluded is:

Sec 45(4) covers only amount received on account of capital assets distribution of firm i.e. different assets are sold and the proceeds are divided amongst the partners.

However, in any other case of dissolution/retirement, when any partner receives any amount from the firm over and above his capital share as on the date of dissolution/retirement which is not from distribution of capital assets of firm, there is no liability to tax in such cases as the same is not covered u/s 45(4) or any other section...!!!!..Really, is it so...?