An Analysis of Section 9B- Dissolution or Reconstitution of Partnership Firm
While presenting the budget -2021, the proposal was there just to replace section 45(4) and introduce section 45(4A). However, drastic changes have been done at the time of passing the bill and new section 9B & 45(4) have been added by dropping section 45(4A).
It is important to understand that when a partner retires from the firm and obtains money or property from the firm, there are two transactions.
- First one, qua the partner and
- Second one, transfer of money or property by the firm.
The former transaction is dealt with in section 45(4) and the later in section 9B. New Section 45(4) now provides for taxation if the partner receives the “capital assets” or “money“ at the time of reconstitutions whereas Section 9B covers situation where the partner receives capital assets or stock in trade at the time of reconstitutions or dissolution.
An Analysis of the Provision of Section 9B:
- The provision is applicable only if there specified person & a specified entity. The provision applies when a specified person ‘receives’ a capital asset or stock in trade.
- Specified person – “Specified person” means any one of the following
(a) a person who is a partner of a firm (b) a member of any AOP (c) a member of any BOI.
- Specified entity – “Specified entity” means a firm or other association of persons or body of individuals (not being a company or a cooperative society).
- The provision provides for “deemed transfer”.
- Newly introduced section 9B provides for taxation in the hands of the firm if any partner receives capital assets or stock in trade or both at the time of reconstitution or dissolution.
- Section 9B provides that receipt by the partner shall be deemed to be “transfer” and the profits on such deemed transfer shall be treated as income of the firm to be chargeable as “Business Income” if stock in trade is transferred or chargeable as “Capital Gains” if the capital assets is transferred.
- Fair Market Value (FMV) of the capital asset or stock in trade on the date of receipt by the partner person shall be relevant for computing the amount of profit in such cases.
- The section applies only if the partner receives any capital asset or stock in trade. The provision does not apply to receipt of money by the specified person. It is covered by section 45(4).
- Income Tax rate of such capital gain will depend on the nature & holding period of capital asset.
- A conversion of a partnership firm under Chapter XXI of the Companies Act, 2013 may not result in reconstitution of the specified entity. Similarly, conversion of a firm into LLP may also not be regarded as reconstitution of the specified entity.
- Mere reconstitution does not trigger applicability of section 9B, unless it is accompanied by receipt of capital asset or stock in trade by a specified person.
- If there is dissolution of the firm then taxation would be there only u/s 9B and nothing would be taxable u/s 45(4). It may be noted that Section 45(4) is applicable only in the case of reconstitution and not otherwise.
- “Reconstitution of the specified entity”means, a case where
(a) one or more partners or members of such specified entity cease to be its partner or member; or
(b) one or more new partners or members are admitted in such specified entity in such circumstances that one or more of the partners or members of the specified entity, before the change, continue as partner(s) or member(s) after the change; or
(c) all the partners or members of such specified entity continue with a change in their respective share or in the shares of some of them.
The meaning of the reconstitution is wide enough to every case of admission & retirement of partner and even change in the profit sharing ratio in the firm.
- The word used in the section is “in accordance with” which means that it is “in a manner conforming with” as held inITC Ltd. v. CCE, AIR 2005 SC 1370 or “not contrary to” or “in conflict with” as held in CIT v. Anjum M.H. Ghaswala  119 Taxman 352/252 ITR 1 (SC).
- Thus, the computation of income and charge to income tax should be in conformity with or not contrary to or in conflict with the provisions of the Act.
- Capital asset includes a running business as held inJ. K. Trust v. CIT  32 ITR 535 (SC); CIT v. Krishna Warriar, AIR 1965 SC 59; PNB Finance Ltd. v. CIT,  117 Taxman 586/252 ITR 491 (Delhi); CIT v. F. X. Periera & Sons (Travancore) (P.) Ltd.,  55 Taxman 242/ 184 ITR 461 (Ker.)]. In short, if a specified person receives a running business of the specified entity, it can be said to a capital asset and provision of section 9B gets attracted.
- The provision does not apply to receipt of money by the specified person. It is covered by section 45(4)
- The definition covers any person who is a partner or member. Hence, it covers all partners/members such as companies, cooperative societies, etc. and whether resident or non-resident. The term “partner” includes a minor who has been admitted to the benefits of partnership (section 2(23)(ii)].
- Section 9B doesn’t make any distinction whether the assessee is opting for presumptive scheme of taxation or not. The provision will apply even if the specified entity is taxed on presumptive basis u/s 44AD.
- A deceased partner ceases to be a partner of the firm and if his share is paid to his legal heirs. The issue would be controversial one and an arguments could there that the provision is not applicable as legal heirs cannot be said to be received by a specified person.
- Section 9B is applicable on “capital asset”. The definition of the word “Capital Assets” is defined in section 2(14). If the an asset is not capital asset within the meaning of section 2(14) then it cannot be said to be the capital asset for the purposes of section 9B. (For example, Rural agricultural land)
- There is no computation required directly as such under section 9B. It is not a computation provision but just an enabling provision. As per section 9B(2)(ii), the computation is to be done under the head “business income” or “capital gains”. Section 9B(3) states “for the purposes of this section” which obviously means for the purposes of computation under the head “profits and gains of business or profession” or “capital gains”.
- Profits and gains arising from the deemed transfer shall be deemed to be the income of such specified entity of the previous year in which the capital asset or stock in trade is received by the specified person. The trigger point for taxation is “receipt”. The use of the term ‘receives’ conveys that the method of accounting followed by specified entity or specified person is not relevant. This may be issue of litigation and controversy if this two events occurs in different financial year. If the reconstitution and receipt are in different years then, going by the strict interpretation of the Act, the tax liability will arise in the year of receipt on the firm, as reconstituted.
- It may be noted that Section 9B(3) states that the FMV shall be regarded as consideration “for the purposes of this section”. Applicability of Sections 50C, 50CA and 43CA is another issue which need to be examined in such case. It may be noted that Section 9B(3) provides that the FMV of the capital asset or stock-in-trade received by the specified person shall be deemed to be the full value of the consideration received or accruing as a result of the deemed transfer of the capital asset or stock-in-trade by the specified entity. FMV here is not linked with section 50C, 50CA & 43CA directly & is a self-contained exhaustive provision. In short, strictly FMV here cannot be substituted by the stamp duty value as referred in section 43CA, section 50C or 50CA, as the case may be. Any contrary interpretation will result in a conflict between section 9B(3) and section 50C, etc. which may be avoided by holding that the FMV under section 9B(3) will prevail. Further, Section 50C applies only in a case where the consideration received or accruing as a result of transfer by an assessee of a capital asset is less than stamp duty value. Section 50C applies only where consideration is received or accruing and there is a transfer. An arguments could be very well placed that in a case of a retirement or dissolution, there is mere settlement of account and no consideration actually accrues or arises to the specified entity. Further, in a case of dissolution there is no transfer by the partnership firm. In fact, it is precisely to overcome the fact that there is no transfer and no consideration that section 9B deems a transfer and deems FMV as consideration. In such circumstances, it could be argued that the preconditions for applicability of section 50C are not satisfied in case of a deemed transfer of capital asset covered by section 9B.
- Since the capital gain is rqeuried to be computed under the relevant provision of the Act, the capital gain exemption like the one provided u/s 54EC may be claimed by the assessee firm.
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