Retirement of a Partner

A partner in a firm may retire due to any reason like old age, better opportunity, or disagreement amongst the partners. The amounts received by the partner on his retirement, are exempt from capital gains tax.

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 an interest of the partner in the goodwill, and the same not assessable as capital gain under section 45 of the Act.

If the old value of goodwill is equal to the new value of goodwill, no adjustment entry is required to be done. But, if the new valuation is higher than the existing value, the excess amount of goodwill is transferred to remaining and outgoing partners according to old profit sharing ratio.

Is Goodwill to a retiring partner taxable?

Now here comes a question, whether any amount which is provided to an outgoing or a retiring partner more than the value of his share of interest in form of goodwill is liable to be taxed as capital gains tax under the Income Tax Act, 1961. The same can be understood by analyzing some of the recent judgments provided by the Hon’ble court. Below are few of the recent judgment which helps in finding the answer to this question.

In case of 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 as per Tribuvandas G. Patel vs. CIT [236 ITR 515 (SC)] and CIT vs. H. R. Aslot [115 ITR 255 (Bom) (HC). When a partner retires from a firm, no part of the amount received by any of the partners is assessable to capital gains tax under section 45 of the Act. Therefore, the amount paid to the retiring partner should not be taxable in the hands of the firm nor in the hands of the partner.

Bombay High Court in the latest decision in the case of Prashant S Joshi (supra) has provided the aforementioned legal position. Bearing in mind the entireness of the legal position, it was confirmed by the Bombay High Court that amount which has been received by a partner on their retirement are exempt and cannot be tax as capital gains tax.