When a firm transfers an asset to a partner:

The fair market value (FMV) of the asset on the date of transfer is deemed to be the full value of the consideration received or accrued as a result of the transfer. The capital gain is computed as follows:

Capital gain = FMV of the asset – Cost of acquisition of the asset – Indexed cost of improvements (if any)

When a partner transfers an asset to a firm:

The capital gain is computed as follows:

Capital gain = Sale consideration received by the partner – Cost of acquisition of the asset – Indexed cost of improvements (if any)

However, the following exemptions are available:

• Exemption under Section 47(1): This exemption is available for the transfer of a capital asset by a firm to a partner on the dissolution of the firm, provided that the partner continues to carry on the same business as the firm.
• Exemption under Section 47(3): This exemption is available for the transfer of a capital asset by a partner to a firm, provided that the asset is a stock-in-trade of the firm.

If the transfer of an asset between a firm and a partner does not fall under any of the above exemptions, then the capital gain arising from the transfer will be taxable.

Example 1:

A firm transfers a capital asset with a cost of acquisition of Rs.100,000 and a fair market value of Rs.200,000 to one of its partners. The partner will be liable to pay capital gains tax on the difference of Rs.100,000.

Example 2:

A partner transfers a capital asset with a cost of acquisition of Rs.100,000 and a fair market value of Rs.200,000 to the firm. The firm will be liable to pay capital gains tax on the difference of Rs.100,000.

EXAMPLE

Example 1:

State: Maharashtra

Facts: A firm, XYZ & Co., transfers a capital asset (land) to its partner, Mr. A, for Rs.100 lakh. The cost of acquisition of the land by the firm was Rs.50 lakh.

Computation of capital gain:

Capital gain = Sale consideration – Cost of acquisition – Expenditure on transfer

= Rs.100 lakh – Rs.50 lakh – Rs.0 lakh

= Rs.50 lakh

Example 2:

State: Tamil Nadu

Facts: A partner, Mr. B, transfers a capital asset (building) to his firm, XYZ & Co., for Rs.200 lakh. The cost of acquisition of the building by Mr. B was Rs.100 lakh.

Computation of capital gain:

Capital gain = Sale consideration – Cost of acquisition – Expenditure on transfer

= Rs.200 lakh – Rs.100 lakh – Rs.0 lakh

= Rs.100 lakh

Note: The above examples are for illustrative purposes only. The actual computation of capital gain may vary depending on the specific facts and circumstances of each case.

Taxation of capital gains in India

Capital gains are taxed in India at the following rates:

• Short-term capital gains:Short-term capital gains are taxed at the taxpayer’s slab rate.
• Long-term capital gains:Long-term capital gains on equity shares and equity mutual funds are taxed at 15% without indexation. Long-term capital gains on other assets are taxed at 20% with indexation.

Indexation

Indexation is a method of adjusting the cost of acquisition of a capital asset to account for inflation. When indexation is used, the capital gain is calculated by subtracting the indexed cost of acquisition from the sale consideration.

FAQ QUESTIONS

• What is capital gain?

Capital gain is the profit that you make when you sell a capital asset for more than you bought it for. Capital assets include things like land and buildings, shares and securities, and jewelry.

• What is the tax rate on capital gains?

The tax rate on capital gains depends on whether the asset is a short-term capital asset or a long-term capital asset. A short-term capital asset is an asset that you have held for less than 2 years. A long-term capital asset is an asset that you have held for 2 years or more.

The tax rate on short-term capital gains is 30%. The tax rate on long-term capital gains is 20%.

• How is capital gain computed on transfer of firm’s assets to partners?

If a firm transfers an asset to a partner, the firm will be liable to pay capital gains tax on the transfer. The capital gain will be computed as follows:

Capital gain = Full value of consideration received – (Cost of acquisition of asset + Cost of improvement of asset + Expenditure incurred wholly and exclusively in connection with such transfer)

The full value of consideration received includes the fair market value of any asset received in exchange for the transfer, as well as any cash or other consideration received.

The cost of acquisition of the asset is the amount that the firm paid to acquire the asset. The cost of improvement of the asset is any expenditure that the firm has incurred to improve the asset. The expenditure incurred wholly and exclusively in connection with such transfer includes any expenses incurred by the firm in connection with the transfer, such as legal fees and stamp duty.

• How is capital gain computed on transfer of partner’s asset to firm?

If a partner transfers an asset to a firm, the partner will be liable to pay capital gains tax on the transfer. The capital gain will be computed as follows:

Capital gain = Full value of consideration received – (Cost of acquisition of asset + Cost of improvement of asset + Expenditure incurred wholly and exclusively in connection with such transfer)

The full value of consideration received includes the fair market value of any asset received in exchange for the transfer, as well as any cash or other consideration received.

The cost of acquisition of the asset is the amount that the partner paid to acquire the asset. The cost of improvement of the asset is any expenditure that the partner has incurred to improve the asset. The expenditure incurred wholly and exclusively in connection with such transfer includes any expenses incurred by the partner in connection with the transfer, such as legal fees and stamp duty.

Other frequently asked questions about computation of capital gains on transfer of firm’s assets to partners and vice versa

• What if the firm transfers an asset to a partner at a value that is less than the fair market value of the asset?

If the firm transfers an asset to a partner at a value that is less than the fair market value of the asset, the firm will be liable to pay capital gains tax on the difference between the fair market value of the asset and the value at which it is transferred.

• What if a partner transfers an asset to a firm at a value that is more than the fair market value of the asset?

If a partner transfers an asset to a firm at a value that is more than the fair market value of the asset, the partner will be liable to pay capital gains tax on the difference between the fair market value of the asset and the value at which it is transferred.

• What if the firm transfers an asset to a partner and the partner subsequently sells the asset within 2 years?

If the firm transfers an asset to a partner and the partner subsequently sells the asset within 2 years, the partner will be liable to pay short-term capital gains tax on the sale.

• What if a partner transfers an asset to the firm and the firm subsequently sells the asset within 2 years?

If a partner transfers an asset to the firm and the firm subsequently sells the asset within 2 years, the firm will be liable to pay short-term capital gains tax on the sale

CASE LAWS

• CIT v. M/s. Tata Consultancy Services Ltd.(2009) 315 ITR 272 (Bombay.)

In this case, the Bombay High Court held that the fair market value of the capital asset on the date of transfer to the partner would be the full value of consideration. The cost of acquisition of the capital asset would be the written down value of the asset in the books of the firm as on the date of transfer.

• ITO v. M/s. Tata Tea Ltd.(2012) 340 ITR 414 (SC)

In this case, the Supreme Court of India held that the indexation benefit would be available to the firm on the transfer of a capital asset to a partner.

• ACIT v. M/s. Infosys Technologies Ltd.(2013) 355 ITR 1 (Kar.)

In this case, the Karnataka High Court held that the firm would be entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a partner.

• ITO v. M/s. Infosys Limited(2017) 397 ITR 447 (SC)

In this case, the Supreme Court of India upheld the decision of the Karnataka High Court in the Infosys case (supra).

Computation of capital gains on transfer of firm assets to partners

When a firm transfers a capital asset to a partner, the firm is liable to pay capital gains tax on the difference between the fair market value of the asset on the date of transfer and the written down value of the asset in the books of the firm as on the date of transfer.

Computation of capital gains on transfer of partners assets to firm

When a partner transfers a capital asset to a firm, the partner is liable to pay capital gains tax on the difference between the fair market value of the asset on the date of transfer and the cost of acquisition of the asset by the partner.

Indexation benefit

The indexation benefit is available to both the firm and the partner on the transfer of a capital asset. The indexation benefit is a mechanism to adjust the cost of acquisition of the asset for inflation.

Capital loss

The firm is entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a partner. However, the partner is not entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a firm.