Capital gains on contribution of capital asset by partner to firm

Introduction

When a partner (or member) introduces a capital asset in the partnership firm (or AOP or BOI) as his capital contribution or otherwise, it is deemed that the partner has transferred such capital asset to the firm. The amount recorded in the books of accounts of the firm in respect of such capital asset is deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.

1. Scope of provision [Section 67(9)]

This provision applies when any person transfers a capital asset either as capital contribution or otherwise to a firm in which he is or becomes a partner. This provision also applies when a member transfers a capital asset to an Association of Persons (AOP) or Body of Individuals (BOI). However, this provision does not apply if a partner or member transfers a movable asset which he has used for his personal purposes as same is not treated as a capital asset or when a capital asset is transferred by a person to a company or a co-operative society.

2. How to calculate capital gains?

The capital gains shall be computed in the following manner:

3. Factors for calculation of capital gains

Any profits or gains arising on contribution of capital assets by a partner (or member) to the firm (or AOP or BOI) shall be chargeable to tax under the head capital gains in the tax year in which such transfer takes place. For computation of capital gains in such case, the following factors are considered:

(a) Period of holding;

(b) Full value of consideration;

(c) Cost of acquisition;

(d) Cost of improvement;

(e) Expenditure incurred in connection with transfer;

(f) Adjustment for the capital gains taxed under Section 67(10);

(g) Exemptions allowed under Section 82 to 88.

It should be noted that the indexation was traditionally allowed under the Income-tax Act when calculating long-term capital gain unless specifically restricted. However, the Finance (No. 2) Act, 2024 removed the indexation benefit and introduced a uniform tax rate of 12.5% on long-term capital gains under ITA 1961 to simplify the computation of capital gains.

However, to ease the transition, the Government introduced a grandfathering provision which provides a specific relief to resident individuals and resident HUFs in respect of land or building (or both) acquired before 23-07-2024. In such cases, the taxpayer has the option to compute tax either:

(a) at 12.5% without indexation benefit; or

(b) at 20% after claiming indexation benefit.

This simplified framework has also been continued under ITA 2025. Thus, no indexation benefit shall be available in respect of contribution of capital assets by a partner (or member) to the firm (or AOP or BOI) except where the grandfathering provision applies.

3.1. Computation of period of holding

The period of holding of the asset contributed to the firm (or AOP or BOI) shall be counted from the date of purchase or acquisition till the date such capital asset is transferred to the firm.

3.2. Computation of full value of consideration

For the purposes of computing capital gain, the amount recorded in the books of accounts of the firm in respect of such capital asset is deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.

Example, Mr. A joins a firm of two partners B and C by transferring securities worth Rs. 10 lakhs but in the books of the firm, it is recorded at Rs. 8 lakhs, Rs. 8 lakhs shall be taken as full value of consideration.

3.3. Computation of cost of acquisition

The cost of acquisition of the capital asset transferred to the firm shall be computed as per general provisions.

3.4. Computation of cost of improvement

The cost of improvement of the capital asset transferred to the firm shall be computed as per general provisions.

3.5. Indexed cost of acquisition or improvement

The indexation benefit is no longer available for computing long-term capital gains on capital assets. However, the Government has introduced a grandfathering provision. This provision allows resident individuals and resident HUFs to apply indexation on land or building acquired before 23-07-2024, but only if the tax calculated without indexation results in a higher amount.

Thus, where the grandfathering provision applies, the "Indexed Cost of Acquisition" and the "Indexed Cost of Improvement" are used to compute the capital gain instead of the original cost of acquisition and improvement.

3.6. Adjustment for the capital gain taxable under Section 67(10)

Where the amount is chargeable to tax as income of partnership firm under Section 67(10), the firm shall attribute such amount to the capital asset remaining with it, including capital assets forming part of block of asset. Such attribution is allowed, at the time of computation of capital gains from the transfer of such capital asset remaining with the partnership firm, by way of deduction under Section 72(5). The deduction under Section 72(5) is allowed if the following conditions are satisfied:

(a) There should be a reconstitution of the partnership firm;

(b) Capital asset or money or both should be given to the partner on such reconstitution;

(c) Capital gain is computed and taxed in the hands of the firm under Section 67(10); and

(d) The book value (or historical value or WDV) of at least one of the capital assets remaining with the firm after such reconstitution should be less than its fair market value. It may also include the self-generated asset.

The amount chargeable to tax under Section 67(10) shall relate to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill of firm if Rule 56.

3.7. Computation of exemptions

Certain exemptions can be claimed under Sections 82 to 88 from the capital gains arising from transfer of capital asset to the firm subject to fulfilment of certain conditions.

3.8. Year in which taxable

When any capital asset, short-term or long-term or depreciable, is transferred by any person either as capital contribution or otherwise to a firm, the profit or gain arising on such transfer is taxable in the tax year in which transfer took place. The liability to pay tax on the capital gain shall be on the partner or member, as the case may be, who contributes assets to the firm.

(Also see Computation of income on dissolution of Firm, AOP or BOI and Computation of income on reconstitution of Firm, AOP or BOI)

References

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.