Opinion Of Eminent Legal Luminaries On Controversial Issues

Whether Distribution Of Assets By A Firm Would Be Liable To Tax?

QUERY: M/s. GE is a registered partnership firm in the business of property development. It holds certain residential flats / office premises, which are not yet sold and which are held as stock-in-trade. Out of such properties, it intends to distribute certain premises among the partners at book value, by journal entries. It wants to know –

(i) What are the implications under the Income- tax Act, 1961 and under Stamp Duty / Registration Act?

(ii) Will it make any difference if the distribution takes place upon dissolution? How accounts are to be settled?

(iii) What will be the character of the property received in the hands of the partners?

As regards the balance stock remaining with the firm, it desires to know what are the implications under Income-tax Act, 1961 and Wealth Tax Act, 1957?
ANSWER: (i) Section 45(4) of the Income-tax Act, 1961 would not be applicable, as M/s. GE is holding properties as stock-in-trade.

Now, as per the query M/s. GE want to distribute the stock-in-trade to its partners. In other words, the partners would withdraw the stock from business. In Sir Kikabhai Premchand v. CIT [24 ITR 506], the Supreme Court has held that withdrawal of stock from business would be at cost and no profit or loss arises from such withdrawal.

However, from April 1, 2014, section 43CA has been introduced under the Act, which provides that consideration received or accruing as a result of the transfer by an assessee of an asset (other than a capital asset), being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government for the purpose of payment of stamp duty in respect of such transfer, then such stamp duty value is taken as full value of consideration for the purpose of computing income under the head “Profits and gains of business or profession”. In this case there is no consideration, hence this section may not be applicable. However, the same would be chargeable in the hands of partners, being individuals, under section 56(2)(vii) of the Act at stamp duty value.

Under the Income-tax Act, a firm and partners are separate and distinct entities. So, when stock is withdrawn by the partners, it would be considered as transfer. As per the Transfer of Property Act, the transfer would be an act of the parties or of the law, by which the title to the property is conveyed from one person to another. So, when stock is withdrawn by the partners; title to the properties would be conveyed from a firm to the partners. Hence, stamp duty would be payable.

(ii) Yes, if properties being stock-in-trade, distributed to partners on dissolution, would be taxable in the hands of the firm at market value as per A.L.A. Firm v. CIT [189 ITR 285 (SC)].

(iii) The character of the properties in the hands of partners would depend upon antecedent and dominant purpose of the partners.

(iv) The balance stock after distribution in the hands of firm would be valued at cost or market value whichever is lower. Profit or loss for the purpose of taxation would be determined on that basis. Further, wealth tax is not applicable to the firm.
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Credit: Several of the queries and answers are reproduced with permission from the AIFTP Journal. We thank AIFTP for generously allowing us to host their research material.
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