Question And Answer
Subject: Sec. 45(4) and 9B of the Income Tax 1961
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Querist: ca.Prerna S. Bora
Answered by:
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Date: October 6, 2021
Query asked by ca.Prerna S. Bora

Assessee is partnership firm having 5 partners ,engaged in the business of construction. The firm has undertaken the construction of housing project. In the partnership deed, it is agreed by and between the partners that all partners will contribute the capital equally and their profit sharing is equal.  It  is also agreed  that in case capital contribution is not made equally, then the profit sharing which is decided as equal, will be change as per the capital contribution by executing the  fresh partnership deed. Accordingly partners have decided to execute the partnership deed and change the profit sharing ratio as per the capital introduced by the each partner. whether it amounts to reconstitution and whether there will be any tax implications in view of new provisions of sec 9B and 45(4) of the Income Tax Act. 1961

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As per explanation (i)(c) to section 9B of the Income-tax Act, 1961 (Act), it is clarified that a change in the share of partners would amount to reconstitution of the firm.

Explanation 1 to section 45(4) of the Act, the expression “reconstitution of the specified entity” shall have the meaning respectively assigned to them in section 9B of Act.

Therefore, there is no doubt that a change in the partnership ratio would amount to reconstitution for the purposes of section 9B of the Act and section 45(4) of the Act.

For section 9B of the Act to attract, there has to be a pay-out by way of a capital asset or stock in trade or both. This is not the case in the given case. Therefore, section 9B of the Act is not attracted.

For section 45(4) of the Act, there has to be a pay-out by way of capital asset or money or both. As we understand, there is no pay-out on account of reconstitution. The partners will receive profits in the ratio of their contribution. Therefore, section 45(4) of the Act is not attracted.

There is a possibility that the Department might take a view that the higher profits received by a partner is on account of the reconstitution as the words of section 45(4) are “specified person receives … from a specified entity in connection with reconstitution of such specified entity”. However, this interpretation doesn’t seem robust.

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