Three partners retired and took cash for their share. The firm carried on. Is the firm liable to capital gains under s.45(4)?
On the pre-2021 provision, no. A Full Bench of the Karnataka High Court held that s.45(4) needs an actual distribution of a capital asset by the firm to a partner, so that the firm's interest in that asset is extinguished and the partner acquires it. Where the retiring partners took only money representing the value of their share and the property stayed with the firm, nothing was distributed and nothing was transferred. The Court held that the earlier Division Bench decision in CIT v. Gurunath Talkies did not lay down the correct law. This is authority for assessment years up to 2020-21 only: the Finance Act 2021 rewrote s.45(4) so that money received by a partner on reconstitution is itself the charging event on the firm.
Decided by the High Court (N. Kumar J, S. Abdul Nazeer J and V. Suri Appa Rao J (Full Bench)) on 2013-09-16, reported as I.T.A. No. 1414 of 2006 (High Court of Karnataka at Bangalore). The Indian Kanoon copy carries the equivalent citation 2014 (1) AKR 244. Later Tribunal decisions cite the judgment as CIT v. Dynamic Enterprises [2013] 359 ITR 83 (Kar) (Full Bench); that ITR citation was not verified against a copy of the report itself.. It bears on section 45(4), section 45(3), section 2(47), section 48 of the Income Tax Act 1961, in Capital Gains and How Tax Law Is Read matters.
This is the leading pre-2021 authority for the proposition that cash to a retiring partner is not a s.45(4) event, and it is still the governing law for any assessment year up to 2020-21 that is alive on appeal, in reassessment or in a s.263 proceeding. It is also the clearest statement of what the old s.45(4) actually required, which is what makes the 2021 rewrite intelligible: Parliament added money to the charge precisely because decisions like this one held money was outside it.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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The firm was constituted on 9 January 1985 and was reconstituted more than once. It purchased property in Sy. No. 13/1 in its own name under a registered sale deed in 1987 for Rs. 2,50,000. Before the reconstitution, the assets of the firm were revalued as per the report of a registered valuer on 28.03.1993 (para 4). On 28 April 1993 five partners of the Khemka group were taken in by a deed of that date, bringing in cash by way of capital. Nearly a year later, on 1 April 1994, three of the erstwhile partners retired under a deed of retirement, taking cash representing the value of their share in the partnership (para 25); paragraph 4 records that the old partners received the enhanced value of the property in financial year 1994-95. The firm was not dissolved; the business continued with the remaining five partners. For assessment year 1995-96 the assessment was reopened by a notice under s.148 issued on 27.03.2002 (para 5), and the Assessing Officer treated the transaction as a transfer of the property from the old firm to the new firm and brought capital gains to tax in the hands of the firm under s.45(4). A Division Bench of the High Court, finding a conflict between CIT v. Mangalore Ganesh Beedi Works (2004) 265 ITR 658 and CIT v. Gurunath Talkies (2010) 328 ITR 59, referred the question to a Full Bench.
The question was answered in favour of the assessee and against the Revenue and the Revenue's appeal was dismissed with no order as to costs (para 33). Where a retiring partner takes only money towards the value of his share and there is no distribution of capital assets among the partners, there is no transfer of a capital asset and no profits or gains are chargeable on the firm under s.45(4) (para 31). The Division Bench decision in Gurunath Talkies does not lay down the correct law (para 29).
The Court set out four conditions precedent for the old s.45(4): there must be a distribution of capital assets of a firm; that distribution must result in a transfer of a capital asset by the firm in favour of the partner; the transfer must give rise to a profit or gain to the firm; and the distribution must be on dissolution of the firm or otherwise (para 23). Putting it another way, the firm's interest in the capital asset must be extinguished and the partner must acquire that interest; only then does the charge arise (para 24). On the facts, the property had been bought by the firm in its own name, no partner had brought it in as capital contribution, the five incoming partners had brought in cash, and the three outgoing partners took cash. There was no dissolution and no distribution of any capital asset on 1 April 1994, so no profit or gain arose in the hands of the firm (para 25). The Court rejected the Revenue's device argument on the footing that the property belonged to the firm and not to the partners; the partners had only a share in the partnership, and what the retiring partners relinquished was that share, not any interest in the immovable property (para 26). The Bombay High Court's decision in A.N. Naik Associates was explained as a case where the assets of the firm were in fact transferred to retiring partners so that the firm's right in the property stood extinguished, which is what attracted s.45(4) there (paras 27 and 28). Gurunath Talkies had applied Naik without appreciating that distinguishing feature (para 29). The Court expressly declined to decide the other aspects of s.45(4) argued before it, because the absence of any distribution disposed of the reference (para 30), and it did not answer the separate question whether the retiring partner would be liable, that question not arising on the appeal (para 32).
When the retiring partners took cash and retired, they were not relinquishing their interest in the immovable property. What they relinquished is their share in the partnership. Therefore, there is no transfer of a capital asset, as such, no capital gains or profit arises in the facts of this case.
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Handle my notice → Ask a CA on WhatsAppOn the pre-2021 provision, no. A Full Bench of the Karnataka High Court held that s.45(4) needs an actual distribution of a capital asset by the firm to a partner, so that the firm's interest in that asset is extinguished and the partner acquires it. Where the retiring partners took only money representing the value of their share and the property stayed with the firm, nothing was distributed and nothing was transferred. The Court held that the earlier Division Bench decision in CIT v. Gurunath Talkies did not lay down the correct law. This is authority for assessment years up to 2020-21 only: the Finance Act 2021 rewrote s.45(4) so that money received by a partner on reconstitution is itself the charging event on the firm. This was decided by the High Court (N. Kumar J, S. Abdul Nazeer J and V. Suri Appa Rao J (Full Bench)) and bears on section 45(4), section 45(3), section 2(47), section 48 of the Income Tax Act 1961. It is reported as I.T.A. No. 1414 of 2006 (High Court of Karnataka at Bangalore). The Indian Kanoon copy carries the equivalent citation 2014 (1) AKR 244. Later Tribunal decisions cite the judgment as CIT v. Dynamic Enterprises [2013] 359 ITR 83 (Kar) (Full Bench); that ITR citation was not verified against a copy of the report itself.. This is the leading pre-2021 authority for the proposition that cash to a retiring partner is not a s.45(4) event, and it is still the governing law for any assessment year up to 2020-21 that is alive on appeal, in reassessment or in a s.263 proceeding. It is also the clearest statement of what the old s.45(4) actually required, which is what makes the 2021 rewrite intelligible: Parliament added money to the charge precisely because decisions like this one held money was outside it. If it applies to you, the first step is this: Fix the assessment year first. If it is 2020-21 or earlier, this case governs the firm's position on a cash retirement. If it is 2021-22 or later, it does not, and you must work through s.9B and the new s.45(4) instead.
The firm was constituted on 9 January 1985 and was reconstituted more than once. It purchased property in Sy. No. 13/1 in its own name under a registered sale deed in 1987 for Rs. 2,50,000. Before the reconstitution, the assets of the firm were revalued as per the report of a registered valuer on 28.03.1993 (para 4). On 28 April 1993 five partners of the Khemka group were taken in by a deed of that date, bringing in cash by way of capital. Nearly a year later, on 1 April 1994, three of the erstwhile partners retired under a deed of retirement, taking cash representing the value of their share in the partnership (para 25); paragraph 4 records that the old partners received the enhanced value of the property in financial year 1994-95. The firm was not dissolved; the business continued with the remaining five partners. For assessment year 1995-96 the assessment was reopened by a notice under s.148 issued on 27.03.2002 (para 5), and the Assessing Officer treated the transaction as a transfer of the property from the old firm to the new firm and brought capital gains to tax in the hands of the firm under s.45(4). A Division Bench of the High Court, finding a conflict between CIT v. Mangalore Ganesh Beedi Works (2004) 265 ITR 658 and CIT v. Gurunath Talkies (2010) 328 ITR 59, referred the question to a Full Bench. The matter was decided on 2013-09-16 by the High Court (N. Kumar J, S. Abdul Nazeer J and V. Suri Appa Rao J (Full Bench)). On those facts the High Court held as follows. The question was answered in favour of the assessee and against the Revenue and the Revenue's appeal was dismissed with no order as to costs (para 33). Where a retiring partner takes only money towards the value of his share and there is no distribution of capital assets among the partners, there is no transfer of a capital asset and no profits or gains are chargeable on the firm under s.45(4) (para 31). The Division Bench decision in Gurunath Talkies does not lay down the correct law (para 29).
The Court set out four conditions precedent for the old s.45(4): there must be a distribution of capital assets of a firm; that distribution must result in a transfer of a capital asset by the firm in favour of the partner; the transfer must give rise to a profit or gain to the firm; and the distribution must be on dissolution of the firm or otherwise (para 23). Putting it another way, the firm's interest in the capital asset must be extinguished and the partner must acquire that interest; only then does the charge arise (para 24). On the facts, the property had been bought by the firm in its own name, no partner had brought it in as capital contribution, the five incoming partners had brought in cash, and the three outgoing partners took cash. There was no dissolution and no distribution of any capital asset on 1 April 1994, so no profit or gain arose in the hands of the firm (para 25). The Court rejected the Revenue's device argument on the footing that the property belonged to the firm and not to the partners; the partners had only a share in the partnership, and what the retiring partners relinquished was that share, not any interest in the immovable property (para 26). The Bombay High Court's decision in A.N. Naik Associates was explained as a case where the assets of the firm were in fact transferred to retiring partners so that the firm's right in the property stood extinguished, which is what attracted s.45(4) there (paras 27 and 28). Gurunath Talkies had applied Naik without appreciating that distinguishing feature (para 29). The Court expressly declined to decide the other aspects of s.45(4) argued before it, because the absence of any distribution disposed of the reference (para 30), and it did not answer the separate question whether the retiring partner would be liable, that question not arising on the appeal (para 32). In the words reproduced by the source cited on this page: "When the retiring partners took cash and retired, they were not relinquishing their interest in the immovable property. What they relinquished is their share in the partnership. Therefore, there is no transfer of a capital asset, as such, no capital gains or profit arises in the facts of this case." The decision followed or applied CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bombay) — explained and distinguished on the facts; CIT v. Gurunath Talkies (2010) 328 ITR 59 (Kar) — held not to lay down the correct law; CIT v. Mangalore Ganesh Beedi Works (2004) 265 ITR 658 — the decision with which the conflict was said to arise (para 1).
It was decided by the High Court on 2013-09-16 and is reported as I.T.A. No. 1414 of 2006 (High Court of Karnataka at Bangalore). The Indian Kanoon copy carries the equivalent citation 2014 (1) AKR 244. Later Tribunal decisions cite the judgment as CIT v. Dynamic Enterprises [2013] 359 ITR 83 (Kar) (Full Bench); that ITR citation was not verified against a copy of the report itself.. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 45(4), section 45(3), section 2(47), section 48, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The question was answered in favour of the assessee and against the Revenue and the Revenue's appeal was dismissed with no order as to costs (para 33). Where a retiring partner takes only money towards the value of his share and there is no distribution of capital assets among the partners, there is no transfer of a capital asset and no profits or gains are chargeable on the firm under s.45(4) (para 31). The Division Bench decision in Gurunath Talkies does not lay down the correct law (para 29). It arises in Capital Gains and How Tax Law Is Read matters, on section 45(4), section 45(3), section 2(47), section 48 of the Income Tax Act 1961, and was decided by N. Kumar J, S. Abdul Nazeer J and V. Suri Appa Rao J (Full Bench). Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. For an old year, show from the retirement deed and the books that what left the firm was money, and that the capital asset stayed on the firm's balance sheet and in the firm's name. Check whether any capital asset was in fact made over to a retiring partner, even in part. The Full Bench expressly accepted that where an asset is transferred to a retiring partner the Bombay High Court's approach in A.N. Naik Associates applies and s.45(4) is attracted. Do not present this case as one in which there was no revaluation. Paragraph 4 records that the assets of the firm were revalued as per the report of a registered valuer on 28.03.1993, a month before the Khemka group partners were inducted on 28.04.1993, and that the old partners received the enhanced value of the property in financial year 1994-95. The Full Bench decided the reference on the absence of any distribution of a capital asset and did not address the revaluation as a separate charging event, which is the question the Supreme Court answered against the assessee in Mansukh Dyeing. The two decisions are in tension on that point rather than distinguishable on their facts, so a cash retirement preceded by a revaluation should not be argued on Dynamic Enterprises alone. If the Assessing Officer argues that the arrangement was a device by which incoming partners bought the property, meet it with paragraph 26: the property belonged to the firm and the retiring partners relinquished only their share in the partnership.
Superseded by amendment. Still the governing High Court authority for assessment years up to and including 2020-21. From assessment year 2021-22 the Finance Act 2021 substituted s.45(4), which charges the specified entity where a specified person receives money or a capital asset or both from the entity in connection with its reconstitution, and inserted s.9B, which deems the entity to have transferred a capital asset or stock in trade received by a specified person on dissolution or reconstitution. Receipt of money by a retiring partner, which this judgment held to be outside the old charge, is inside the new one to the extent it exceeds the balance in his capital account. Separately, the Supreme Court in CIT v. Mansukh Dyeing and Printing Mills (2022) 449 ITR 439 applied the old s.45(4) where firm assets were revalued and the revaluation was credited to partners' capital accounts on reconstitution. That decision does not in terms deal with Dynamic Enterprises, and the two sets of facts are closer than they first appear: paragraph 4 of this judgment records a revaluation of the firm's assets by a registered valuer on 28.03.1993 and that the old partners received the enhanced value of the property in financial year 1994-95. The Full Bench decided the reference on the absence of any distribution of a capital asset and was not asked to treat the revaluation as a separate charging event, so on the revaluation question the two decisions are in tension rather than distinguishable, and a cash-retirement case with a preceding revaluation should not be argued on Dynamic Enterprises alone. No Supreme Court proceeding against this judgment was located. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
Read verbatim on Indian Kanoon: paragraphs 1, 2 and 22 to 33 (the reference, the question referred, the Court's construction of s.45(3) and s.45(4), the application to the facts, the treatment of Gurunath Talkies and A.N. Naik Associates, and the final order). Paragraphs 4 and 5 were afterwards checked verbatim for the revaluation of 28.03.1993, the receipt of the enhanced value in financial year 1994-95 and the s.148 notice of 27.03.2002, all of which are stated in the facts on the authority of those two paragraphs. The remaining paragraphs, 3 and 6 to 21, were read only in summarised form and the entry does not rely on them. The answer recorded in paragraph 31 is printed in the source with a question mark at the end of what is plainly a declaratory sentence; that is how it appears in the report. No Supreme Court proceeding against this judgment was located. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The question was answered in favour of the assessee and against the Revenue and the Revenue's appeal was dismissed with no order as to costs (para 33). Where a retiring partner takes only money towards the value of his share and there is no distribution of capital assets among the partners, there is no transfer of a capital asset and no profits or gains are chargeable on the firm under s.45(4) (para 31). The Division Bench decision in Gurunath Talkies does not lay down the correct law (para 29).
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