• Captial gains tax deduction for partnership firm

My father and I own a Partnership Firm which bought a commercial property back in 1984. We want to sell it now and buy a residential property with the money. My questions are:

1) Are we (partners as individuals) eligible for Long Term Capital Gains tax deduction? If yes, how would the cash flow work?
2) If not, can we convert the partnership firm into propretorship firm and would the propreitor then be eligible for LTCG tax deduc?
3) If not, can we dissolve the firm and become inidividual joint owners of the commercial property, would we be eligible then?
4) For none of the above, how de we save tax?
Asked 10 days ago in Taxation

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7 Answers

1. Individually yes

2. No need

3.No need.

4. you have tax liability in partnership as individual partners

Prashant Nayak
Advocate, Mumbai
23361 Answers
49 Consultations

4.4 on 5.0

If the property belonged to the partnership firm then the partners cannot decide to alienate the property without passing any resolution authorising the sale of the property to the prospective buyer. The sale consideration amount has to be settled to the firm and not to the partners' names.

Income tax act: Section 45. (4) The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.

Prior to introduction of s. 45(3) / s. 45(4), the settled legal position was that, a partnership firm is not a distinct legal entity and the partnership property in law belongs to all the partners constituting the firm, though the partnership firm may possess a personality distinct from the persons constituting it and, therefore, on dissolution, as the firm has no separate rights of its own in the partnership assets, the consequence of distribution, division or allotment of assets of the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of s. 2(47) of the Act.

Thus, Sec. 45(4) seems to have been introduced with a view to overcome the judgment of the apex Court in Malabar Fisheries Co. vs. CIT (1979) 120 ITR 49 (SC) and other judgments which took a view that the firm on its own has no right but it is the partners who own jointly or in common the asset and thereby remedy the mischief occasioned.

Sub-section 4 of section 45 imposes tax, w.e.f. 01.04.1988, on the firm when its capital assets are distributed on dissolution or otherwise; and for this purpose, the FMV of the assets on the date of such distribution is deemed to be full value of consideration accruing to or received by it.

By enacting s. 45(4), parliament has provided that firm shall pay capital gain tax as if there is a transfer (by legal fiction), even though there would be none under the general law of partnership.

On dissolution/reconstitution of partnership firm, only firm is taxable on capital gain on assets distributed to Partners.

In CIT v. Vijaylaxmi Metal Industries [2002] 256 ITR 540 (Mad), The High Court found that Section 45(4) would have application only where there is distribution and not where business of the firm continued apparently by the surviving partners with legal heirs.

when there is a dissolution of a partnership or a partner retires and obtains in lieu of his interest in the firm, an asset of the firm, no transfer is involved .

Two partners – one died – other continuing business as a going concern / takeover of business by one of the partners on dissolution of firm as proprietory concern:

Section 45(4) deems transfer of assets distributed to a partner on dissolution or otherwise. There should not only be dissolution, but also distribution to attract the provision. Where one of the two partners of the firm dies, there is dissolution of the firm. But where the surviving the partner carries on the business with all the assets and liabilities as a going concern, there is no distribution within the meaning of the guidelines  given by the Supreme Court in Sakthi Trading Co. v. CIT [2001] 250 ITR 871 (SC). Therefore there is no liability for the Capital gains tax [CIT v. Moped and Machines [2006] 281 ITR 52 (MP)]

 

T Kalaiselvan
Advocate, Vellore
72168 Answers
1078 Consultations

5.0 on 5.0

The firm is not recognised as a legal entity under the Indian Partnership Act, 1932.

 


─ For the purposes of the ITA, the identity of the firm as well as that of the partners for taxability of income is separate and distinct. The firm is a separate taxable entity liable to pay tax on its income because of its own distinct set of income earning activities and factors.

 

Accordingly, if there was a transfer of capital asset effected by a firm i.e. property held by the firm, the capital gains tax arises in the hands of the firm and not in the hands of the partners and vice versa.

Ajay Sethi
Advocate, Mumbai
82096 Answers
5156 Consultations

5.0 on 5.0

Dear Sir,

 Please consult chartered accountant.

Kishan Dutt Kalaskar
Advocate, Bangalore
5787 Answers
283 Consultations

4.8 on 5.0

1. the partnership firm can sell the asset and the sale consideration can be paid to the partners

2. the partners can then invest the capital gains either for purchase of a residential house or in the specified government bonds

3. section 54 and 54ec of income tax act nowhere states that the new asset or bonds have to be purchased in the name of the assessee firm only 

4. the capital gains can be invested by the partners also in their own names

5. if section 54 exemption is available in case of an investment of capital gains made by the husband in the name of his wife, then on same analogy the benefit should also be available if the capital gains are invested by the partners and not in the name of the firm

6. the main requirement is that the capital gains have to be invested either for purchase of a new residential house or in the specified bonds 

7. the provision nowhere states that it has to be purchased in the name of the assessee only

8. the partners can also first dissolve the firm and the property of the firm will then go to the partners as per their respective shares. This would not amount to a conveyance in my view since by dissolving the firm, the partner's share only becomes defined which before dissolution was an unspecified share 

9. the partners can then sell the asset and the transfer by them will not be treated as short term capital gains because there was no transfer by the firm to the individual partners 

10. the aforesaid is my prima facie view and needs further legal research

Yusuf Rampurawala
Advocate, Mumbai
6157 Answers
50 Consultations

5.0 on 5.0

Dear sir,

The firm is not recognized as a legal entity under the Indian Partnership Act, 1932. For the purposes of the ITA, the identity of the firm, as well as that of the partners for taxability of income, is separate and distinct. The firm is a separate taxable entity liable to pay tax on its income because of its own distinct set of income-earning activities and factors. Accordingly, if there was a transfer of capital asset effected by a firm i.e. property held by the firm, the capital gains tax arises in the hands of the firm and not in the hands of the partners and vice versa.

Remember: the partnership firm can sell the asset and the sale consideration can be paid to the partners. the partners can then invest the capital gains either for the purchase of a residential house or in the specified government bonds. section 54 and 54ec of the income tax act nowhere states that the new asset or bonds have to be purchased in the name of the assessee firm only. the capital gains can be invested by the partners also in their own names. if section 54 exemption is available in case of an investment of capital gains made by the husband in the name of his wife, then on the same analogy the benefit should also be available if the capital gains are invested by the partners and not in the name of the firm. the main requirement is that the capital gains have to be invested either for the purchase of a new residential house or in the specified bonds. the provision nowhere states that it has to be purchased in the name of the assessee only. the partners can also first dissolve the firm and the property of the firm will then go to the partners as per their respective shares. This would not amount to a conveyance in my view since by dissolving the firm, the partner's share only becomes defined which before dissolution was an unspecified share. the partners can then sell the asset and the transfer by them will not be treated as short-term capital gains because there was no transfer by the firm to the individual partners. the aforesaid is my prima facie view and needs further legal research.

ALSO:

If the property belonged to the partnership firm then the partners cannot decide to alienate the property without passing any resolution authorizing the sale of the property to the prospective buyer. The sale consideration amount has to be settled to the firm and not to the partners' names.

Income tax act: Section 45. (4) The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.

Prior to the introduction of s. 45(3) / s. 45(4), the settled legal position was that a partnership firm is not a distinct legal entity and the partnership property in law belongs to all the partners constituting the firm, though the partnership firm may possess a personality distinct from the persons constituting it and, therefore, on dissolution, as the firm has no separate rights of its own in the partnership assets, the consequence of distribution, division or allotment of assets of the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of s. 2(47) of the Act.

 

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Anik Miu
Advocate, Bangalore
1125 Answers
10 Consultations

5.0 on 5.0

- Under the Income Tax Act , property is regarded as a capital asset and any gains arising from its sale is taxable as Capital Gains.

- Further, if the property is held for less than three years prior to its sale, it is termed as a short-term capital asset and any gain arising from the sale is treated as a short-term capital gain.

- Further, if the property is sold after a holding period of more than three years, it is to be treated as a long-term capital asset and a gain arising from its sale is assessed as long-term capital gains

- Further as per Section 54EC of the IT Act, any capital gains arising from the transfer of a long-term capital property/asset would be exempt if the gains are invested within a period of six months in specified investments, and these investments are three-year bonds of National Highway Authority of India (NHAI) or Rural Electrification Corporation

- Further, as per Section 54EC of the IT Act, any capital gains arising from the transfer of a long-term capital asset/ property, would be exempt if the gains are invested within a period of six months in specified investments, and these investments are three-year bonds of National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC). However, there is a restriction in this investment: the amount invested cannot exceed Rs 50 lakh in any financial year.

- Further , the Capital gains arising from the sale of any asset by the partnership firm are taxable under section 112, if it is short-term capital gain tax rate as per normal tax slab, if it is long-term capital gain tax rate is 20%.

- Hence, the better option is No. 3

Mohammed Shahzad
Advocate, Delhi
6719 Answers
71 Consultations

5.0 on 5.0

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