As discussion in article titled ‘Dissolution / Reconstitution of Partnership Firm / LLP / AOP / BOI’ and article titled ‘Attribution of Profits upon dissolution / reconstitution of LLP / Partnership Firm’, it becomes imperative to understand the provisions related to tax implication on reconstitution and dissolution of a Specified Entity. So, lets understand the provisions based on the case study as under:
Case Study:
M/s ABC and sons is a registered partnership firm engaged in the business of manufacture and trading of gold ornaments. Further, M/s ABC and sons also owns 3 retail shops. The balance sheet of M/s ABC and sons is as under:
Liabilities | Book Value Amount (INR in Lakhs) | Fair Value Amount (INR in Lakhs) | Assets | Book Value Amount (INR in Lakhs) | Fair Value Amount (INR in Lakhs) |
Partner’s Capital | |||||
Mr. A | 10 | 44 | Retail Shops | ||
Mr. B | 15 | 66 | RS 1 | 10 | 40 |
Mr. C | 25 | 110 | RS 2 | 10 | 60 |
RS 3 | 10 | 80 | |||
Inventories | 18 | 38 | |||
Cash and cash equivalent | 2 | 2 | |||
Total | 50 | 220 | Total | 50 | 220 |
Mr. A wants to retire from the firm as he has attained retirement age. Upon retirement, Mr. A would be given RS 2 and Inventory worth 20% of total inventory and cash and cash equivalent worth INR 10. Accordingly, distribution to Mr. A would be made as under:
Particulars | Book Value Amount (INR in Lakhs) | Fair Value Amount (INR in Lakhs) | Appreciation (INR in Lakhs) |
RS 2 | 10 | 60 | 50 |
Inventories | 3.6 | 7.6 | 4 |
Cash and Cash equivalent | 10 | 10 | – |
Total | 23.6 | 77.6 | 54 |
Accordingly, as per section 9B of the ITA, it would be considered as M/s ABC and sons has deemed to have transferred distribution as above. Thus, calculation of capital gains u/s 9B of the ITA and u/s 45(4) of the ITA would be as under:
Particulars | Section 9B of the ITA | Section 45(4) of the ITA | ||||||||||||
Distribution of assets | ||||||||||||||
Immovable Property (RS 2) | 60 | 60 | ||||||||||||
Less: Indexed cost of acquisition (assumed) | 20 | |||||||||||||
Long term Capital Gains u/s 9B of the ITA in the hands of M/s ABC and sons | 40 | |||||||||||||
Tax (LTCG) @ 20% | 8 | |||||||||||||
Inventory | 7.6 | 7.6 | ||||||||||||
Less: Cost of acquisition | 3.6 | |||||||||||||
Short term Capital Gains u/s 9B of the ITA in the hands of M/s ABC and Sons | 4 | |||||||||||||
Tax (STCG) @ 30% | 1.2 | |||||||||||||
Cash and Cash Equivalent | 2 | |||||||||||||
Total distribution | 69.6 | |||||||||||||
Less: Adjusted Capital balance of Mr. A
| 18.96 | |||||||||||||
Capital Gains u/s 45(4) of the ITA in the hands of M/s ABC and Sons | 50.64 |
In the above case, cost of acquisition of RS 2 in the hands of Mr. A shall be INR 60. As against the adjusted capital balance of INR 18.96 lakhs, Mr. A is in receipt of Assets worth INR 69.6 Lakhs, thus, INR 50.64 Lakhs is required to be charged to tax u/s 45(4) of the ITA.
Further, u/s 48(iii) of the ITA, INR 50.64 Lakhs is required to be attributed to the remaining assets of M/s ABC and sons, at the time of subsequent sale for the purposes of claiming deduction as under:
Particulars | Amount (INR in Lakhs) |
Remaining Inventory | 6.98 |
Property at RS 1 | 13.10 |
Property at RS 3 | 30.56 |
Total | 50.64 |
As it is seen from the above, the tax event for the distribution of assets as above arises u/s 9B of the ITA as well as u/s 45(4) of the ITA. Total taxable amount for the reconstitution as above is INR 94.64 Lakhs whereas Mr. A has only received assets worth fair value of INR 69.6 Lakhs. Even though the deduction for tax u/s 45(4) would be available u/s 48(iii) of the ITA at the subsequent sale of such assets, it is an additional liability on the Specified Entity on the date of distribution. Such tax liability causes additional undue tax liability on the Specified Entity. Considering factors like inflation vis a vis value of money, distribution of capital asset / stock-in-trade could turn out to be tax inefficient structure for a Specified Entity, also it may tantamount to be as commercially non-viable option.
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