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Heightened Onus on Assessee to Prove Genuineness of Share Subscription Money Routed Through Web of Entities

The Hon’ble Mumbai Tribunal in the case of Leena Power Tech Engineers Pvt Ltd[1] has held that the onus (i.e. burden) is on the assessee to prove the ‘bonafides’ or ‘genuineness’ of the share application money credited in the books of accounts. The Tribunal further remarked that it would be superficial approach to examine assessee’s claim only on the basis of documents filed and overlook the unusual pattern in the documents filed by the assessee and pretend to be oblivious of the ground realities.  

Considering the fact that the monies were routed through complex web of entities, which failed to inspire any confidence about the genuineness of the investing company and made it looks like a shell company, the Tribunal upheld the additions made by the Assessing Officer (AO) in the hands of the assessee with respect to the receipt of share application money.

 

Facts – Leena Power Tech Engineer’s Pvt. Ltd.:

In the instant case, the assessee had received share application monies from Rohan Vyapar Private Limited (RVPL) and Manbhawan Commercial Pvt Ltd (MCPL). The equity shares were issued at 900% premium on the face value of Rs 10 each i.e. Rs 90 per share. The assessee had issued 3,78,290 equity shares to RVPL and accordingly received an amount aggregating to Rs 3,78,29,600. Similarly, the assessee had received an amount aggregating to Rs 4,35,00,000 from MCPL.

The case of the assessee was reopened by the Assessing Officer (‘AO’) on the basis of certain information received from the investigation wing which mentioned that the assessee has received share application money from RVPL which was subjected to routing through several layers and ultimately has its source in of huge cash deposits in one of the branches of ICICI Bank.

The transaction flow has been elaborated below for ease of reference.



Assessee’s Contentions: Relevant documentary evidence produced

The Assessee’s contentions have been summarized below:

The assessee contended that it had submitted all the relevant documentary evidence such as details of the subscribers to the share capital, share premium, bank statement, justification of share premium (computed on a scientific basis), share valuation by cash flow method, and ledger confirmation from the subscribers. The assessee further submitted that the Revenue had also issued a notice under section 133(6) of the Income-tax Act, 1961 (Act) which was duly replied along with the details of the transaction with the assessee, ledger account, return of income, audited balance sheet, etc. and accordingly it was contended that the assessee had discharged its initial onus cast upon it and now it is for the revenue authorities to prove otherwise.

It was further contended that the proviso to section 68[2] of the Act inserted with effect from 1 April 2013 cannot have retrospective operation. In this regard, reliance was placed on the ruling of Hon’ble jurisdictional High Court in the case of Gagandeep Infrastructure Pvt Ltd[3].

The Assessee further contended that the companies from which the assessee had received the share subscriptions were companies with proper net-worth and these companies were properly assessed to tax and have not been declared as shell companies by the Government or any official body and just because five levels below these companies, there are cash deposits in some bank accounts, the receipts cannot be rejected as lacking bonafide.

Accordingly, it was contended that the entries in the books of accounts of the companies subscribing to the shares cannot be brought to tax in the hands of the assessee.

Revenue’s Contentions: Assessee has failed to prove ‘Bonafides’

The primary contention of the Revenue was that the assessee has failed to prove the ‘bonafides’ of the share application money. Further, the Revenue further contended that the surrounding circumstance of the transaction clearly demonstrates that the transaction is not bonafide and the assessee is a beneficiary of a sophisticated money-laundering racket wherein the money is routed through multiple layering of accounts to the accounts of entities subscribing to the share capital of the assessee.

The Revenue further contended that it was the responsibility of the assessee to show the genuineness of the share application money received and merely producing PAN, income-tax returns, and financial statements of the subscriber do not prove that the transaction is bonafide. It was pointed out that there were hardly any overnight balances in the bank accounts of the companies subscribing to the shares of the assessee company, and all this indicates that these companies are merely conduit companies.

Issue Before the Tribunal:

The question which arose before the Tribunal was whether the learned Commissioner of Income-tax (Appeals) was justified in deleting the addition of Rs 8,13,29,600 as unexplained credit under section 68 of the Act in the hands of the assessee.

Mumbai Tribunal’s Ruling:

The Mumbai Tribunal observed and held as under:

At the outset, the Tribunal observed that there cannot be any dispute on the fundamental legal position that the onus is on the assessee to prove ‘bonafides’ or ‘genuineness’ of the share application money credited in the books of accounts and to prove the nature and source on the money to the satisfaction of the assessing officer.

The Tribunal placed reliance on the cases of Youth Construction Pvt Ltd[4], United Commercial and Industrial Co (P.) Ltd[5] & Precision Finance (P.) Ltd[6] and noted the kind of explanations which assessee is expected to provide:

  1. proof regarding the identity of the share applicants;
  2. their creditworthiness to purchase the shares; and
  3. genuineness of the transaction as a whole.

The Tribunal remarked that the onus of the assessee of explaining nature and source of credit does not get discharged merely by filing confirmatory letters, or demonstrating that the transactions are done through the banking channels, or even by filing the income tax assessment particulars.

The Tribunal further went on to add that, being a final fact-finding authority, it cannot be superficial in its assessment of the genuineness of a transaction and this call has to be taken not only in the light of the face value of the documents presented before the Tribunal but also in the light of all the surrounding circumstances, the preponderance of human probabilities and ground realities. The Tribunal placed reliance on the case of Durga Prasad More[7] wherein it was held that “If all that an assessee who wants to evade tax is to have some recitals made in a document either executed by him or executed in his favour then the door will be left wide open to evade tax. A little probing was sufficient in the present case to show that the apparent was not real. There may be a difference in subjective perception on such issues, on the same set of facts, but that cannot be a reason enough for the fact-finding authorities to avoid taking subjective calls on these aspects and remain confined to the findings on the basis of irrefutable evidence.”

The Tribunal further analyzed the financial statements of RVPL and observed that RVPL has earned only an interest income of Rs 1.13 lakhs and has not carried out any substantial activity during the relevant period. Further, the Tribunal found it difficult to believe that company handling investments in excess of Rs 10 crores and making such aggressive investments as buying shares for Rs 3.78 crores, at a huge premium of nine times the face value of shares, in the private limited and wholly unconnected companies, without any management control, will operate in such a modest manner. This defies logic and such transactions do not take place in the real-life world. The Tribunal also examined the bank account of RVPL and noted that there are series of transactions that do not inspire any confidence about the genuineness of the investing company but make it looks like a shell company acting as a conduit.

The Tribunal also observed that the entities involved in the transaction only provide different layers to the transaction and de facto hide the true investor. The assessee was also unaware of the actual beneficial investor in his company.

Additionally, the Tribunal examined, in detail, the valuation carried out by the assessee on the basis of Discounted Cash Flow (DCF) method and rejected the same thereby holding that the share premium at which the shares are issued is wholly unrealistic.   

A similar analysis was also carried out by the Tribunal with respect to another investor ‘MCPL’.

In light of the above facts and circumstances, the Tribunal rejected the assessee’s contention and held that the transactions under consideration are not ‘bonafide’ and accordingly restored the additions made by the AO.

Our Observation:

The order of the Mumbai Tribunal has, indeed, widened the scope of ‘onus’ placed on the assessee to prove the genuineness of a particular transaction. Such ‘onus’ will not be deemed to be discharged by merely filing the documents before the tax authorities, but the assessee would have to go one step further to justify the rationale of such transactions in order to prove that the transaction has not been entered as a colorable device to defraud the Revenue. The judgment further emphasizes taking a holistic view of the matter based on the surrounding circumstances rather than just relying upon the documentary evidence. Having said this, one has to keep in mind that documentary evidence will always be the primary source of substantiation of a particular transaction.

Going forward, it would be interesting to see the repercussions of this judgment and whether the other Tribunal and lower tax authorities would adopt a similar path and undertake a holistic view of the matter in order to differentiate between the apparent and the real.’

References

[1] [TS-883-ITAT-2021(Mum)]

[2] It provides that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless— (a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and (b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory.

 

[3] (2017) 80 taxmann.com 172 (Bom)

[4] [(2013) 357 ITR 197 (Del)]

[5] [1991] 187 ITR 596 (Cal)]

[6] [1994] 208 ITR 465 (Cal)]

[7] 1971) 82 ITR 540 (SC)

 

 

Image Credits: Photo by Nataliya Vaitkevich from Pexels

The order of the Mumbai Tribunal has, indeed, widened the scope of ‘onus’ placed on the assessee to prove the genuineness of a particular transaction. Such ‘onus’ will not be deemed to be discharged by merely filing the documents before the tax authorities, but the assessee would have to go one step further to justify the rationale of such transactions in order to prove that the transaction has not been entered as a colorable device to defraud the Revenue.

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Tax Alert: Latest COVID-19 Related Relaxations and Exemptions Issued by the Government

In view of the prevailing COVID-19 pandemic situation in the country, resulting in hardship and difficulty vis-à-vis complying with various due dates under the Indian Income tax Act, 1961 (‘the Act’) and causing severe impact on the cash flows, the Central Board of Direct Taxes (‘CBDT’) has time and again issued relevant Notifications, Circulars and Press Releases extending the due date w.r.t  various direct tax compliances.

 

Updated as on 13th July 2021

 

In the table below, we have summarized the key Notifications and Circulars issued by the CBDT, which has extended the due dates of various direct tax compliances under the Act:

Sr No

Compliance Particulars

Original Due Date

Extended Due Date[1]

1

Objections to Dispute Resolution Panel (DRP) and Assessing officer under section 144C

01 June 2021

31 August 2021 (note 1)

2

Statement of Deduction of Tax for the last quarter of the Financial Year 2020-21

31 May 2021

15 July 2021

3

Certificate of Tax Deducted at Source in Form 16

15 June 2021

31 July 2021

4

Statement of income paid or credited in Form 64D by Investment Fund to its unit holders for Financial Year 2020-2021

15 June 2021

15 July 2021

5

Statement of income paid or credited in Form 64C by Investment Fund to its unit holders for Financial Year 2020-2021

30 June 2021

31 July 2021

6

The application under Section 10(23C), 12AB, 35(1)(i i)/(iia)/(iii) and 80G of the Act in Form No. 10Af Form No.10AB. for registration/ provisional registration/ intimation/ approval/ provisional approval of Trusts/ Institutions/ Research Associations

30 June 2021

31 August 2021

7

Compliances for claiming exemption under provisions contained in sections 54 to 54GB

01 April 2021 to 29 September 2021

01 April 2021 to 30 September 2021

8

Quarterly Statement in Form 15CC to be furnished by Authorized Dealer in respect of foreign remittances made for quarter ended 30th June 2021

15 July 2021

31 July 2021

9

Equalization Levy Statement in Form 1 for Financial Year 2020-21

30 June 2021

31 July 2021

10

Time Limit for processing Equalization Levy return

30 September 2021

11

Annual Statement in Form 3CEK to be furnished under section 9A(5) by Eligible Investment Fund

29 June 2021

31 July 2021

12

Uploading declaration received from recipients in Form No 15G / 15H for quarter ended 30th June 2021

15 July 2021

31 August 2021

13

Exercising of option under section 245M(1) in Form No. 34BB for withdrawing application before Settlement Commission

27 June 2021

31 July 2021

14

Last date of linking of Aadhar with PAN under section 139AA

31 March 2021

30 September 2021

15

Last date of payment under Vivad se Vishwas (without additional amount)

31 August 2021

16

Last date of payment under Vivad se Vishwas (with additional amount)

31 October 2021

17

Time Limit for passing assessment / reassessment order

31 March 2021

30 September 2021

18

Time Limit for passing penalty order

30 September 2021

19

Due date for furnishing Return of Income – Non Audit Case

31 July 2021

30 September 2021

20

Due date for furnishing Tax Audit Report

30 September 2021

31 October 2021

21

Due date for furnishing Transfer Pricing Audit

31 October 2021

30 November 2021

22

Due date for furnishing Return of Income – Audit case

31 October 2021

30 November 2021

23

Due date for furnishing Return of Income where Transfer Pricing is applicable

30 November 2021

31 December 2021

24

Belated / Revised return for Assessment Year 2021-22

31 December 2021

31 January 2022

Note:

1) If the last date allowed u/s. 144C is later than 31 August 2021 then such a later date shall prevail.

 

References:

[1] Notification No 74/2021 & 75/2021 and Circular No 9/2021 dated 20 May 2021 and 12/2021 dated 25 June 2021

Image Credits: Photo by Nataliya Vaitkevich from Pexels

We have summarized the key notifications and circulars issued by the CBDT, extending the due dates of various direct tax compliances under the Act.

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Tax Alert: New Rules for Determining Taxability on Reconstitution of Firms

The Central Board of Direct Taxes (CBDT), vide notification[1] dated 2nd July 2021, has inserted a new sub-rule 5 under Rule 8AA of the Income-tax Rules, 1962 (Rules) which deals with the characterisation of capital gains under section 45(4) of the Act. The CBDT has also notified Rule 8AB, which deals with the attribution of income taxable under section 45(4) of the Act to the capital assets remaining with the specified entity. Additionally, the CBDT, vide circular[2] dated 2nd July 2021, has also issued guidelines for practical application of provisions under section 9B and section 45(4) of the Act.
Background
Finance Act, 2021 had inserted a new section 9B under the Income-tax Act, 1961 (Act) which provides that where a specified person[3] receives any capital asset or stock in trade or both from a specified entity [4] on dissolution or reconstitution of such specified entity, then such specified entity shall be deemed to have transferred such capital asset or stock in trade, or both, in the year in which such capital asset or stock in trade or both are received by the specified person and shall be chargeable to tax as income of the specified entity in that year, under the head “Profits and gains of business or profession” or under the head “Capital gains”, as the case may be. It is also provided that fair market value (FMV) of such capital asset or stock in trade, shall be deemed to be the full value of consideration as a result of such deemed transfer. Further, Finance Act, 2021 had also substituted the provisions of section 45(4) of the Act, which now provides that where a specified person receives any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from such receipt by the specified person shall be chargeable to tax as income of the specified entity under the head “Capital gains” in that year. The amount chargeable to tax under section 45(4) of the Act shall be calculated as per the below-mentioned formula. A = B + C – D where, A = Income chargeable to tax under section 45(4) of the Act B = Value of any money received by the specified person C = Amount of FMV of the capital asset received by the specified person D = Amount of balance in the capital account [represented in any manner (excluding increase due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset)] of the specified person in the books of account of the specified entity at the time of reconstitution. It is also clarified that the provisions of section 45(4) shall operate in addition to the provisions of section 9B and accordingly the taxation under these provisions need to be worked out independently. The Finance Act, 2021 has also inserted a new clause (iii) under section 48 of the Act (deduction from the full value of consideration) which provides that the amount of income chargeable to tax under section 45(4) which is attributable to the capital asset being transferred by the specified entity shall be calculated in the prescribed manner. It may be noted that the above-mentioned provisions are applicable w.r.e.f 1 April 2021 i.e. from the tax year 2020-21 onwards.
Notification/Circular
The Central Board of Direct Taxes (CBDT), vide notification[1] dated 2nd July 2021, has inserted a new sub-rule 5 under Rule 8AA of the Income-tax Rules, 1962 (Rules) which deals with the characterisation of capital gains under section 45(4) of the Act. The CBDT has also notified Rule 8AB, which deals with the attribution of income taxable under section 45(4) of the Act to the capital assets remaining with the specified entity. Additionally, the CBDT, vide circular[2] dated 2nd July 2021, has also issued guidelines for practical application of provisions under section 9B and section 45(4) of the Act. This tax alert summarizes the notification and guidelines issued by the CBDT as under: In order to avoid double taxation of the same amount, the provisions of section 45(4) r.w.s 48(iii) of the Act requires that the amount taxed under section 45(4) of the Act should be attributed to the remaining capital asset(s) of the specified entity, such that when these capital asset(s) get transferred in the future, the amount attributed to such capital asset(s) gets reduced from the full value of consideration.
Capital Gains Charged under Section 45(4)

It is further clarified that the revaluation of an asset or valuation of self-generated asset or goodwill does not entitle the specified entity for deprecation on such increased value. 

The specified entity is required to furnish, electronically, the details of the amount attributed to the capital asset remaining with the specified entity in Form No 5C on or before the due date as prescribed under section 139(1) of the Act.

 
Applicability of Attribution Rule (Rule 8AB) to Capital Assets Forming Part of Block of Assets

 

It was observed that the current provisions provide attribution of capital gains under section 45(4) of the Act only for the purpose of section 48 of the Act. It may be noted that provisions of section 48 apply to capital assets that do not form part of block of assets.

Accordingly, in order to provide clarity and remove the difficulty, the CBDT has stated that the attribution rule i.e. Rule 8AB of the Rules shall also apply in relation to capital assets forming part of the block of assets.

It is further clarified that the amount attributed under Rule 8AB of the Rules shall be reduced from the full value of the consideration received or accruing as a result of the subsequent transfer and accordingly net consideration shall be reduced from the written-down value (WDV) of the block of assets under section 43(6)(c) of the Act or for the purpose of calculating capital gains under section 50 of the Act.

 
Characterization of capital gains under section 45(4) of the Act

 

The CBDT has notified Rule 8AA(5) under the Rules which provides for characterization of the nature of capital gains (i.e. long term or short term) under section 45(4) of the Act. It provides that where the amount of capital gains chargeable under section 45(4) is attributed to short term capital asset, capital asset forming part of a block of assets or capital asset, being self-generated asset or goodwill, then the capital gains under section 45(4) shall be deemed to be from the transfer of short-term capital asset; otherwise, it shall be deemed to be transferred from long term capital asset.

 
Examples under the Guidelines

 

In order to better understand the provisions, few examples have been given in the guidelines:

 
Example 1

 

Facts

There are three equal partners A, B and C in a Firm ‘FR’ having a capital balance of INR 10 lacs each. The details of capital assets held by the firm are as under.

Partner ‘A’ wishes to exit and accordingly the firm decides to give him INR 11 lacs of money and Land ‘U’ to settle his capital balance.

 

Tax Implications

A. Under section 9B of the Act

It shall be deemed that the Firm ‘FR’ has transferred the Land ‘U’ to Partner ‘A’ and accordingly an amount of INR 35 lakhs (50 – 15) shall be chargeable to tax in the hands of ‘FR’ under the head capital gains as long-term capital gains and a tax liability of INR 7 lakhs (assuming no surcharge or cess) shall be payable.

For Partner ‘A’, the cost of acquisition Land ‘U’ would thus be INR 50 lakhs.

B. Accounting in the books of Firm ‘FR’

The net book profit after tax of INR 33 lakhs (computed as amount of capital gains without indexation INR 40 lakhs less tax of INR 7 lakhs) shall be credited to each Partner’s capital account i.e. INR 11 lakhs each.

Pursuant to the above, the capital balance of Partner ‘A’ would increase to INR 21 lakhs (10+11).

C. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per the afore-mentioned formula.

Capital Gains under Section 45(4)

The capital gains of INR 40 lakhs shall be chargeable to tax in the hands of Firm ‘FR’ in addition to INR 35 lakhs chargeable under section 9B of the Act.

D. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Characterization of capital gains under section 45(4) of the Act

Subsequently, when the Land ‘S’ or Land ‘T’ would be transferred by the Firm ‘FR’, the amount of attribution would get reduced from the full value of consideration as per the provisions of section 48(iii) of the Act.

E. Characterization of capital gains

Since the amount of INR 40 lakhs charged to tax under section 45(4) of the Act has been attributed to Land ‘S’ and Land ‘T’, being long term capital assets, such amount shall be chargeable as long term capital gains as per Rule 8AA(5) of the Rules.

 

Example 2

 

Facts

The facts of Example 2 are the same as in Example 1 with a modification that the Firm ‘FR’ sells the Land ‘U’ at FMV of INR 50 lakhs to an outsider and on the exit of Partner ‘A’, the Firm decides to give him INR 61 lakhs to settle his capital balance.

 

Tax Implications

A. Under section 9B and section 45 of the Act

Since neither ‘capital asset’ nor ‘stock in trade’ have been distributed to Partner ‘A’, the provisions of section 9B of the Act do not get triggered. However, the Firm would be liable to normal capital gains tax on the sale of Land ‘U’. Accordingly, an amount of INR 35 lakhs (50 – 15) shall be chargeable to tax in the hands of ‘FR’ under the head capital gains as long-term capital gains and tax liability of INR 7 lakhs (assuming no surcharge or cess) shall be payable.

B. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per the afore-mentioned formula.

Characterization of capital gains under section 45(4) of the Act

The capital gains of INR 40 lakhs shall be chargeable to tax in the hands of Firm ‘FR’ under section 45(4) of the Act.

C. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Characterization of capital gains under section 45(4) of the Act

Subsequently, when the Land ‘S’ or Land ‘T’ would be transferred by the Firm ‘FR’, the amount of attribution would get reduced from full value of consideration as per the provisions of section 48(iii) of the Act.

D. Characterization of capital gains

Since the amount of INR 40 lakhs charged to tax under section 45(4) of the Act has been attributed to Land ‘S’ and Land ‘T’, being long term capital assets, such amount shall be chargeable as long term capital gains as per Rule 8AA(5) of the Rules.

In effect, the final result in both Example 1 and 2 would be same due to operation of section 9B of the Act.

 

Example 3

 

Facts

There are three equal partners A, B and C in a Firm ‘FR’ having capital balance of INR 100 lacs each. The details of capital assets held by the firm are as under.

Characterization of capital gains under section 45(4) of the Act

Partner ‘A’ wishes to exit and accordingly the firm decides to give him INR 75 lacs in money and Land ‘S’ to settle his capital balance.

 

Tax Implications

A. Under section 9B of the Act

It shall be deemed that the Firm ‘FR’ has transferred the Land ‘S’ to Partner ‘A’. However, since the full value of consideration is equal to indexed cost of acquisition, there would be no capital gain tax in the hands of the Firm.

For Partner ‘A’, the cost of acquisition would be INR 45 lakhs.

B. Accounting in the books of Firm ‘FR’

The net book profit after tax of INR 15 lakhs (computed as amount of capital gains without indexation) shall be credited to each Partners capital account i.e. INR 5 lakhs each.

Pursuant to above, the capital balance of Partner ‘A’ would increase to INR 105 lakhs (100+5).

C. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per afore-mentioned formula.

Characterization of Capital Gain - Circular No. 14 of 2021 - Tax Circular - CBDT

The capital gains of INR 15 lakhs shall be chargeable to tax in the hands of Firm ‘FR’. 

D. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

d) Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Subsequently, when the Firm transfers ‘Patent’ or ‘Goodwill’, the amount of attribution would get reduced from full value of consideration as per the provisions of section 48(iii) or section 43(6)(c) or section 50 of the Act, as the case may be.

It may also be noted that for the purpose of computing depreciation under section 32 of the Act, the WDV of the block of asset of which ‘Patent’ is a part, shall remain INR 45 lakhs only and should not be increased to INR 60 Lakhs. Similarly, no depreciation would be allowed on self-generated ‘Goodwill’.

E. Characterization of capital gains

Since the amount of INR 15 lakhs charged to tax under section 45(4) of the Act has been attributed to asset forming block of asset i.e. Patent and to self-generated Goodwill, such amount shall be chargeable as short term capital gains as per Rule 8AA(5) of the Rules.

 
FM Comments

 

The detailed guidelines and notification issued by the CBDT is indeed a welcome move and shall certainly help in addressing various concerns of the taxpayers. However, beyond the 3 specific Examples illustrated, in our view, there would be certain other issues which may require similar deliberation and clarification.

It is pertinent to note that the substituted provisions 45(4) and section 9B of the Act are applicable w.r.e.f. 1 April 2021 (i.e. from tax year 2020-21 onwards), whereas the rules for attribution of income and its characterization have been notified on 2 July 2021. The notification is silent with respect to the date of its applicability.

Generally, such notifications come into force on the date of its publication in the Official Gazette, unless the effective date of its applicability is already provided in the notification itself. CBDT, while notifying Rule 8AA(5) and Rule 8AB, has not provided any ‘effective applicable date’ for the same and accordingly it may be inferred that such Rules are to be made effective from 2 July 2021. Thus, the question which may arise is whether Rule 8AA(5) and Rule 8AB would be applicable to the reconstitution of specified entities that have already been undertaken between 1 April 2020 to 1 July 2021.

It may further be noted that the earlier provisions of section 45(4) provided that the transfer of a capital asset on the dissolution of a firm was made chargeable to tax as the income of the firm. But the distribution of money on dissolution was neither chargeable to tax in the hands of the firm nor in the hands of the recipient Partner.

However, the new provisions of section 45(4) state that distribution of money or capital asset exceeding the balance in the capital account of Partner would now be chargeable to tax under the head “capital gains”. Accordingly, the new provisions create a charge of capital tax on the distribution of money. It may be noted that, generally, ‘money’ or ‘currency’ is not considered as a ‘capital asset’ and accordingly the issue which may arise is that whether the distribution of money could be taxed under the head ‘capital gains’ as there is no transfer of capital asset.

It is also pertinent to note that the attribution rules under Rule 8AB of the Rules would lead to a premature collection of the taxes by the Government, the benefit of which may or may not be obtained by the specified entity.

The specified entity would get the benefit of attribution only when they transfer the remaining capital assets subsequently, which is a contingent event, that may or may not happen. Further, in a case where the excess payment chargeable to tax under section 45(4) of the Act, relates to the valuation of self-generated goodwill, then the entity may not be able to claim the benefit of attribution unless the entity hives off its business undertaking, which is highly unlikely. Another interesting question that would arise is how the specified entity would be eligible to claim the benefit of attribution where remaining capital assets are transferred under tax-neutral arrangements.

Moreover, in a scenario, where the aggregate value of money received by the specified person exceeds the balance in his capital account and it does not relate to the revaluation of any capital assets, then the following issues may arise:

  • Characterization of capital gains as ‘Short-term’ or Long-term’ as no attribution of income would be made by the specified entity to the remaining capital assets under Rule 8AB.
  • Such excess payment may have been made by a specified entity due to other business reasons such as payment for non-compete, etc. Accordingly, the deductibility of such excess amount while computing the taxable income of the specified person, would be a challenge.

Going forward, it would be imperative for specified entities to carefully assess the impact of the above provisions while carrying out any reconstitution activity in order to avoid double taxation.

References: [1] “specified person” means a person, who is a partner of a firm or member of other association of persons or body of individuals (not being a company or a co-operative society) in any previous year. [2] “specified entity” means a firm or other association of persons or body of individuals (not being a company or a co-operative society). [3] Notification No. 76/2021 [4] Circular No. 14 of 2021 Image Credits: Photo by Nataliya Vaitkevich from Pexels

It is pertinent to note that the substituted provisions 45(4) and section 9B of the Act are applicable w.r.e.f. 1 April 2021 (i.e. from tax year 2020-21 onwards), whereas the rules for attribution of income and its characterization have been notified on 2 July 2021. The notification is silent with respect to the date of its applicability.

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