What the courts have decided on section 45(3), in one screen. Read this first; open an entry when you need the facts, the reasoning and the source.
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CIT v Dynamic Enterprises (Karnataka Full Bench)
High CourtHelps taxpayerSuperseded by amendment
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.
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ACIT v Manikandan (ITAT Chennai) — money credited to a continuing partner for his 'sacrificing ratio' is not his capital gain, for years before AY 2021-22
ITATHelps taxpayerSuperseded by amendment
A new partner came into our LLP and paid in a large sum, part of which was credited to the existing partners' accounts in their sacrificing ratio. The AO has taxed my share of it as short-term capital gain for an old year. Is that right?
Not for a year before assessment year 2021-22. The Tribunal held that where the existing partners do not retire and merely their profit-sharing ratios are realigned on the admission of a new partner, there is no relinquishment of any share in the firm's assets, no transfer within section 2(47), and therefore no capital gain in the continuing partner's hands. It added that the amendments made by the Finance Act 2021 — the substitution of section 45(4) and the insertion of section 9B — take effect only from assessment year 2021-22 and had no application to the year before it, which was AY 2017-18.
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Amartara Pvt Ltd v DCIT (ITAT Mumbai)
ITATHelps taxpayerNo later treatment found
I put land into an LLP as capital. The stamp value is higher than the value the firm recorded. Can the Assessing Officer apply s.50C?
On this order, no. Section 45(3) itself supplies the deemed full value of consideration for a capital contribution, namely the amount recorded in the books of the firm. The Mumbai Tribunal held that one deeming fiction cannot be extended by importing another, so s.50C cannot be used to replace the book figure with the stamp duty value. The addition made by substituting a stamp value of Rs. 9,41,78,500 for the recorded Rs. 5.60 crores was deleted.
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Statutory position — the substituted section 45(4): the firm is taxed on what a partner takes out above his capital account
CBDT Circulars & InstructionsCuts both ways
A partner retired and we paid him Rs 2 crore, most of it out of a revaluation of the firm's land. He says it is his own capital. Is the FIRM taxable?
Yes, on the excess. The substituted s.45(4) charges the FIRM to capital gains on money or a capital asset (or both) received by a partner in connection with a reconstitution, to the extent it exceeds the balance in his capital account — and that balance must be computed WITHOUT the increase caused by revaluation of any asset or by self-generated goodwill or any other self-generated asset. The formula is A = B + C − D, and if A is negative it is deemed to be zero, so a loss cannot be thrown up. Substituted by the Finance Act 2021 with effect from 1 April 2021, i.e. AY 2021-22.
Listed strongest first: Supreme Court, then High Court, then Tribunal, then CBDT. Nothing here has yet been read in full by a chartered accountant — open an entry to see where it came from.
