Tax Insights
from India Tax & Regulatory Services
Immovable property allotted to
retiring partner by firm - on
specific facts held not covered by
section 45(4) of the Act
May 14, 2019
In brief
Recently, the Madras High Court (HC)1 held that the allotment of immovable property by a firm to its
retiring partners towards their share in the partnership firm should not attract section 45(4) of the
Income-tax Act, 1961 (Act).
In detail
Facts
 The taxpayer was engaged
in the business of
construction. It also owned,
managed and maintained a
commercial complex, two
theatres and two kalyana
mandapams.
 The taxpayer was originally
a sole proprietorship
concern. After the founder’s
death, the partnership
composed of two daughters
and two sons-in-law of the
founder.
 During assessment year
(AY) 2004-05, the
partnership firm was
reconstituted by the
retirement of two existing
partners, and subsequent
admission of a new partner.
 At the time of retirement of
the two partners,
immovable properties were
1
T.C.A. Nos. 365 & 366 of 2009
2
B. T. Patil & Sons v. Commissioner of Gift Tax [2000] 163 CTR 363 (SC)
allotted amongst the
retiring and continuing
partners based on a
valuation of the assets and
liabilities of the firm.
 During the assessment
proceedings, the Tax Officer
added an income to the
return of the taxpayer as
long-term capital gains on
the transfer of immovable
properties to the retiring
partners.
Issue before the High Court
 Whether section 45(4) of
the Act applies to the
retirement of a partner
from a partnership firm?
 Whether the word
“otherwise” in section 45(4)
of the Act would include
cases of reconstitution of
firm on retirement of
partners and not only in
cases akin to dissolution?
Taxpayer’s contention
 Section 45(4) of the Act
would apply only in a case
of “dissolution” of firm. It
would not apply on
retirement of partners
where the firm had not been
dissolved.
 The retiring partners were
allotted properties to the
extent of the credit balance
in the capital account and
did not receive any
consideration for the
transfer of their interests in
the firm.
 A mere allocation of assets
in lieu of partnership
interest cannot be termed
as a “transfer”2.
 The taxpayer placed
reliance on the decision of
the Bombay HC in the case
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of Prashant S. Joshi3 where it
was held that no capital gains
arose under section 45(4) of
the Act on transfer of assets on
the retirement of partners.
Revenue’s contention
Placing reliance on A.N. Naik
Associates4 the Revenue argued
that when there is a dissolution or
“otherwise” of a partnership firm,
resulting in the transfer of assets
to the partners, section 45(4) of
the Act would apply.
High court’s decision
 The Madras HC held that the
retirement of partners and the
allotment of their shares in the
assets of the firm would not
attract the provisions of
section 45(4) of the Act for the
following reasons:
- “Transfer of capital asset”
and “distribution of capital
assets on dissolution of
firm or otherwise” were
the essential conditions for
the applicability of section
45(4) of the Act.
- Section 2(47)(vi) of the Act
defines the term “transfer”
to inter alia include any
transaction that has the
effect of transferring, or
enabling the enjoyment of
any immovable property.
- The Madras HC observed
that the interest of a
partner in a firm is a right
to obtain his share of
profits from time-to-time
during the subsistence of
the firm. Further, on
dissolution or on
retirement from the firm,
the partner obtains the
value of his share in the
net partnership assets,
which remain after
deducting the debts and
3 5
Prashant S. Joshi v. The Income-tax
Office and Ors. [2010] 324 ITR 154
(Bombay)
4 7 CIT v. M/s. Nathan and Company [TCA
CIT v. A.N.Naik and Others [2004] 265
ITR 346 (Bombay)
2 pwc
liabilities of the
partnership3. This could
be in the form of
immovable assets or in the
form of cash in lieu of the
immovable assets.
- Therefore, when a partner
retires, he receives his
share in the partnership,
and not any consideration
for transfer/
relinquishment of his
interest in the partnership
to the continuing
partners5. Therefore, there
is no element of transfer of
interest by retiring
partners to the continuing
partners.
- The Madras HC also
placed reliance on the view
expressed by the author in
Sampath Iyengar’s “Law of
Income Tax”6 that section
45(4) of the Act would not
apply on the retirement of
a partner from a
partnership firm, when
there is transfer of assets.
- The decisions in the case
of A.N. Naik Associates4
and M/s Nathan and
Company7 relied upon by
the Revenue was
distinguished based on
facts of the present case,
since the same dealt with
the distribution of
business in view of agreed
settlements.
- The Madras HC observed
that in the present case,
the firm continued and
only underwent a
reconstitution. On
retirement, there was only
a division of the assets in
accordance with the
partner’s entitlement.
- It may be mentioned that
CIT v. Mohanbhai Pamabhai [1973] 165
ITR 166 (SC)
6
12th edition
No. 1458 of 2005 (Bombay)]
the premise of section
45(4) of the Act is taxation
in the hands of the
partnership firm arising
on dissolution or
“otherwise”, the
judgement of Madras HC
discusses capital gains
arising on settlement of
partner’s share in the
assets of the partnership
firm on his retirement.
- The Madras HC also
mentioned that arguably
the retiring partners
received their share in the
firm that they were legally
entitled to, out of holdings
of the founder by virtue of
their relationship.
The takeaways
 The Madras High Court once
again affirms the principle laid
down by the Supreme Court
and various other courts
thereafter that no capital gains
arises on the retirement of a
partner and that the term “or
otherwise” does not
encompass distributions
arising on account of the
retirement of a partner.
 Furthermore, the Bombay HC
has upheld the same principle
in a recent decision in the case
of Electroplast Engineers8,
which has not been discussed
in the present case.
 However, it should be noted
that the said decision does not
deal with retirement of
partners from limited liability
partnerships (LLPs)
considering the constitutional
differences.
Let’s talk
For a deeper discussion of how this
issue might affect your business,
please contact your local PwC advisor
8Pr. CIT v. Electroplast Engineers [ITA
No. 137 of 2017 (Bombay)]
Tax Insights

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