Guidelines under section 9B and sub-section (4) of section 45 of the Income Tax Act, 1961

Introduction:
The Government has inserted a new section 9B of the Act and substituted sub-section (4) of section 45 of the Income Tax Act, 1961 by the Finance Act, 2021. The CBDT has come out with  Notification No. 76/2021 dated 2nd July, 2021 to insert sub-rule (5) to Rule 8AA and a new Rule-8AB so as to precribe the manner of calculating the income chargeable to tax under section 45(4) of the Act as "capital gains" and also the manner in which such income shall be attributed to remaining assets with the specified entity under clause (iii) of section 48 of the Act. Further, the CBDT issued Circular No. 14/2021 dated 2nd July, 2021 to provide guidelines for application of section 9B and section 45(4) read with the aforesaid rules. In this article, we have summarised the circular for better understanding of the readers as below:

• Finance Act, 2021 inserted a new section 9B in the Income Tax Act, 1961 (hereinafter referred to as “the Act”). This section mandates that whenever a specified person receives any capital asset or stock in trade or both from a specified entity, during the previous year, in connection with the dissolution or reconstitution of such specified entity, then it shall be deemed that the specified entity has transferred such capital asset or stock in trade or both, as the case may be, to the specified person (hereinafter referred to as “deemed transfer”).
• This deemed transfer would be in the year in which such capital asset or stock in trade or both are received by the specified person.
• Any profits and gains arising from such deemed transfer is deemed to be the income of such specified entity of the previous year in which such capital asset or stock in trade or both were received by the specified person.
• Further, it is chargeable to income-tax as income of such specified entity under the heads “Profits and gains of business or profession” or under the head “Capital gains”, in accordance with the provisions of this Act.
• It has also been provided that the fair 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 receiving or accruing as a result of such deemed transfer.
• The definition of terms “reconstitution of the specified entity”, “specified entity” and “specified person” are provided in section 9B of the Act.
• Similarly, the Finance Act, 2021 substituted sub-section (4) of section 45 of the Act. This newly substituted sub-section (4) now provides that where a specified person receives any money or capital asset or both from a specified entity, during the previous year, in connection with the reconstitution of such specified entity, then any profits or gains arising from receipt of such receipt by the specified person shall be chargeable to income-tax as income of the specified entity under the head “Capital gains”.
• It has been further deemed that this income shall be the income of the specified entity of the previous year in which such money or capital asset or both were received by the specified person.
• A formula to calculate such profits and gains has also been provided in this sub-section. The terms “self-generated goodwill” and “self-generated asset” have been defined in this sub-section.
• It has been further clarified that when a capital asset is received by a specified person from a specified entity in connection with the reconstitution of such specified entity, the provisions of sub-section (4) of section 45 of the Act shall operate in addition to the provisions of section 9B of the Act and the taxation under the said provisions thereof shall be worked out independently.
• Both section 9B and substituted sub-section (4) of section 45 are applicable for the assessment year 2021-22 and subsequent assessment years.
• Sub-section (4) of section 9B of the Act provides that if any difficulty arises in giving effect to the provisions of this section and sub-section (4) of section 45 of the Act, the Board, may, with the approval of the Central Government, issue guidelines for the purposes of removing the difficulties.
• For these purposes, the CBDT hereby issues the following guidelines with the approval of the Central Government.

Guidelines

• It is noticed that the amount taxed under section 45(4) of the Act is required to be attributed to the remaining capital assets of the specified entity, so that when such capital assets get transferred in the future, the amount attributed to such capital assets get reduced from the full value of the consideration and to that extent the specified entity does not pay tax again on the same amount.
• It is further noticed that this attribution is given in the Act only for the purposes of section 48 of the Act. It may be seen that section 48 of the Act only applies to the capital assets which are not forming block of assets.
• For capital assets forming block of assets, there is sub-clause (c) of clause (6) of section 43 of the Act to determine written down value of the block of the asset and section 50 of the Act to determine the capital gains arising on transfer of such assets.
• However, the Act has not yet provided that amount taxed under section 45(4) can also be attributed to capital assets forming part of block of assets and which are covered by these two provisions.
• To remove difficulty, it is clarified that Rule 8AB of the Income Tax Rules, 1962 notified vide Notification No. 76 dated 02-07-2021 also applies to capital assets forming part of block of assets.
• Wherever the terms capital asset is appearing in the Rule 8AB of the Rules, it refers to capital asset whose capital gains is computed under section 48 of the Act as well as capital asset forming part of block of assets. Further, wherever reference is made for the purposes of section 48 of the Act, such reference may be deemed to include reference for the purposes of sub-clause (c) of clause (6) of section 43 of the Act and section 50 of the Act.
• It is further clarified that in case the capital asset remaining with the specified entity is forming part of a block of asset, the amount attributed to such capital asset under Rule 8AB of the Rules shall be reduced from the full value of the consideration received or accruing as a result of subsequent transfer of such asset by the specified entity, and the net value of such consideration shall be considered for reduction from the written down value of such block under sub-clause (c) of the clause (6) of section 43 of the Act or for calculation of capital gains, as the case may be, under section 50 of the Act.

For the purposes of understanding and for removing difficulties, the application of section 9B of the Act and sub-section (4) of section 45 of the Act is explained with the help of the following examples:

Example-1: Following is the Balance Sheet of Firm “FR” having partners A, B, C with equal profit-sharing ratio.

All the three lands were acquired by the firm more than 2 years ago, thus, these are long term capital assets. Partner “A” wishes to exit from the firm. On his exit, the firm decides to give him Rs. 11 Lakh of money and land “U” to settle his capital balances. Indexed cost of acquisition of land “U” is Rs. 15 Lacs. Tax rate 20% on LTCG.

Solution:

• As per section 9B of the Act, it shall be deemed that the firm “FR” has transferred land “U” to partner “A” at FMV Rs. 50 Lacs.
• Therefore, Long Term capital Gain in the hands of firm “FR” =

This exercise is carried out since section 9B of the Act mandates that it is to be deemed that the firm “FR” has transferred the land “U” to the partner “A” and therefore, LTCG of Rs. 35 Lacs are charged to tax under section 9B of the Act.

• Net Book Profit on deemed transfer of land “U” to be credited to partner’s capital account:

Capital Accounts of the partners

• Thus, the excess money as calculated above Rs. 40 Lacs shall be charged to tax under section 45(4) of the Income Tax Act. This shall be in addition to an amount of Rs. 35 Lacs charged to tax under section 9B of the Act.
• According to Rule 8AB, the above Rs. 40 Lacs is attributed to remaining assets of the firm “FR” on the basis of increase in their value due to revaluation. In our example, both remaining assets “S” and “T” have their values increased by Rs. 60 Lacs. Thus, Rs. 40 Lacs will be attributed to both “S” & “T” in 60:60 i.e. Rs. 20 Lacs each.
• When either of these lands are sold in future, the above amount as attributed to them Rs. 20 Lacs shall be reduced from sales consideration under clause (iii) of section 48 of the Act.
• The amount of Rs. 40 Lacs which is charged to tax under section 45(4) of the Act shall be charged as long-term capital gains in view of Rule 8AB, since the amount of Rs. 40 Lac is attributed to land “S” and “T” which are both long term capital assets at the time of taxation of Rs. 40 Lacs under section 45(4) of the Act.

Example-2: Suppose, the example-1 above, all the facts are same except that the land “U” is sold at its fair market value of Rs. 50 Lacs. The final settlement to partner “A” is made in cash Rs. 61 Lacs.

Solution:

• Therefore, Long Term capital Gain in the hands of firm “FR” =

• Net Book Profit on sale of land “U” to be credited to partner’s capital account:

Capital Accounts of the partners

• Thus, the excess money as calculated above Rs. 40 Lacs shall be charged to tax under section 45(4) of the Income Tax Act. This shall be in addition to an amount of Rs. 35 Lacs charged to capital gains tax.
• According to Rule 8AB, the above Rs. 40 Lacs is attributed to remaining assets of the firm “FR” on the basis of increase in their value due to revaluation. In our example, both remaining assets “S” and “T” have their values increased by Rs. 60 Lacs. Thus, Rs. 40 Lacs will be attributed to both “S” & “T” in 60:60 i.e. Rs. 20 Lacs each.
• When either of these lands are sold in future, the above amount as attributed to them Rs. 20 Lacs shall be reduced from sales consideration under clause (iii) of section 48 of the Act.
• The amount of Rs. 40 Lacs which is charged to tax under section 45(4) of the Act shall be charged as long-term capital gains in view of Rule 8AB, since the amount of Rs. 40 Lac is attributed to land “S” and “T” which are both long term capital assets at the time of taxation of Rs. 40 Lacs under section 45(4) of the Act.

Note: The final result in both example-1 and 2 is same due to the operation of section 9B of the Act.

Example-3: Following is the Balance Sheet of Firm “FR” having partners A, B, C with equal profit-sharing ratio.

The land was acquired by the firm more than 2 years ago and thus, it is a long-term capital asset. The patent was acquired/developed/registered only 1 year back. Partner “A” wishes to exit. As per the valuation report, there is also a self-generated goodwill of Rs. 30 Lacs. On the exit of partner “A”, the firm decides to give him Rs. 75 Lakhs in cash and land “S” to settle his balances. Indexed cost of land “S” is Rs. 45 Lacs.

Solution:

• As per section 9B of the Act, it shall be deemed that the firm “FR” has transferred land “S” to partner “A” at its FMV Rs. 45 Lacs.

• Therefore, Long Term capital Gain in the hands of firm “FR” =

This exercise is carried out since section 9B of the Act mandates that it is to be deemed that the firm “FR” has transferred the land “S” to the partner “A”. However, since the LTCG as calculated above is “Nil”, there will be no capital gain tax on application of section 9B of the Act.

• For partner “A”, the cost of acquisition of land “S” shall be taken as Rs. 45 Lacs.
• Net Book Profit on deemed transfer of land “S” to be credited to partner’s capital account:

Capital Accounts of the partners

• Thus, the excess money as calculated above Rs. 15 Lacs shall be charged to tax under section 45(4) of the Income Tax Act. This shall be in addition to any amount charged to tax under section 9B of the Act which is “Nil” in this example.
• According to Rule 8AB, the above Rs. 15 Lacs is attributed to remaining assets of the firm “FR” on the basis of increase in their value due to revaluation of existing capital assets, or due to recognition of the value of self-generated goodwill, based on the valuation report of registered valuer. In our example, the value of patent “T” has increased by Rs. 15 Lakhs (45-30) and the self-generated goodwill value has been recognised at Rs. 30 Lakhs.
• So, Rs. 15 Lacs will be attributed between patent and the self-generated goodwill in the ration of 15:30 or 1:2. Thus, Rs. 5 lakhs will be attributed to patent “T” and Rs. 10 Lacs attributed to self-generated goodwill.
• The amount of Rs. 15 Lacs which is to be charged to tax under section 45(4) of the Act shall be charged as short-term capital gains, as Rs. 5 Lacs as attributed to the Patent “T” is a depreciable asset and Rs. 10 Lacs is attributed to self-generated goodwill. In accordance with sub-rule (5) of Rule 8AA of the Rules, both of these are to be characterised as short-term capital gains.
• Rs. 5 lacs as attributed to patent “T” shall not be added to the block of the assets and no depreciation shall be available on the same. When patent “T” gets transferred subsequently, this Rs. 5 Lacs attributed shall be reduced from the full value of consideration receiving or accruing as a result of transfer of patent “T” by the firm “FR” and the net value shall be considered for reduction from the written down value of the intangible block under section 43(6)(c) of the Act or for calculation of capital gains as the case may be, under section 50 of the Act.
• Let us say that patent “T” is sold for Rs. 25 Lacs. Then, net sales consideration will be taken as Rs. 20 Lacs (25-5) and Rs. 20 Lacs shall be considered for reduction from the WDV of the intangible block or for calculating short term capital gain u/s 50.
• Similarly, when the goodwill is sold subsequently, Rs. 10 Lacs would be reduced from its sales consideration under clause (iii) of section 48.

Note: For the purpose of calculation of depreciation u/s 32 of the Act, the WDV of the block of intangible of which patent “T” is also a part, would remain Rs. 45 Lacs and would not be increased to Rs. 60 Lacs due to revaluation during the year.

In this regard, following provisions are relevant in determination of the amount on which depreciation is allowable under the Act:

(a) Explanation 2 of sub-section (1) of section 32 of the Act provides that the term “written down value of the block of assets” shall have the same meaning as in section 43(6)(c) of the Act.
(b) Section 43(6)(c) of the Act provides that the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year is to be increased by the actual cost of any asset falling within that block, acquired during the previous year. This clause does not allow any increase on account of revaluation.
(c) Sub-section (1) of section 43 of the Act which defines “Actual cost” as actual cost of the assets to the assessee. In revaluation, there is no actual cost to the assessee.

Further, section 32 of the Act does not allow depreciation on self-generated goodwill or asset.

Detailed circular can be accessed at: https://www.incometaxindia.gov.in/communications/circular/circular_14_2021.pdf