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.