In accordance with Section 9B and Subsection (4) of Section 45 of the Income-tax Act of 1961, the Central Board of Direct Taxes (CBDT) established instructions for taxing partnership firms on their reconstitution.
After the Finance Act of 2021 added a new section 9B to the Income Tax Act and replaced another provision - 4 of section 45 - the recommendations aim to provide clarity on the techniques to be used when calculating tax liabilities.
Section 9B taxed the firm's income on the transfer of capital assets and stock in trade, whereas Section 45(4) now taxes income in the hands of the firm, which is actually the income in the hands of the partner.
The CBDT observed that the amount taxed under section 45(4) of the Act must be attributed to the specified entity's remaining capital assets, so that when such capital is transferred in the future, the amount attributed to such capital assets is subtracted from the value of the consideration, and the specified entity does not have to pay tax on the amount again.
It should also be noted that this attribution is only made in the Act for the purposes of section 48 of the Act.
The adjustments will take effect in the evaluation year 2021-22. These parts cover the deemed transfer of a capital asset or stock in trade to a firm's leaving partner and the receipt of a capital asset or funds by a firm's partner. Any profits and gains flowing from such a presumed transfer are considered as partnership income under the Finance Act.
In a circular, the CBDT stated that the instructions were issued under provisions intended to make implementation easier. The recommendations explain how to attribute an entity's income on its reconstitution and provide examples of scenarios where a partner leaves a firm and the organisation settles the capital balance.
The Act does not, however, state that the amount charged under section 45(4) of the Act can also be ascribed to capital assets that are part of a block of assets and are covered by these two sections.