Admission of a new partner /Retirement from Partnership Firm - Taxability under the Income Tax Act, 1961

Partnership firm is a very common method of doing business in India. The Income tax has recognized the Partnership firm and its members as separate legal entity and has defined provisions for the taxation of the Partnership and its partners.

Partnership, by and large, is still the most popular form of people coming and staying together in life as well as in business. There may be occassionally changes in the constitution of the firm. In most cases, this is carried out either through a retirement or an admission of one or more partners, with some of the existing partners continuing. In such a case, for purposes of taxation, the same partnership firm is regarded as having continued with a change in constitution. Even if the change has occurred in the middle of a year, only one assessment is made for the year on the firm on its income for the entire year (Section 187). The proviso to Section 187 clause (a) of the said section shall not apply where the partnership is dissolved due to death of any one of the partners.

 

[A]  Capital Gains implications in case of Admission of New Partner(s)

 

TAXABILITY IN THE HANDS OF FIRM AND PARTNER(S) IN CASE OF ADMISSION [Section 45(3)]

Section 45(3) applies when a capital asset is introduced into a firm as capital contribution. This was inserted to supercede Sunil Siddharthbhai 156 ITR 509 (SC). In Sunil Siddharthbhai, it was held that when a partner introduces his asset into a firm as capital contribution, there is a “transfer” though the gains are not chargeable to tax as the consideration is not determinable.

 

Text of Section 45(3)

The profits and gains arising from the transfer of a capital asset by a person to a firm (not being company or co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and for the purposes of Section 48, the amount recorded in the books of account of the firm as the value of capital asset shall be deemed to be the full value of consideration received or accruing as a result of the transfer of the capital asset.

 

Therefore capital gain arising on transfer of capital asset to the firm is taxable in the hands of assessee. Section 45(3) of Income Tax Act provides the calculation of the same. Thus, at whatever amount the asset is brought in the books of account, the capital gain in the hands of the partner will be computed on the basis of the value recorded in the books of account as consideration. As such, if not otherwise beneficial, the capital should be contributed in cash only and not in the form of capital asset.

 

 

KEY NOTE

Section 50C and Section 56(2)(x) will not be applicable in the above case as these both are deeming provisions and two deeming provisions cannot be applied on a single transactions.

 

Admission of a Partner

If new partners come into the partnership and bring cash by way of capital contribution and the retiring partners take cash and retire, the retiring partners are not relinquishing their interest in the immovable property. What they relinquish is their share in the partnership. As there is no transfer of a capital asset, no capital gains or profit can arise & section 45(4) has no application (CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom) distinguished, Dynamic Enterprises 359 ITR 83 (Karn) [FB] followed) (Related Assessment year : 2010-11 – [PCIT v. Electroplast Engineers – Date of Judgement : 26.03.2019 (Bom)]

 

Admission of partner – Admission of a new partner in partnership firm does not attract provisions of section 45(4)  

Assessee-firm was engaged in business of builders and developers. It admitted a new partner. Assessing Officer found that assessee owned a plot of land 50 per cent of which was transferred in favour of new partner. He thus, opined that assessee-firm was liable to be taxed under section 45(4). On appeal, it was noted that from very beginning of partnership, plot in question was treated as stock-in-trade and even at end of relevant assessment year it was shown as current asset in balance sheet of firm. In view of above, there was no extinguishment of right as envisaged by section 2(47) in case of assessee-firm. Admission of a new partner in partnership firm does not attract provisions of section 45(4). In the instant case no capital asset was transferred by the assessee during the relevant assessment year. From the very beginning of the partnership the plot of land in question was treated stock-in-trade by the assessee firm. Even on 31.03.2008 it was shown as current asset (i.e. WIP) in the balance sheet. The Assessing Officer has nowhere rebutted/ doubted this factual position. Considering the above, the Commissioner (Appeals) rightly held that no capital asset was transferred by the assessee-firm and, hence, provisions of section 45(4) should not have been invoked. In the result, the revenue’s appeal has to be dismissed. (Related Assessment year : 2008-09) – [ITO v. Fine Developers. (2013) 55 SOT 122 (ITAT Mumbai)]

 

Any reduction in share of a partner in the partnership firm on admission of new partners does not amount to transfer of share in the landed property of the firm and accordingly, the same cannot be taxed in the hands of the existing partners.

In the case of CIT v. P. N. Panjawani (Decd), the provisions of section 2(47) were examined, in the context of reduction of share in partnership firm on induction of new partners. It was held that reduction of share of old partners of the firm on reconstitution of firm by inducting new partners and withdrawal of amount by old partners out of the capital contributed by new partners, did not constitute transfer in the hands of partners, making them liable to capital gains tax. It was also held that the provisions of section 45(3) or section 45(4) were not applicable to the facts of the case. – [CIT v. P.N. Panjawani (Decd) (2013) 356 ITR 676 : (2012) 208 TAXMAN 22 : 80 DTR 200 (Karn)]

 

[B]  Capital Gains implications in case of Retirement of Partner(s)

A partner may decide to retire or withdraw from the firm due to reasons such as his age, his bad health, change in firm's nature of a business, etc. In case of Partnership at Will, a partner may retire at any time.

At the time of the retirement, the retiring partner is eligible to receive the share of his capital, share of revaluation profit, the share of Goodwill and Reserves. The partners calculate the final payment after adding all these amounts.

Final Payment to Retiring Partner

At the time of retirement of a partner, we need to adjust the following amounts in the Capital Account of the retiring partner:

(i)    Reserves

(ii)   Goodwill

(iii)  Profit or loss on Revaluation

(iv)  Any loan by the partner to the firm.

 

After all these adjustments the amount standing to the credit side of the Capital Account of the Retiring partner is payable to him.

 

Chargeability of sums/assets received by partners on retirement/dissolution
There are a number of judgements of the Supreme Court, as well as the High Courts, according to which when a partner retires from a firm and receives an amount in respect of his share in the partnership, there is no transfer of interest of the partner in the assets of the firm and no part of the amount received by him would be assessable to capital gains tax under section 45 of the Act. The reason for the same is that an amount paid to a partner upon retirement, after taking accounts and upon deduction of liabilities, does not involve an element of transfer within the meaning of section 2(47) of the Act.

 

Distinction between ‘retirement of a partner’ and ‘dissolution of a partnership firm’

There is a clear distinction between ‘retirement of a partner’ and ‘dissolution of a partnership firm’. On retirement of the partner, the reconstituted firm continues and the retiring partner is to be paid his dues in terms of Section 37 of the Partnership Act. In case of dissolution, accounts have to be settled and distributed as per the mode prescribed in Section 48 of the Partnership Act. When the partners agree to dissolve a partnership, it is a case of dissolution and not retirement A partnership firm must have at least two partners. When there are only two partners and one has agreed to retire, then the retirement amounts to dissolution of the firm.

 

Settlement of retiring partner(s) by revaluation of assets should not have capital gain implication on the firm since the assets of the firm continue to remain with the firm

Taxation on cash settlement at the time of Retirement

The partner can retire from firm at any time after complying with their partnership deed. The partner may agree to settle his accounts by cash or by taking some of the assets. The cash received by the partner in his capital account will not be again subject to tax even though if he receives in excess of the capital or current account balance. In the case of Ajay Kumar Doshi v. ACIT [TS-6396-ITAT-2015(Kolkata)], the Honorable ITAT Kolkata held that, the amount received by the partner is capital receipt and not liable for tax.

 

Assets taken by the outgoing partners

The outgoing partner account is settled by giving some of the assets or all the assets, and then section 45(4) will come into play. The section states that, the firm is liable to tax by considering the fair market value of the assets given up to the partners.

 

In CIT v. A. N. Naik Associates, it was held that, after amendment of Finance act in 1988, subsection (ii) of section 47 was removed. Hence the exemption given earlier for transfer of assets at the time of dissolution or otherwise was no more applicable. Hence the asset given by the firm to its partner at the time of dissolution or otherwise will be chargeable to tax in the hands of the firm. - [CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom)]

The Bombay High Court in the case of A.N. Naik Associates  held that the term “otherwise” forming part of section 45(4) would include within its sweep the ‘reconstitution of the firm’ and capital gains tax would therefore also be leviable in such cases. In this case, the taxpayer was a partnership firm constituted by family members and during reconstitution, various assets belonging to the firm were given to the retiring partners through a family arrangement. The High Court held that the gains arising out of the said arrangement is taxable, which was subsequently upheld by various High Courts, including the Madras High Court in CIT v. Nathan and Co. – Date of Judgement : 31.10.2012 (TCA No. 1458 of 2005) -

Section 45(4) does not apply if the retiring partner takes only money towards the value of his share and there is no distribution of capital assets among the partners as such there was no transfer of capital asset, therefore no profits or gains are chargeable to tax under section 45(4) of the Act

The assessee partnership firm was constituted on 09.01.1985 with Anurag Jain and Nirmal Kumar Dugar as its partners. On 13.04.1987, Nirmal Kumar Dugar retired from partnership and L.P. Jain entered the partnership and contributed capital for purchase of land to construct a housing complex. The assessee-firm purchased land for a consideration of Rs. 2.5 lakhs. Another reconstitution took place on 01.07.1991 by which L.P. Jain retired from the firm and Pushpa Jain and Shree Jain were inducted as partners. Later, on 28.04.1993, five partners belonging to the Khemka Group were inducted. Prior to the induction of the Khemka Group, the assets of the firm were revalued. The three old partners retired through deed of retirement dated 01.04.1994 and received the enhanced value of the property in Financial year 1994-95. The Assessing Officer held that the introduction of the Khemka Group and the retirement of the old partners was a device adopted to transfer the immovable property and to evade capital gains tax and stamp duty. He assessed the firm on capital gains. This was upheld by the CIT(A) though reversed the Tribunal. The Tribunal held that as the land continued to remain with the assessee-firm, there was no transfer under section 2(47) and that the retiring partners had merely withdrawn the amounts standing to their credit in the capital account. On appeal by the department to the High Court, it was felt that there was a conflict between CIT v. Mangalore Ganesh Beedi Works (2004) 265 ITR 658 (Karn) and CIT v. Gurunath Talkies (2010) 328 ITR 59 (Karn) and the issue was referred to the Full Bench. HELD by the Full Bench:

(i) Section 45(4) deals with a distribution of capital assets on the dissolution of a firm or other AOP or BOI or otherwise and provides that if in the course of such distribution of capital asset there is a transfer of a capital asset by the firm, the firm shall be chargeable to tax on capital gains. In order to attract section 45(4), the conditions precedent are (1) there should be a distribution of capital assets of a firm; (2) such distribution should result in transfer of a capital asset by firm in favour of the partner; (3) on account of the transfer there should be a profit or gain derived by the firm and (4) such distribution should be on dissolution of the firm or otherwise. In other words, the capital asset of the firm should be transferred in favour of a partner, resulting in firm ceasing to have any interest in the capital asset transferred and the partners should acquire exclusive interest in the capital asset. On facts, the partnership firm purchased the property and it was not in the name of any partner. No partner brought that capital asset as capital contribution into the firm. Also, there was no dissolution of the firm because the firm continued to exist even after the retirement of some partners. What was given to the retiring partners is cash representing the value of their share in the partnership. No capital asset was transferred on the date of retirement. In the absence of distribution of a capital asset and in the absence of transfer of capital asset in favour of the retiring partners, no profit or gain arose in the hands of the partnership firm and so the question of the firm being assessed under section 45(4) would not arise;

(ii) The department’s argument that the transaction by which the five incoming partners brought money into the firm and the three erstwhile partners retired by taking money (leaving the capital asset in the firm) is a device adopted to evade payment of profits or gains is not acceptable because it proceeds on the premise that the immovable property belongs to the erstwhile partners and that after the retirement the erstwhile partners have taken cash and given the property to the incoming partners. The property belongs to the partnership firm and not to the partners. The partners only had a share in the partnership asset when they retired and took their share in cash, they were not relinquishing their interest in the immovable property. What they relinquished is their share in the partnership.Therefore, there is no transfer of a capital asset and no capital gains or profit arises (CIT v. Ganesh Beedi Works (2004) 265 ITR 658 (Karn) approved; Gurunath Talkies 328 ITR 59 reversed; Narayanappa v. Bhaskara Krishnappa AIR 1966 SC 1300, Malbar Fisheries Co 120 ITR 49 (SC), Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC), CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom) referred) - [CIT v. Dynamic Enterprises (2013) 359 ITR 83 (Karn)]

 

Thus the Karnataka High Court in the case of Dynamic Enterprises held that the firm shall not be liable to capital gains tax under Section 45(4) of the Income-tax Act, 1961 on account of payment of money to the retiring partner, not involving distribution of any asset. In order to attract capital gains tax under Section 45(4) of the Act, there should be an absolute cessation of right in property of the firm, as a result of which the retiring partners should hold an absolute title to property so relinquished by the firm. If this condition is absent, there could be no application of Section 45(4) of the Act.

 

The Bangalore ITAT in the case of Savitri Kadur v. DCIT was considering whether the excess consideration given to the retiring partner, over and above what was lying in its capital account, was subject to capital gains tax or not. In view of the same, it considered the following issues:

(a) Taxability when the retiring partner was paid the amount lying to his credit in the capital account.

(b) Taxability when the retiring partner was paid over and above the amount lying in his/her capital account.

(c) Taxability when the retiring partner is paid a lump sum consideration with no reference to the amount lying in the capital account

 

In respect of the situation laid out in (a), the Bangalore ITAT held that the position taken by the Supreme Court in the case of CIT v. Mohanbhai Pamabhai (1973) 165 ITR 166 (SC) still holds good by holding that the said section intends to levy capital gains tax in the hands of the partnership firm on distribution of ‘capital assets’ and the Supreme Court had held that the amounts lying in the own capital accounts of partners represents their interest and the payment of the same, upon retirement, does not attract capital gains tax. In view of the same, it had held that section 45(4) cannot be said to have nullified that position held by Supreme Court.

In respect of situation (b) and (c), the Bangalore ITAT held that when a partner was paid over and above the amount lying to the credit in his capital account or when a lump sum consideration was paid, it cannot be stated that the partner received only what he was entitled to. The excess consideration payable over and above the amount lying in the capital account could be regarded as having been paid for releasing his interest in the partnership firm, which also could be construed as a transfer of his rights in the firm, and shall have to be subject to capital gains tax in his hands. Similarly, when a lump sum consideration is being paid to the retiring partner without having regard to the capital account, it would also be construed as a consideration received for the transfer of rights in the firm towards the continuing partners and the difference between such lumpsum consideration and the amount standing to the credit of the concerned retiring partner shall be subject to tax.

Retiring partner to pay capital gains tax in excess amount received against capital account

On retirement, assessee gave up all her rights as partner of the firm and its assets nor was the assessee liable to pay any of its liabilities. The capital account of Assessee as on 01.04.2006 showed an opening balance of  Rs.1,64,14,044. Profit for the year of Rs. 46,20,591 was credited to his account. Similarly on revaluation of the land and building on 15.01.2007, a sum of Rs.53,26,462 and Rs.9,24,650 respectively was credited to her account. Another sum of Rs. 18,12,528 was also credited as interest on capital in her capital account. After reducing the Partner’s drawing and other payments made the balance to the credit of assessee’s capital account was Rs. 2,77,88,200/-. The difference between the sum of Rs. 3,39,50,000 and the sum of Rs. 2,77,88,200 viz., a sum of Rs. 61,61,800 was taxed as capital gain by Assessing Officer.  Assessing Officer held that when the partnership firm paid lump-sum amount to retiring partner, it was paid in consideration of her retirement in the partnership and assignment of her interest to other partners, the transaction would amount to transfer under section 2(47) and liable to tax under the provisions of Section 45. Since assessee had also invested Rs. 50,00,000/- in Rural Electrification Corporation Ltd under the provisions of Section 54 EC, therefore, the capital gains was worked out as under. (61,61,800/- (-) 50,00,000/- = 11,61,800/-). It was held  the action of the revenue authorities in taxing the excess paid over and above the sum standing to the credit of the capital account of the assessee as capital gain was justified. When the partnership firm paid lump-sum amount to retiring partner, it was paid in consideration of her retirement in the partnership and assignment of her interest to other partners, the transaction would amount to transfer under section 2(47) and liable to tax excess amount over partner’s capital account under the provisions of Section 45. However, the computation of the capital gain had been modified by treating value of goodwill also as part of the credit in the partners capital account. Consequently, the capital gain in question was less than Rs. 50 lacs and since assessee had been allowed exemption under section 54EC to the extent of  Rs. 50 lacs, no capital gain was exigible to tax. (Related Assessment Year : 2008-09) – [Savitri Kadur v. DCIT - Date of Judgement : 03.05.2019 (ITAT Bangalore)]

 

Allotment of immovable property by a firm to its retiring partners towards their share in the partnership firm not attract section 45(4)

It was held that the retirement of partners and the allotment of their shares in the assets of the firm would not attract the provisions of section 45(4) of the Act for the following reasons: - “Transfer of capital asset” and “distribution of capital assets on dissolution of firm or otherwise” were the essential conditions for the applicability of section 45(4) of the Act. Section 2(47)(vi) of the Act defines the term “transfer” to inter alia include any transaction that has the effect of transferring, or enabling the enjoyment of any immovable property.

 

The Madras High Court observed that the interest of a partner in a firm is a right to obtain his share of profits from time-to-time during the subsistence of the firm. Further, on dissolution or on retirement from the firm, the partner obtains the value of his share in the net partnership assets, which remain after deducting the debts and liabilities of the partnership [Prashant S. Joshi v. ITO and Ors. (2010) 324 ITR 154 (Bom)]. This could be in the form of immovable assets or in the form of cash in lieu of the immovable assets. Therefore, when a partner retires, he receives his share in the partnership, and not any consideration for transfer/ relinquishment of his interest in the partnership to the continuing partners [CIT v. Mohanbhai Pamabhai (1973) 165 ITR 166 (SC)]. Therefore, there is no element of transfer of interest by retiring partners to the continuing partners.

The Madras High Court also placed reliance on the view expressed by the author in Sampath Iyengar’s “Law of Income Tax” 12th edition that section 45(4) of the Act would not apply on the retirement of a partner from a partnership firm, when there is transfer of assets. The decisions in the case of CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom) and CIT v. Nathan and Company [TCA No. 1458 of 2005 (Bombay)] relied upon by the Revenue was distinguished based on facts of the present case, since the same dealt with the distribution of business in view of agreed settlements.

The Madras High Court observed that in the present case, the firm continued and only underwent a reconstitution. On retirement, there was only a division of the assets in accordance with the partner’s entitlement. It may be mentioned that the premise of section 45(4) of the Act is taxation in the hands of the partnership firm arising on dissolution or “otherwise”, the judgement of Madras High Court discusses capital gains arising on settlement of partner’s share in the assets of the partnership firm on his retirement.

The Madras High Court also mentioned that arguably the retiring partners received their share in the firm that they were legally entitled to, out of holdings of the founder by virtue of their relationship. - [National Company v. ACIT  - Date of Judgement : 08.04.2019 (Mad)]

 

Amount paid to a partner upon retirement after taking accounts and upon deduction of liabilities did not involve an element of transfer within meaning of section 2(47) and not chargeable to income tax

Assessee was in the business of real estate and film production. Assessee conducting the business as a proprietary concern and various other concerns including the firm M/s. BC which was constituted with four partners. As the disputes arouse among the partners assessee was forced to retire from the firm accordingly the deed for release was signed and assessee retired from the partnership. Finally, assessee and the partners settled the dispute by entering into consent terms. Assessing Officer concluded that there was a transfer of interest of the retiring partner over the assets of the partnership firm on her retirement and therefore there was a liability to tax on account of capital gains. Hence goodwill was assessed as capital gains in the hands of assessee. It was held following the decision in the case of Prashant S. Joshi v. ITO and the decision of CIT v. R. Lingamallu Rajkumar (2001) 247 ITR 801 (SC) wherein it was held that amount paid to a partner upon retirement after taking accounts and upon deduction of liabilities did not involve an element of transfer within meaning of section 2(47) and not chargeable to income tax. The Court also held, that the payment made to a partner in realization of his share in net value of assets upon his retirement from a firm was not liable to income tax.It was concluded amounts received on retirement by a partner was not subject to capital gain tax. (Related Assessment Year : 2012-13)  - [James P. D’Silva v.  DCIT - Date of Judgement : 30.01.2019 (ITAT Mumbai)]

 

Sum received by partner on retirement from firm on account of goodwill is exempt from capital gain tax

Amount received by retiring partner on retirement from firm on account of goodwill will not be subjected to tax as capital gains in his hands. (Related Assessment year : 2009-10) – [PCIT v. R. F. Nangrani HUF (2018) 93 taxmann.com 302 (Bom)]

 

Amount received on retirement from partnership firm - There was no transfer of its interest in the goodwill of the firm. Thus, no capital gains was chargeable under section 45

Assessee company was partner in a firm. It held 99 percent interest in the firm. During the year, it relinquished its right of 99 per cent vide retirement deed and received consideration, which it claimed as capital receipt. Assessing Officer held that assessee had relinquished its right in partnership firm and, therefore, consideration received was taxable as capital gains. Assessee contended that there was no transfer of any property by the assessee at the time of retirement and so, no capital gain tax could be levied. Held: On retirement, share was determined after taking into account of notional sale of partnership assets. What assessee received was his share in the partnership and not any consideration for transfer of its interest in the partnership to the continuing partners. There was no element of transfer of interest in partnership assets by the retiring partners to the continuing partner as also no extinguishment of its interest in partnership assets. Further, there was no transfer of its interest in the goodwill of the firm. Thus, no capital gains was chargeable under section 45. (Related Assessment year : 2009-10) – [Sharadha Terry Products Ltd. v. ACIT (2016) 180 TTJ 284 : 141 DTR 220 (ITAT Chennai)]

 

Amount received by partner on his retirement is not chargeable to tax as capital gains

The assessee, a partner in a firm, received Rs. 66 lakhs over and above his capital contribution on his retirement from the firm. The assessee claimed that the said sum was a capital receipt not chargeable to tax. However, the Assessing Officer held that the retirement had resulted in a relinquishment of his pre-existing rights in the partnership firm and, therefore, the same was in the nature of capital gain on transfer of goodwill and liable to tax under section 45 read with section 2(47)(i) & (ii) of the Act.

The CIT(A) and Tribunal reversed the finding of the AO on the ground that when a partner retires from the firm and receives his share of an amount calculated on the value of the net partnership assets including goodwill of the firm, there is no transfer of interest of the partner in the goodwill, and no part of the amount received is assessable as capital gain under section 45 of the Act. The Tribunal has correctly referred to the fact that N A Mody v. CIT (1986) 162 ITR 420 (Bom) followed CIT v. Tribhuvandas G. Patil (1978) 115 ITR 95 and that the same has been reversed by the Apex Court in Tribhuvandas G Patel v. CIT (1999) 236 ITR 515. This Court in Prashant S Joshi v. CIT (2010) 324 ITR 154 (Bom.) has also referred to the decision of Tribuvandas G. Patel rendered by this Court and its reversal by the Apex Court. Moreover, the decision of this Court in Prashant S. Joshi placed reliance upon the decision of the Supreme Court in CIT v. R. Lingamallu Rajkumar (2001) 247 ITR 801 (SC) wherein it has been held that amounts received on retirement by a partner is not subject to capital g ins tax.  On appeal by the department to the High Court HELD dismissing the appeal. (Related Assessment year : 2002-03) – [CIT v. Riyaz A. Sheikh (2014) 221 Taxman 118 : 41 taxmann.com 455 (Bom)]

 

Transfer – Assignment of interest by retiring partner to continuing partner  i.e. by assignment of share and hence, his retirement gave rise to taxable capital gains

The continuing partners agreed to pay to the retiring partner for assigning or release of interest by retiring partner in favour of continuing partners. The transaction would amount to a transfer within the meaning of section 2(47). If the retiring partner is paid something over and above sum standing to credit of his capital account, there would be a capital gain chargeable to tax. In view of amendment carried out by Finance Act, 1987 by omitting section 47(ii), profits or gains arising from transfer of a capital asset by a firm to a partner on dissolution or otherwise would be chargeable as firm’s income in previous year in which transfer took place and for purposes of computation of capital gains, fair market value of assests would be consideration received or accruing as a result of transfer. (Related Assessment year : 2007-08). – [Sudhakar M. Shetty v. ACIT (2011) 139 TTJ 687 : 130 ITD 197 : 58 DTR 289 (ITAT Mumbai)]

 

Capital gains - Transfer of capital assets - Applicability of section 45(4) - Provision of section 45(4) clearly attracted where there was reconstitution of firm twice; once in July, 1994 and another in December, 1994 and entire assets retained in the hands of the newly admitted two partners, results in transfer of assets of the firm in the sense that the assets of the firm as had been held by the erstwhile partners is transferred to the newly admitted two partners though all along the assets of the firm continued in the hands of the firm. Therefore, there is transfer of capital assets within the meaning of section 2(47) and provisions of section 45(4) was clearly attracted. – [CIT & Anr. v. Gurunath Talkies (2010) 328 ITR 59 : 189 TAXMAN 171 : (2009) 226 CTR 474 (Karn)]

 

It was held that Retiring partner assigning his interest in the partnership firm specifically by a deed of retirement executed in writing to the continuing partner for a consideration in lumpsum such consideration was chargeable to capital gain tax. – [Sevantibhai C. Mehta v. ITO (2004) 83 TTJ 542 (ITAT Pune)]

 

It was held that on retirement of a partner of the firm there is no transfer of the assets of the firm in favour of the continuing partners within the meaning of section 45(4) of the Act. – [CIT v. Kunnamkulam Mill Board (2002) 257 ITR 544 : 178 CTR 356 (Ker)]

Where a partner retiring from the firm receives a sum more than the amount standing to his credit, such excess is taxable as capital gains – [Bishan Lal Kanodia v. CIT (2002) 257 ITR 449 (Del.)]

It was held that amounts received on retirement by a partner is not subject to capital gains tax. – [CIT v. R. Lingamallu Rajkumar (2001) 247 ITR 801(SC)]

It was held that when a partners retires and obtains in lieu of his interest in the firm an asset of the firm, no transfer is involved. – [B.T. Patil & Sons v. Commissioner of Gift Tax (2001) 247 ITR 588 : (2000) 163 CTR 363 (SC)]

If a retiring partner assigning, releasing or abandoning his interest and share in the partnership in favor of continuing or new partner, it amounts to transfer and is liable to tax. – [Tribuvandas G. Patel v. CIT (1999) 236 ITR 515 (SC)]

The Gujarat High Court, in the case of CIT v. Mohanbhai Pamabhai (1973) 91 ITR 393 (Guj), held that when a partner retires from the firm and receives his share of an amount calculated on the value of the net partnership assets of the firm, there was no transfer of interests of the partner in the assets of the firm and no part of the amount received by him would be assessable as capital gains under section 45 of the Act. The Department preferred an appeal to the Supreme Court against the aforesaid judgement of the Gujarat High Court.

The Supreme Court, in view of its earlier judgement, in the case of Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC), dismissed the appeal of the Department and thus, the aforesaid judgement of the Gujarat High court was affirmed by the Supreme Court. - [Addl. CIT v. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC)]

It was held in this case that when a partner retires from a firm and receives an amount in respect of his share in the partnership, there is no transfer of interest of the partner in the assets of the firm and no part of the amount received by him would be assessable to capital gains tax under section 45 of the Act.

The gist of the aforesaid judgement may be stated as follows :

Section 2(47) defines “transfer” in relation to a capital asset. This definition gives an artificially extended meaning to the term by including within its scope and ambit two kinds of transactions which would not ordinarily constitute “transfer” in the accepted connotation of that word, namely, relinquishment of the capital asset and extinguishment of any rights in it. But, even in this artificially extended sense, there is no transfer of interest in the partnership assets involved when a partner retires from the partnership.

The interest of a partner in a partnership is not interest in any specific item of the partnership property. It is a right to obtain his share of profits from time to time during the subsistence of the partnership and on dissolution of the partnership or on his retirement from the partnership to get the value of his share in the net partnership assets which remain after satisfying the debts and liabilities of the partnership. When, therefore, a partner retires from a partnership and the amount of his share in the net partnership assets after deduction of liabilities and prior charges is determined on taking accounts on the footing of notional sale of the partnership assets and given to him, what he receives is his share in the partnership and not any consideration for transfer of his interest in the partnership to the continuing partners. His share in the partnership is worked out by taking accounts in the manner prescribed by the relevant provisions of the partnership law and it is this, namely, his share in the partnership which he receives in terms of money. There is in this transaction no element of transfer of interest in the partnership assets by the retiring partner to the continuing partners.

The transfer of a capital asset in order to attract capital gains tax must be one as a result of which consideration is received by the assessee or accrues to the assessee. When a partner retires from a partnership what he receives is his share in the partnership which is worked out and realized and does not represent consideration received by him as a result of the extinguishment of his interest in the partnership asset.

Hence, when an assessee retires from a firm and receives an amount in respect of his share in the partnership there is no transfer of interest of the assessee in the goodwill of the firm and no part of the amount received by him would be assessable to capital gains tax under section 45. – [CIT v. Mohanbhai Pamabhai (1973) 91 ITR 393 (Guj)]