PROBLEM: Mr.
A ( Chartered Accountant) is running a proprietorship firm and his
firm is converted into a partnership by inducting his son as new partner on
31.03.2021 with 50% share. All assets and liabilities of the erstwhile proprietary
firm were transferred into newly constituted partnership firm.
Tax implications on self generated goodwill on conversion of proprietorship firm
into partnership
Mr. A was credited and paid a amount of Rs. 5.00 Lakhs from the firm. Your advise
is required on below mentioned points; Changeability of amount of Rs. 5.00 lakhs
paid to Mr. A when it stands paid for ;
1. Transfer of business into partnership;
2. Goodwill by the incoming partner.
LET’S FIRST CONSIDER APPLICABLE PROVISIONS OF THE INCOME TAX ACT, 1961
SECTION 2(47) DEFINE WHAT IS CONSIDERED TO BE TRANSFER UNDER
Transfer, in relation to capital asset, includes:
i. the sale, exchange or relinquishment of the asset; or
ii. the extinguishment of any rights therein; or
iii. the compulsory acquisition thereof under any law; or
iv. in a case where the asset is converted by the owner thereof into, or is treated
by him, as stockin-trade of a business carried on by him, such conversion or
treatment; or
v. the maturity or redemption of zero coupon bonds; or
vi. any transaction involving the allowing of the possession of any immovable
property to be taken or retained in part performance of a contract of the nature
referred to in section 53A of the Transfer of Property Act, 1882; or
vii. any transaction (whether by way of becoming a member of, or acquiring shares
in a cooperative society, company or other association of persons or by way of any
agreement or any arrangement or in any other manner whatsoever) which has the
effect of transferring, or enabling the enjoyment of any immovable property.
SECTION 45(3) PROVIDES THAT; The profits or gains arising from the transfer of a
capital asset by a person to a firm or other association of persons or body of
individuals (not being a company or a co- operative society) in which he is or
becomes a partner or member, by way of capital contribution or otherwise, shall be
chargeable to tax as his income of the previous year in which such transfer takes
place and, for the purposes of section 48, the amount recorded in the books of
account of the firm, association or body as the value of the capital asset shall be
deemed to be the full value of the consideration received or accruing as a result
of the transfer of the capital asset.
COST OF ACQUISITION: SECTION 55 OF INCOME TAX ACT 1961
Goodwill of business
Trademark or brand name associated with business
Tenancy rights
Loom hours
Right to carry on any business or profession
Stage carriage permits
Right to produce or purchase any article or thing
In case of acquisition from previous owner: Cost of acquisition is purchase price.
In case of self generated: Cost of acquisition is Nil.
ANSWER;
1. Where proprietor business is converted into a partnership, the exclusive
interest of the proprietor is reduced and the business assets become sets of the
firm in which he becomes a partner. Consequently this transaction will be
considered as transfer under Section 45(3) of the Income Tax Act, 1961.
In above case Mr. A has received Rs. 5.00 Lakhs from the firm , will be considered
as consideration of transfer of his interest in proprietorship firm into a
partnership firm ad same will be taxable as capital gain in his hands in the year
of transfer of business to a partnership firm. According to the provisions of
Section 45(3) the Rs. 5.00 Lakhs will be considered as book value recorded into
books of accounts of the firm.
2. If the amount is paid by incoming partner as Goodwill;
Let’s consider judgement of Supreme Court in case of CIT Vs. B.C. Srinivasa Shetty
(1981)128 ITR 294- the apex court observed that the income chargeable to capital
gain tax is to be computed by deducting from the full value of consideration ,” the
cost of acquisition of capital asset” and if it is not possible to a certain the
cost of acquisition ,then transfer of such asset is not chargeable to tax.
