Avoiding Double Taxation U/s 9B & Section 45(4) on Reconstitution of Partnership Firm

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Avoiding Double Taxation U/s 9B & Section 45(4) on Reconstitution of Partnership Firm

 

 

Finance Act – 2021 has introduced section 9B and replaced section 45(4) so as to tax partnership firm on its reconstitution.

Section 9B provides for taxation of income of the firm on transfer of capital assets & stock in trade whereas Section 45(4) now provides for taxation of income in the hands of the firm which is actually the income in the hands of the partner.

This provisions leads to double taxation and to compensate the implications of double taxation, section 48 is also amended by adding the clause (iii) therein. Before understanding the amendment, 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.

  1. First one,  qua the partner and
  2. 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.

 

Avoiding Double Taxation:

To avoid the rigour of double taxation U/s 9B as well U/s 45(4), consequential amendment is also done in section 48 wherein it is provided that the amount of cost of acquisition of capital assets will include the amount of capital gain chargeable to tax u/s 45(4).

Clause (iii) is added to section 48 which reads as under:

 “(iii) in case of value of any money or capital asset received by a specified person from a specified entity referred to in sub-section (4) of section 45, the amount chargeable to income-tax as income of such specified entity under that sub-section which is attributable to the capital asset being transferred by the specified entity, calculated in the prescribed

The Explanatory Memorandum at the time of introduction of Finance Bill 2021 on 1st March 2021 stated as follows:

“Consequential amendment is also proposed in section 48 of the Act to provide that in case of specified entity, the amount included in the total income of such specified entity under sub-section (4A) of section 45 which is attributable to the capital asset being transferred, shall be reduced from the full value of the consideration to compute income charged under the head “capital gains”. This is to be calculated in the manner to be prescribed later. This is to mitigate the double taxation which may have happened but for this provision in a situation where an asset which was revalued and for which income under the proposed sub-section (4A) of section 45 of the Act was brought to tax is transferred subsequently by the specified entity.”

 

By reading section 48(iii), one can reasonably arrive at the following conclusions:

  1. Clause is applicable when any money or capital asset is received by a specified person from a specified entity referred to in section 45(4); and
  2. Once the provision is applicable, then the deduction shall be equal to the amount chargeable “under that sub-section” i.e., section 45(4) which is attributable to the capital asset transferred by the specified entity;
  3. The amount attributable shall be calculated in the prescribed manner.

 

Though the scheme of taxation as finally enacted by the Finance Act 2021 is altogether different from the scheme as was proposed in the Finance Bill – 2021, one can reasonably conclude that the intention behind insertion of section 48(iii) has remained the same.

Still there is some doubt as the wording of the provision is not very clear. The question arises as to where the deduction by virtue of clause (iii) will be available? In my view, considering the reading all the provision together, Section 48(iii) is applicable to computation for the purpose of section 9B & not elsewhere.  As a result, amount of gain under section 45(4), which is required to be computed on aggregate basis therein,  will have to be bifurcated into the amount attributable to receipt of money by the specified person and the amount attributable to receipt of capital asset. At present, section 45(4) is not providing for the manner in which the income under section 45(4) shall be bifurcated into the amount of income attributable to receipt of money and the amount of income attributable to receipt of capital asset.

 

As a result of above addition, the computation mechanism u/s 45(1)read with Section 9B shall be as under:

Full value of consideration received

or accruing as a result of a transfer of

the capital asset                                                                  

Less: Expenditure incurred wholly

and exclusively in connection with

such transfer [clause (i)]                                                        

Less: The cost of acquisition or Indexed

Cost of the asset and any cost of improvement

Or indexed cost of improvement thereto

[clause (ii)]                                                                                

Less: Capital gain computed u/s 45(4)

 [clause (iii)]                                                                               

Capital Gain Taxable u/s 45(1)                                  

The CBDT has been authorised to prescribe the manner of computation in such case. It is expected that the CBDT will shortly issue the suitable guidelines for avoiding the rigour of double taxation.

 

 

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