Section 45(4)

Section 45(4) — the law in short

What the courts have decided on section 45(4), in one screen. Read this first; open an entry when you need the facts, the reasoning and the source.

• CIT v Mansukh Dyeing and Printing Mills Supreme CourtHelps departmentSuperseded by amendment
  The firm revalued its land and credited the surplus to the partners' capital accounts. Is that taxable?
  Under the old s.45(4), yes. The Supreme Court held that crediting a revaluation surplus to partners' capital accounts on a reconstitution is in effect a distribution of the assets to the partners and a transfer chargeable to capital gains, because the enhanced balances were immediately available for withdrawal — and two partners did withdraw.
• 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.
• Chalasani Venkateswara Rao v ITO High CourtHelps taxpayerNo later treatment found
  A partner took money in full settlement of his share when the firm was dissolved. Is he personally liable to capital gains?
  No. The Andhra Pradesh High Court held that a partner who receives the money value of his share on dissolution is not making a transfer; he is having his account made up. The Court also held that when Parliament inserted s.45(4) with effect from 1 April 1988 it deliberately placed the charge on the firm and not on the partner. On that second point the position is unchanged after the Finance Act 2021: both s.9B and the substituted s.45(4) charge the specified entity, not the partner.
• CIT v A.N. Naik Associates High CourtHelps department
  Our family split the firms by a settlement and gave assets to the partners who retired. There was no dissolution, so section 45(4) cannot apply, can it?
  It can. The Bombay High Court held that otherwise in section 45(4) is not to be read ejusdem generis with dissolution. It goes with the words transfer of capital assets by way of distribution of capital assets, so where a subsisting firm hands assets to a retiring partner the firm's right in the property is extinguished and there is a transfer chargeable under section 45(4), with the fair market value on the date of transfer deemed to be the full value of consideration. The Court accepted that there was no dissolution and that the family settlement was genuine and not a device, but allowed the Revenue's appeals and restored the assessments.
• CIT v Texspin Engg & Mfg Works High CourtHelps taxpayer
  My partnership firm became a limited company under Part IX of the Companies Act. The Assessing Officer wants capital gains tax on the market value of the assets. Is that right?
  No, on the law as it stood for assessment year 1996-97. The Bombay High Court held that section 45(4) needs a transfer by way of distribution of capital assets, and statutory vesting on a Part IX conversion is not distribution: vesting takes the properties across as they stand, while distribution presupposes division, realisation and appropriation. Section 45(1) also failed, both because a firm treated as a company is a case of transmission with no counterparty and no incoming consideration, and because even if there were a transfer, full value of consideration in section 48 means what the transferor gets, not the market value of what he parts with.
• 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.
• DCIT v Sathyabama Ramachandran — money taken for giving up profit share, and why the 2021 scheme did not reach it ITATHelps taxpayerNo later treatment found
  A partner was paid a large sum when a new partner came in and her profit share fell. The officer has taxed it as goodwill. Is it taxable, and does section 9B or the new section 45(4) apply?
  Not on these facts, and not for a year before AY 2021-22. The Tribunal held that where a new partner is admitted and the existing partners simply realign their profit-sharing ratios, the assets remain with the firm, no partner has any defined share in those assets during the subsistence of the partnership, and there is therefore no relinquishment and no transfer within s.2(47) — so nothing is chargeable under s.45 in the partner's hands, and the receipt is not 'goodwill'. It then recorded expressly that s.9B and the substituted s.45(4) came into force on 1 April 2021 and had no application to the year before it, which was AY 2017-18.
• Gokulakrishna v DCIT (ITAT Chennai) ITATHelps taxpayerNo later treatment found
  A new partner came into an LLP, my profit share fell and an amount was credited to my current account. Am I taxable on it?
  On this order, for a pre-2021 year, no. The Chennai Tribunal held that where an existing partner does not retire but simply sees his profit-sharing ratio reduced on the admission of a new partner, there is no transfer under s.2(47), because during the subsistence of the firm a partner has no defined share in its assets and nothing is relinquished. The Tribunal also held that the revaluation of the LLP's assets, credited to partners' accounts before the new partner came in, did not by itself give rise to capital gains. It recorded expressly that s.9B and the substituted s.45(4) are prospective and had no application to assessment year 2017-18.
• ITO v Bhushan Dharamdas Karia (ITAT Mumbai) — the excess a retiring partner receives is taxed in the firm's hands, not his ITATHelps taxpayerSuperseded by amendment
  I retired from a firm and received a lump sum well above the balance in my capital account. The AO has assessed it as long-term capital gain in my hands and applied section 50C. Is that correct for a pre-2021 year?
  No. The Tribunal held that the amount received by a retiring partner on the reconstitution of a firm is taxable in the hands of the partnership firm and not in the hands of the partner. The partner was never the owner of the firm's assets; on a reconstitution there is simply a revaluation of assets and liabilities so that the retiring partner's capital account can be settled. The revenue's appeal was dismissed and the deletion of the addition in the partner's hands was upheld.
• CBDT Circular 14/2021 CBDT Circulars & InstructionsCuts both waysNo later treatment found
  A partner retired and took assets out of the firm. How do s.9B and s.45(4) work together?
  Separately, and both can apply to the same reconstitution. Section 9B is applied first, to the deemed transfer of the assets received by the partner at fair market value; s.45(4) is then applied to the money or asset received in excess of the partner's capital account balance, computed without any revaluation increase. There is no set-off between the two.
• Statutory position — Rule 8AA(5): whether the section 45(4) charge on the firm is short-term or long-term CBDT Circulars & InstructionsCuts both ways
  The firm has been charged under section 45(4) on a payout to a partner on reconstitution. Is that gain short-term or long-term, and how do I work out the split?
  You look through the charge to the assets the amount has been attributed to. Rule 8AA(5) deems the amount, or a part of it, to be from the transfer of a short-term capital asset where it is attributed to an asset that is short-term at the time of the section 45(4) taxation, to an asset forming part of a block of assets, or to a self-generated asset or self-generated goodwill; and to be from the transfer of a long-term capital asset where it is attributed to any other asset that is long-term at that time. One section 45(4) charge can therefore split into a short-term part and a long-term part.
• Statutory position — Rule 8AB and section 48(iii): how the section 45(4) amount is set off when the firm later sells the asset CBDT Circulars & InstructionsCuts both ways
  My firm paid capital gains tax under the substituted section 45(4) on the money we paid a partner on reconstitution. When the firm later sells the land that was revalued, can it deduct that already-taxed amount from the sale consideration?
  Only if the section 45(4) charge arose out of a revaluation of a capital asset or the valuation of a self-generated asset or self-generated goodwill, and only through Rule 8AB. Section 48(iii) allows the firm to deduct so much of the section 45(4) amount as is attributable to the capital asset being transferred, 'calculated in the prescribed manner', and the prescribed manner is Rule 8AB: the amount is spread over the assets in the same proportion as the increase in the value of each asset on revaluation bears to the total increase, and the attribution must be reported in Form 5C by the section 139(1) due date.
• Statutory position — section 9B: the firm is deemed to transfer, at fair market value, whatever a partner takes out CBDT Circulars & InstructionsCuts both ways
  My firm handed a flat and part of its stock to a retiring partner. Nothing was sold and no money changed hands. Is the FIRM taxable on that?
  Yes. Section 9B, inserted by the Finance Act 2021 with effect from 1 April 2021 (AY 2021-22), deems the firm to have transferred the capital asset or stock in trade to the partner in the year he receives it, and deems the fair market value on the date of receipt to be the full value of consideration. The charge falls on the FIRM, not the partner, and it arises on both dissolution and mere reconstitution — a partner retiring or a new partner coming in is enough.
• 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.