Question & Answer

Ganesh Purohit, Sr. Advocate

QUESTION No.1

The assessee is a partnership firm constituted by four partners having mainly stock in trade. The firm is reconstituted two partners of the firm have retired. The retiring partners are given stock in trade as their share the questions are as under:

1. The stock in trade given to the outgoing partner will be subject to capital gain or business profit, and it will be taxable in whose hands that is the hands of firm or the outgoing partner?
2. The second question is , will it be capital gains or business profit, and income tax that has been paid, weather will be added to the cost of remaining assets available in the ballot sheet of the firm. Although large amount of stock entry will still be available with the continuing firm?
3. Will the situation will change if the stock in trade is only available and there is no capital asset what will happen in that scenario?

Answer

The transaction in question will be governed by section 9B of the income tax act. Section 9B provides that in case of retirement of partners, if the specified entity gives to the specified person, either capital asset or stock in trade, same will have to be valued at the market price, and shall be taxable in the hands of specified entity and not specified person that is partner.

Subsection three of section 9B reads as under:

“(3) for the purpose of this section, fare market value of the capital asset or stock in trade or both 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 of the capital asset or stock in trade or both by the specified entity.”

In view of the above provision, the transfer of stock in trade has to be made on market value and it will be subject to income tax in the hands of specified entity that is firm and not in the hands of the specified person that is partner. The question then arises that what will be the market value of the stock that is being transferred, in my opinion, the cost price of the stock transferred should be the market value of the stock. It is for the reason that if somebody wants to acquire the stock from the market then cost in his hands will be the market value. The profit or loss arising from such transaction shall be assessable in the hands of specified entity. In case of capital asset since section 50 C shall be applicable. That in case of land and building the guideline value of the property will have to be adopted as market value of the assets transferred; in case of other assets that is machinery or other items those are subject to depreciation shall be chargeable as short-term capital gain.

(ii) section 2(43) defines tax and provides that in relation to assessment year, the income chargeable to tax under the provisions of the income tax act, shall be the tax on income for that assessment year.

In view of this provision, the tax paid on transfer of stock cannot form the capital accretion the capital asset or stock in trade and therefore cannot be added to the cost or value of the remaining assets.

 (iii) In response to 3rd question, it may be pointed out that it will not make any difference that if there is only stock in trade in the hands of the specified entity and there is no capital asset. The stock transferred to the specified person shall be subject to tax as business income in the hands of specified entity.

(iv) In case of transfer of capital asset to the outgoing partner, it will be subject to tax under section 45(4) of the income tax act, this section provides the mechanism for subjecting to tax the capital gains arising on transfer of capital asset to the specified person. The income that will be charged as capital gain shall be calculated by adding the cash payment with the market value of assets as reduced by the capital of the outgoing partner, the resultant profit or loss shall be subject to capital gain depending upon the period of holding as long-term or short-term capital gain.

Question No.2

In case of a charitable society running educational institution, if all the members of the society, retire and new members are introduced the executive body is also replaced by the new members. However, this being a commercial deal, the incoming members desire to pay the outgoing members say by way of gift through account payee cheques. In such a situation can incoming members pay to the outgoing members directly. The outgoing members are in the tax bracket of 30% plus surcharge, then what will be the implication of such transaction, and whether society will lose its character of being a charitable organization?

Answer

The change in guard of the institution should not normally make any difference, unless the objects and functioning of the institution is changed for the purpose of income tax. If there is no change in the objects and functioning of the institution, the society shall not lose its character of being a charitable organization.

The making of gift by cheque is a transaction inter-sea between the parties Will be subject to income tax in the hands of recipient as per normal rate of tax applicable to the recipient. However, such transaction will put the individuals on the radar of income tax department which may result into deeper scrutiny in their assessment or other preventive actions provided in the income tax act for protection of revenue.