Can loss be carried forward in case of change in profit sharing ratio in partnership?
The provision containing carry forward and set off in case of change of constitution is governed by Section 78 of the Income Tax Act, 1961. The change in profit sharing ration does not result in change in constitution as per section 78(1).
Section 78 of the Income Tax Act, 1961 reads as under:
Carry forward and set off of losses in case of change in constitution of firm or on succession.
- (1) Where a change has occurred in the constitution of a firm, nothing in this Chapter shall entitle the firm to have carried forward and set off so much of the loss proportionate to the share of a retired or deceased partner as exceeds his share of profits, if any, in the firm in respect of the previous year.
(2) Where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance, nothing in this Chapter shall entitle any person other than the person incurring the loss to have it carried forward and set off against his income.
However, section 187(2) contends that change in profit sharing ratio in partnership is the change in the constitution. Section 78, prohibits the set off or carry forward of the proportionate loss in case of change of constitution due to retirement or death.
The set off and carry forward of loss will not be effected due to change in the ratio of partnership.
To conclude, the word change of constitution has different meaning at two places in the Income Tax Act. At the first place (in section 78 – Setoff and Carry forward) it does not include the change in profit sharing ration. At second place ( in Section 187) the word change in constitution includes change in profit sharing ratio.
A single section made a difference in taxation for around 8 yrs (Till the continuation of carry forward provision).
