Tax Alert | Delivering Clarity

6 July 2021

Guidelines issued for taxability on transfer of capital asset to partner or member on dissolution
or reconstitution
The Central Board of Direct Taxes vide Circular No. 14 of 2021 dated 2 July 2021 has laid down
certain guidelines in relation to the taxability on transfer of capital asset to partner or member
on dissolution or reconstitution of a firm or other association of persons or body of individuals
(not being a company or a co-operative society).

Background:
• Finance Act, 2021 (FA 2021) inserted a new section 9B in the Income-tax Act, 1961 (ITA), which
mandates that whenever a specified person1 receives any capital asset or stock-in-trade or both
from a specified entity2, in connection with the dissolution or reconstitution of such specified
entity3, then it shall be deemed that the specified entity has transferred such capital asset and / or
stock-in-trade, to the specified person.
─ The deemed transfer would be in the previous year in which such capital asset or stock in trade
is received by the specified entity (deemed transfer).
─ The profits and gains (from deemed transfer) would be deemed to be the income of the
specified entity in the year of receipt of such capital asset and / or stock-in-trade by the
specified person [as ‘Profits and gains of business or profession’ or ‘Capital gains’ as applicable].
─ The fair market value of the capital asset and / or stock-in-trade, as on the date of its receipt by
the specified person, shall be deemed to be the full value of the consideration received or
accruing as a result of such deemed transfer.
• Similarly, the FA 2021 substituted section 45(4) of the ITA to provide that where a specified person
receives any money or capital asset or both from a specified entity, during the previous year, in
connection with the reconstitution of such specified entity, then any profits or gains arising from receipt

1The term ‘specified person’ has been defined under section 9B of the ITA to mean a person, who is a partner of a firm or member of other association
of persons or body of individuals (not being a company or a co-operative society) in any previous year.
2 The term ‘specified entity’ has been defined under section 9B of the ITA to mean a firm or other association of persons or body of individuals
(not being a company or a co-operative society)
3 The term ‘reconstitution of the specified entity’ means, where:
a. one or more of its partners or members, as the case may be, of such specified entity ceases to be partners or members; or
b. one or more new partners or members, as the case may be, are admitted in such specified entity in such circumstances that one or more of the
persons who were partners or members, as the case may be, of the specified entity, before the change, continue as partner or partners or
member or members after the change; or
c. all the partners or members, as the case may be, of such specified entity continue with a change in their respective share or in the shares of
some of them.

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 of such receipt by the specified person shall be chargeable to income-tax as income of the specified
entity under the head ‘Capital gains’.
─ The income shall be taxable in the hands of the specified entity in the previous year in which
such money and / or capital asset are received by the specified person.
• The Central Board of Direct Taxes (CBDT) has now issued Circular 14 of 2021 dated 2 July 2021
(Circular) to provide guidelines in relation to sections 9B and 45(4) of the ITA.

Highlights of the Circular / Guidelines:

• As per section 48(iii) of the ITA, the amount taxed under section 45(4) of the ITA is required to be
attributed to the remaining capital assets of the specified entity. Accordingly, when such capital
assets get transferred in the future, the amount attributed to such capital assets would get reduced
from the full value of consideration and to that extent the specified entity would not pay tax again
on the same amount.
─ This attribution is given only for the purposes of section 48 of the ITA.
─ Section 48 of the ITA only applies to capital assets which are not forming a part of block of
assets.
─ For capital assets forming block of assets – (i) section 43(6)(c) of the ITA applies to determine
written down value of the block of asset, and (ii) section 50 of the ITA applies to determine the
capital gains arising on transfer of such assets.
─ However, under the provisions of the ITA, it was not yet provided that the amount taxed under
section 45(4) of the ITA could also be attributed to capital assets forming part of block of assets
and which were covered by the aforesaid two provisions.
• The guidelines now provide that:
─ Rule 8AB of the Income Tax Rules, 1962 (Rules) notified vide Notification no. 76 dated 2 July
20214 (refer Annexure 1) would also apply to capital assets forming part of block of assets.
─ The term capital asset referred in Rule 8AB of the Rules, would refer to capital asset whose
capital gains is computed under section 48 of the ITA as well as capital asset forming part of
block of assets.
─ Reference made for the purposes of section 48 of the ITA, would deem to include reference for
the purposes of sections 43(6)(c) and 50 of the ITA.
─ In case the capital asset remaining with the specified entity forms part of a block of asset, the
amount attributed to such capital asset under Rule 8AB of the Rules would be reduced from
the full value of the consideration received or accruing on subsequent transfer of such asset by
the specified entity. The net value of such consideration shall be considered for reduction from
the written down value of such block under section 43(6)(c) of the ITA or for calculation of
capital gains, as the case may be, under section 50 of the ITA.

4 Notification No. 76/2021/F. No. 370142/22/2021 - TPL

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• Further, the guidelines provide certain examples (refer Annexure 2) for the purposes of
understanding / removing difficulties in relation to the application of section 9B and section 45(4)
of the ITA.

Comments:
These guidelines will provide clarity to the taxpayers while applying the newly inserted provisions under
sections 9B and 45(4) of the ITA. The examples provided in the guidelines also indicate clarity in terms
of computational issues, which may have arisen at the time of applying these provisions by the relevant
taxpayers.

©2021 Deloitte Touche Tohmatsu India LLP

Annexure 1
Extract of Notification no. 76 dated 2 July 2021
1. Short title:-(1) These rules may be called the Income tax Amendment (18th Amendment), Rules, 2021.
2. In the Income-tax Rules, 1962, (hereinafter referred to as the principal rules) in rule 8AA, after sub-
rule (4), the following sub-rule shall be inserted, namely:-
(5). In case of the amount which is chargeable to income-tax as income of specified entity under sub-
section (4) of section 45 under the head “Capital gains”,-
(i) the amount or a part of it shall be deemed to be from transfer of short term capital asset, if it is
attributed to,-
(a) capital asset which is short term capital asset at the time of taxation of amount under
subsection (4) of section 45; or
(b) capital asset forming part of block of asset; or
(c) capital asset being self-generated asset and self-generated goodwill as defined in clause (ii)
of Explanation 1 to sub-section (4) of section 45; and
(ii) the amount or a part of it shall be deemed to be from transfer of long term capital asset or
assets, if it is attributed to capital asset which is not covered by clause (i) and is long term capital
asset at the time of taxation of amount under sub-section (4) of section 45.
3. In the principal rules, after rule 8AA, the following rule shall be inserted, namely:—
“8AB. Attribution of income taxable under sub-section (4) of section 45 to the capital assets remaining
with the specified entity, under section 48.-
(1) For the purposes of clause (iii) of section 48, where the amount is chargeable to income-tax as
income of specified entity under sub-section (4) of section 45, the specified entity shall attribute such
amount to capital asset remaining with the specified entity in a manner provided in this rule.
(2) Where the aggregate of the value of money and the fair market value of the capital asset received
by the specified person from the specified entity, in excess of the balance in his capital account,
chargeable to tax under sub-section (4) of section 45,relates to revaluation of any capital asset or
valuation of self-generated asset or self-generated goodwill, of the specified entity, the amount
attributable to the capital asset remaining with the specified entity for purpose of clause (iii) of section
48 shall be the amount which bears to the amount charged under sub-section (4) of section 45 the
same proportion as the increase in, or recognition of, value of that asset because of revaluation or
valuation bears to the aggregate of increase in, or recognition of, value of all assets because of the
revaluation or valuation.
(3) Where the aggregate of the value of money and the fair market value of the capital asset received
by the specified person from the specified entity, in excess of the balance in his capital account,
charged to tax under sub-section (4) of section 45 does not relate to revaluation of any capital asset or
valuation of selfgenerated asset or self-generated goodwill, of the specified entity, the amount charged
to tax under sub-section (4) of section 45 shall not be attributed to any capital asset for the purposes of
clause (iii) of section 48.

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(4) Notwithstanding anything contained in sub-rules (2) or (3), where the aggregate of the value of
money and the fair market value of the capital asset received by the specified person from the specified
entity, in excess of the balance in his capital account, charged to tax under sub-section (4) of section 45
relate only to the capital asset received by the specified person from the specified entity, the amount
charged to tax under sub-section (4) of section 45 shall not be attributed to any capital asset for the
purposes of clause (iii) of section 48.
(5) The specified entity shall furnish the details of amount attributed to capital asset remaining with the
specified entity in Form No. 5C.
(6) Form No. 5C shall be furnished electronically either under digital signature or through electronic
verification code and shall be verified by the person who is authorised to verify the return of income of
the specified entity under section 140.
(7) Form No. 5C shall be furnished on or before the due date referred to in the Explanation 2 below
subsection (1) of section 139 for the assessment year in which the amount is chargeable to tax under
subsection (4) of section 45.
(8) The Principal Director General of Income-tax (Systems) or the Director General of Income-tax
(Systems), as the case may be, shall –
(i) specify the procedure for filing of Form No. 5C;
(ii) specify the procedure, format, data structure, standards and manner of generation of electronic
verification code, referred to in sub-rule (6), for verification of the person furnishing the said
Form; and
(iii) be responsible for formulating and implementing appropriate security, archival and retrieval policies
in relation to the Form No 5C so furnished.
Explanation 1: For the purposes of this rule, the amount chargeable to tax under sub-section (4) of
section 45 shall relate to revaluation of any capital asset or valuation of self-generated asset or self-
generated goodwill, of the specified entity, if the revaluation is based on a valuation report obtained
from a registered valuer as defined in clause (g) of rule 11U.
Explanation 2: For the removal of doubt it is clarified that revaluation of an asset or valuation of
selfgenerated asset or self-generated goodwill does not entitle the specified entity for the depreciation
on the increase in value of that asset on account of its revaluation or recognition of the value of self-
generated asset or self-generated goodwill due to its valuation.
Explanation 3: For the purposes of this rule, the expressions “self-generated asset” and “self-generated
goodwill” shall have the same meaning as assigned to them in clause (ii) of Explanation 1 to sub-section
(4) of section 45.”

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Annexure 2
Examples provided in the Circular for the purposes of understanding / removing difficulties in relation
to the application of section 9B and section 45(4) of the ITA
Example 1:
There are three partners "A", 'B" and "C" in a firm "FR", having one third share each. Each partner has a
capital balance of INR 1 million in the firm. There are three pieces of lands "S", "T" and "U" in that firm
and there is no other capital asset in that firm. Book value of each of the land is INR 1 million. All these
three lands were acquired by the firm more than two years ago. Partner "A" wishes to exit. The firm
revalues its lands based on valuation report from a registered valuer, as defined in Rule 11U of the
Rules and as per that valuation report fair market value of lands "S" and "T" is INR 7 million each, while
fair market value of land "U" is INR 5 million. On the exit of partner "A", the firm decides to give him INR
1.1 million of money and land "U" to settle his capital balance.
In accordance with the provisions of section 9B of the ITA, it would be deemed that the firm "FR" has
transferred land "U" to the partner "A" at its fair market value of INR 5 million. Let us assume that the
indexed cost of acquisition of land "U" is INR 1.5 million.
Now on account of the deeming provisions of section 9B of the ITA, it is deemed that the firm "FR" has
transferred land "U" to partner " A". Thus, an amount of INR 5 million less INR 1.5 million would be
charged to tax in the hands of firm "FR" under the head "Capital gains". For partner "A", the cost of
acquisition of this land would be INR 5 million. Hence, the amount of INR 3.5 million is charged to long
term capital gains and let us assume that the tax is INR 0.7 million (assume no surcharge or cess just for
ease of calculation and illustration purposes).
This, net book profit after tax of INR 3.3 million (capital gains of INR 4 million without indexation less tax
of INR 0.7 million) is to be credited in the capital account of each of the three partners, i.e. INR 1.1
million each. Thus partner "A" capital account would increase to INR 2.1 million. This exercise is
required to be carried out since section 9B of the ITA mandates that it is to be deemed that the firm
"FR" has transferred the land "U" to partner "A" and the long term capital gains of INR 3.5 million is
chargeable to tax in the hands of the firm "FR".
As against capital balance of INR 2.1 million, partner "A" has received INR 6.1 million (INR 1.1 million of
money plus land "U" of fair market value of INR 5 million). Thus, INR 4 million is required to be charged
to tax under section 45(4) of the ITA. This shall be in addition to an amount of INR 3.5 million charged to
tax under section 9B of the ITA.
On account of clause (iii) of section 48 of the ITA, read with rule 8AB of the Rules, this INR 4 million is to
be attributed to the remaining assets of the firm "FR" on the basis of increase in their value due to
revaluation based on the valuation report of registered valuer. In this case as per revaluation there are
only two capital assets remaining: lands "S" and "T". In both cases the value has increased by INR 6
million each. Thus, out of INR 4 million, INR 2 million shall be attributed to land "S" and INR 2 million to
land "T".
When either of these lands gets sold, this amount attributed to them would be reduced from sales
consideration under clause (iii) of section 48 of the ITA.

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The amount of INR 4 million which is charged to tax under section 45(4) of the ITA shall be charged as
long term capital gains in view of sub-rule (5) of rule 8AA of the Rules, since the amount of INR 4 million
is attributed to land "S" and land "T" which are both long term capital assets at the time of taxation of
INR 4 million under section 45(4) of the ITA.

Example 2:
There are three partners "A", "B" and "C" in a firm " FR", having one third share each. Each partner has a
capital balance of INR 1 million in the firm. There are three pieces of lands "S", "T" and "U" in that firm
and there is no other capital asset in that firm. All these three lands were acquired by the firm more
than two years ago.
Book value of each of the land is INR 1 million. Partner "A" wishes to exit. The firm sells land "U" for its
fair market value of INR 5 million. Let us assume that the indexed cost of acquisition of land "U" is INR
1.5 million. Thus, an amount of INR 5 million less INR 1.5 million would be charged to tax in the hands of
firm "FR" under the head "Capital gains". Hence, the amount of INR 3.5 million is charged to long term
capital gains and let us assume that the tax is INR 0.7 million (assume no surcharge or cess just for ease
of calculation and illustration purposes).
This, net book profit after tax of INR 3.3 million (capital gains of INR 4 million without indexation less tax
of INR 0.7 million) is to be credited in the capital account of each of the three partners, i.e. INR 1.1
million each. Thus partner "A" capital account would increase to INR 2.1 million.
Partner "A" decides to exit the firm "FR". The firm revalue its lands "S" and "T" based on valuation
report from a registered valuer, as defined in rule 11U of the Rules, and as per that valuation report fair
market value of lands "S" and "T" is INR 7 million each. On the exit of partner "A", the firm decides to
give him INR 6.1 million of money to settle his capital balance. Thus, as against capital balance of INR
2.1 million, partner "A" has received INR 6.1 million of money. Thus, INR 4 Million is required to be
charged to tax under section 45(4) of the ITA. This will be in addition to INR 3.5 million already charged
to capital gains.
On account of clause (iii) of section 48 of the ITA, read with rule 8AB of the Rules, this INR 4 million is to
be attributed to the remaining assets of the firm "FR" on the basis of increase in their value due to
revaluation based on the valuation report of registered valuer. In this case as per revaluation there are
only two capital assets remaining: lands "S" and "T". In both cases the value has increased by INR 6
million each. Thus, out of INR 4 million, INR 2 million shall be attributed to land "S" and INR 2 million to
land ''T''. When either of these lands gets sold, this amount attributed to them would be reduced from
sales consideration under clause (iii) of section 48 of the ITA.
The amount of INR 4 million which is charged to tax under section 45(4) of the ITA shall be charged as
long term capital gains in view of sub-rule (5) of rule 8AA of the Rules, since the amount of INR 4 million
is attributed to land "S" and land "T" which are both long term capital assets at the time of taxation of
INR 4 million under section 45(4) of the ITA.
Note: The final result in both example 1 and 2 is same due to the operation of section 9B of the ITA.

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Example 3:
There are three partners "A", "B" and "C" in a firm "FR", having one third share each. Each partner has a
capital balance of INR 10 million in the firm. There is a piece of land "S" of book value of INR 3 million.
There is patent "T" of written down value of INR 4.5 million and there is cash of INR 22.5 million. The
land was acquired by the firm more than two years ago. The patent was acquired/developed/
registered one year back.
Partner "A" wishes to exit. The firm revalue its land and patent based on valuation report from a
registered valuer, as defined in rule 11U of the Rules, and as per that valuation report fair market value
of land "S" is INR 4.5 million and fair market value of patent "T" is INR 6 million. As per the valuation
report there is also
self-generated goodwill of INR 3 million. On the exit of partner "A", the firm decides to give him INR 7.5
million in money and land "S" to settle his capital balance.
In accordance with the provisions of section 9B of the ITA, it would be deemed that the firm "FR" has
transferred land "S" to the partner "A" at its fair market value of INR 4.5 million. Let us assume that the
indexed cost of acquisition of land "S" is INr 4.5 million. However, since the sale consideration is equal
to indexed cost of acquisition, there will not be any capital gains tax. For partner "A", the cost of
acquisition of this land would be INR 4.5 million.
The net book profit of INR 1.5 million (capital gains of INR 1.5 million without indexation) is to be
credited in the capital account of each of the three partners, i.e. INR 0.5 million each. Thus, partner "A"
capital account would increase to INR 10.5 million. This exercise is required to be carried out since
section 9B of the ITA mandates that it is to be deemed that the firm "FR" has transferred the land "S" to
partner "A". Thus, any gain in the books is to be apportioned to partners' capital accounts.
As against capital balance of INR 10.5 million, partner "A" has received INR 12 million (money of INR 7.5
million plus land "S" of fair market value of INR 4.5 million). Thus, INR 1.5 million is required to be
charged to tax under section 45(4) of the ITA.

On account of clause (iii) of section 48 of the ITA, read with rule 8AB of the Rules and this guidance
note, this INR 1.5 million is to be attributed to the remaining capital assets of the firm "FR" on the basis
of increase in the value due to revaluation of existing capital assets, or due to recognition of the value
of self-generated goodwill, based on the valuation report of registered valuer. In this case as per this
report the value of patent 'T " has increased by INR 1.5 million and the self-generated goodwill value
has been recognised at INR 3 million. Thus, one third of INR 1.5 million (i.e. INR 0.5 million) would be
attributed to patent "T", while two third of INR 1.5 million (i.e. INR 1 million) would be attributed to self-
generated goodwill. INR 0.5 million attributed to patent "T" shall not be added to the block of the assets
and no depreciation shall be available on the same. When patent "T" gets transferred subsequently, this
INR 0.5 million attributed shall be reduced from the full value of the consideration received or accruing
as a result of transfer of patent "T" by the firm "FR", and the net value shall be considered for reduction
from the written down value of the intangible block under sub-clause (c) of section 43(6) of the ITA or

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for calculation of capital gains, as the case may be, under section 50 of the ITA 5. Let us say that Patent T
is sold for INR 2.5 million. INR 0.5 million shall be reduced from INR 2.5 million and only net amount of
INR 2 million shall be considered for reduction from the written down value of the intangible block
under sub-clause (c) of clause (6) of section 43 of the ITA or for calculation of capital gains, as the case
may be, under section 50 of the ITA . Similarly, when goodwill gets sold subsequently, INR 1 million
would be reduced from its sales consideration under clause (iii) of section 48 of the ITA.
The amount INR 1.5 million which is charged to tax under section 45(4) of the ITA shall be charged as
short-term capital gains, as INR 0.5 million is attributed to the Patent "T" which is part of block of assets
and INR 1 million is attributed to self-generated goodwill. In accordance with sub-rule (5) of Rule 8AA of
the Rules, both of these are to be characterised as short-term capital gains.
Note: For the purpose of calculation of depreciation under section 32 of the ITA, the written down
value of the block of asset " intangible" of which Patent "T" is part, would remain INR 4.5 million and
would not be increased to INR 6 million due to revaluation during the year. In this regard it may be
highlighted that the following provisions are relevant in determining the amount on which depreciation
is allowable under the ITA:
─ Explanation 2 of sub-section (1) of section 32 of the ITA provides that the term "written down value
of the block of assets" shall have the same meaning as in clause (c) of sub-section (6) of section 43
of the ITA.
─ Clause (c) of sub-section (6) of section 43 of the ITA, with respect to block of assets, interalia,
provides that the aggregate of the written down values of all the assets falling within that block of
assets at the beginning of the previous year is to be increased by the actual cost of any asset falling
within that block, acquired during the previous year. This clause does not allow any increase on
account of revaluation.
─ Sub-section (1) of section 43 of the ITA which defines "Actual cost" as actual cost of the assets to
the assessee. In revaluation, there is no actual cost to the assessee.
Further, section 32 of the ITA does not allow depreciation on goodwill. If in the given example "self-
generated goodwill" is replaced by "self-generated asset", even then the depreciation will not be
admissible on the amount of INR 3 million recognised in valuation. In this regard it may be highlighted
that the above-mentioned provisions, in the immediate preceding paragraph, are also applicable to
"self-generated asset" and since there is no actual cost to assessee in case of "self-generated asset",
depreciation is not allowable under section 32 of the ITA on an asset whose actual cost is nil.

5For the removal of doubt it is further clarified that in case the capital asset remaining with the specified entity is forming part of a block of asset, the
amount attributed to such capital asset under rule 8AB of the Rules shall be reduced from the full value of the consideration received or accruing as a
result of subsequent transfer of such asset by the specified entity, and the net value of such consideration shall be considered for reduction from the
written down value of such block under sub-clause (c) of clause (6) of section 43 of the ITA or for calculation of capital gains, as the case may be,under
section 50 of the ITA.

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