Computation of income on dissolution of Firm, AOP or BOI

Introduction

Where any partner or member receives capital asset or stock-in-trade in connection with dissolution of firm (or AOP/BOI), it shall be deemed as transfer by such firm. Profit and gains arising from such deemed transfer shall be taxable as income of such firm in the tax year in which such stock-in-trade or capital asset is received by such partner (or member).

1. About

In the event of dissolution of the firm (including AOP or BOI), the firm may distribute capital asset or other assets to the partners (or members). Such distribution of asset to the partner may give rise to the capital gains (if capital assets are distributed) and the business income (if stock-in-trade is distributed). The computation of income from such distribution shall be made as per this provision of Section 8.

1.1. Applicability of Section 8

Section 8 deals with the taxability of the income arising to the specified entity on transfer of any capital asset or stock-in-trade to a specified person in connection with dissolution or reconstitution of a specified entity.

"Specified entity" means a partnership firm or Association of Persons (AOP) or Body of Individuals (BOI) [not being a company or a co-operative society] (hereinafter collectively referred as 'Firm').

"Specified person" means a person who is a partner of a firm or member of AOP or BOI (not being a company or a co-operative society) in any tax year (hereinafter collectively referred as 'Partner').

1.2. When does taxability arise on dissolution of firm?

The taxability of a firm under Section 8 arises only if a partner receives any capital asset or stock-in-trade or both from a firm in connection with the dissolution of such firm. In such a situation, the firm shall be deemed to have transferred such capital asset or stock-in-trade or both, as the case may be, to the partner in the year in which such capital asset or stock in trade or both are received by that partner.

1.3. How to compute the income taxable under Section 8?

Any profits and gains arising from transfer of capital asset or stock in trade or both, as the case may be, by the firm on its dissolution shall be deemed to be the income of the firm of the tax year in which stock or capital asset were received by the partner. It shall be chargeable to income-tax under the head 'Profit and Gains from Business or Profession' or 'Capital Gain' in accordance with the provisions of the Act.

1.3-1. In case of stock-in-trade

Profit and Gains arising from transfer of stock-in-trade shall be charged to tax under the head "Profit and Gains from Business or Profession". For computing such profit and gains, fair market value of such stock on the date of its receipt by the partner shall be deemed to be the full value of consideration.

1.3-2. In case of capital asset

Profit and gains arising from transfer of capital asset shall be charged to tax under the head "Capital Gain". For computing such profit and gains, fair market value of such capital asset on the date of its receipt by the partner shall be deemed to be the full value of consideration.

The computation of capital gain under this provision shall be as follows:

It is important to note that the firm cannot apply indexation when computing the capital gain.

Note: While computing capital gains arising from transfer of capital asset, profit and gains chargeable to tax under Section 67(10), which is attributable to capital asset being transferred by the firm shall also be allowed as deduction under Section 72(5), if the following conditions are satisfied:

(a) Before dissolution of the firm, there was a reconstitution of the 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 fair market value. It also includes the valuation of a self-generated asset.

The rate at which such capital gain shall be charged to tax will be depend on the nature of capital asset transferred and period for which such asset is held by the firm.

1.4. Issue of guidelines

The CBDT is empowered to issue guidelines, with prior approval of the Central Government, for removing difficulties arising in giving effect to the provisions of this section. Every such guidelines shall be laid before each house of parliament. The Parliament has the authority to review, amend, or even annul the guidelines issued by the board, but whatever has already been done in accordance with the guidelines shall remain valid and lawful.

(See also Computation of income on reconstitution of Firm, AOP or BOI and Assessment on dissolution or discontinuance of AOP or firm)

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