Capital Gain Tax on a Specified Entity at “Dissolution or Reconstitution” under Section 9B and 45(4) of Income Tax Act

Capital Gain Tax on a Specified Entity at “Dissolution or Reconstitution” under Section 9B and 45(4) of Income Tax Act

Provision under Section 9B of Income Tax Act:

Where a specified person receives any “capital asset or stock in trade or both” from a specified entity during the previous year in connection with the “dissolution or reconstitution” of such specified entity then the specified entity shall be deemed to have transferred such capital asset or stock in trade or both, as the case may be to the specified person in the year in which such capital asset or stock in trade or both are received by the specified person.

Explanation:

In this Section 9B (1) it’s says that deemed transfer at a time of:

  • At a time of Dissolution or Reconstitution
  • Transfer of capital assets or stock in trade or both and,
  • The tax to be payable by the specified entity not in the hand of the specified person.

In case of transfer of Capital assets:

Capital Gain Tax to be charged in the hand of the specified entity under the provision of Sec. 45(1).

For this sale consideration is the fair market value (FMV) of the capital assets at the time of transfer (-) minus Cost of Acquisition/ indexed Cost of Acquisition  

In case of transfer of Stock in Trade:

For this sale consideration is the fair market value (FMV) of the capital assets at the time of transfer (-) minus Cost of Acquisition

Provision under Section 45(4) of Income Tax Act:

Notwithstanding anything contained in sub-section (1) of section 45 of Income Tax Act, where a specified person receives any money or capital asset or both from a specified entity in connection with the “reconstitution” of such specified entity during the previous year, then any profits or gains arising from such receipt by the specified person shall be chargeable to income-tax as income of such specified entity under the head “Capital gains and shall be deemed to be the income of such specified entity of the previous year in which such money or capital asset or both were received by the specified person.

 Such profits or gains shall be determined as per this formula :-“A=B+C-D”

Where,

A = income chargeable under the head “Capital gains” in the hand of the entity,

B = value of any money received by the specified person from the specified entity (on the date of receipt),

C= the amount of fair market value of the capital asset received by the specified person from the specified entity (on the date of receipt),

D = the amount of balance in the capital account of the specified person in the books of account of the specified entity (at the time of its reconstitution)

if the value of ‘A’ in the above formula is negative then its deemed to be zero.

Explanation:

In this Section 45(4) it’s says that:

  • At a time of Reconstitution only
  • Transfer of capital assets or money or both and,
  • The tax to be payable by the specified entity not in the hand of the specified person.

Let’s understand with the help of an Example:

Mr. “A “who is retired from a partnership firm (consider as Reconstitution of partnership firm) get:

Capital Assets of Rs. –     6 Crores      Cost of Acquisition of Rs –             4 Crores

Stock in Trade od Rs.-     1.5 Crores   Cost of Stock of Rs.-                        1 Crore

Cash of Rs.                         2 Crores     Capital in books Rs.                         5 Crore

Then Partnership firm is liable to pay tax on an amount calculated as under-

Capital Gain u/s 45(1) = 6-4=2 Crores

Business profession u/s 28 = 1.5-1=.50 crore

Capital Gain u/s 45(4) = 2+6-5= 3 crores

Definitions:

1) “Reconstitution of the specified entity” means where:

(a) One or more of its partners or members, as the case may be of such specified entity ceases to be partners or members,

(b) One or more new partners or members, as the case may be, are admitted in such specified entity in such circumstances that one or more of the persons who were partners or members, as the case may be, of the specified entity before the change, continue as partner or partners or member of members after the change or

(c) All the partners or members, as the case may be of such specified entity continue with a change in their respective share or in the shares of some of them.

(ii) “Specified entity” means a firm or other association of persons or body of individuals (not being a company or a co-operative society)

(iii) “Specified person” means a person who is a partner of a firm or member of other association of persons or body of individuals (not being a company or a co-operative society) in any previous year.

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