As is renowned in income-tax forums, there is a lot of disagreement regarding the interpretation of section 45(4) of the Income-Tax Act, 1961. As per section 45(4), capital gains tax is charged on a firm for transferring a capital asset and in the distribution of the capital assets, during the dissolution of the firm or otherwise. The retirement of the partners is understood to be covered under the term “otherwise”, as per section 45(4). Lately, a view was sought whether the capital gains liability would arise in the hands of a firm at the time of Transfer of Assets of partnership firm among the Partners. In other words, a view was required was the firm would be held liable for paying capital gains tax on the retirement of 2 of its partners.
Partnership Firm not a separate entity but just a name provided to group of partners- As per the judgment provided the Apex Court, in the case of N. Khadervali Saheb Vs N. Gudu Sahib (Dec) [2003] 261 ITR 1 (SC), it was held that the firm is not a separate entity. It is just a name provided to the partnership for the ease and real owners of the firm’s assets are the partners. Hence, during the dissolution of the firm, the accounts are settled with the partners and assets of the firm are dispersed among the partners in line with their respective shares in the firm. Therefore, during the dissolution of the firm, the distribution of assets to the partners cannot be considered as a transfer of assets of the firm.
Assets received on Retirement of Partner not subject to Capital Gains Tax- There are several judgments of the Apex Court and the High Courts, as per which where a partner retires from the firm and gets a sum for his share in the partnership, it has been ruled that it does not amount to transfer of interest in the assets and the amount received by the partner is not chargeable to capital gains tax.
To support the aforesaid stand, reliance has been placed on the below mentioned legal precedents:
In the case of CIT Vs R.L. Raghukumar [2001] 247 ITR 801 (SC): 166 CTR 398 (SC), the Andhra Pradesh High Court ruled that no transfer of assets was observed, as intended by the word “transfer‟ as per the definition provided in the under section 2(47) of the Income Tax Act, 1961.
The Hon’ble Court placed the reliance on the ruling of the Gujarat High Court with respect to the case of CIT Vs Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj) where it was held that when the partner retires from the partnership firm and receives an amount for his share in the firm’s assets after settling of his liabilities and previous charges as determined while taking into accounts the manner agreed in the partnership law, no part of the transfer of the interest in the firm’s assets by retiring partner to continuing partners and the said sum received by retiring partner won’t be chargeable to capital gains tax under section 45 of the said Act.
Also Read- Process of Dissolution of Partnership
