Firm and LLP reconstitution: section 9B, section 45(4) and the disputes

A partner joins. A partner leaves. Two partners swap five per cent. The partnership firm revalues its land because the bank asked for a net worth statement. None of these feels like a sale, and for most of the life of the Income-tax Act none of them was taxed as one. Everything in this note applies equally to a limited liability partnership, because an LLP is a firm for income-tax purposes.

That changed with effect from assessment year 2021-22. The Finance Act 2021 inserted section 9B and substituted section 45(4) with effect from 1 April 2021, which means they reach every reconstitution from the year ended 31 March 2021 onwards, not only those from April 2021. Between them they tax the firm, at fair market value, on events that involve no purchaser, no price and often no cash. The Income-tax Act, 2025 carries both forward unchanged in substance as sections 8 and 67(10). Five years on, no decision has yet applied either of them substantively.

One note on vocabulary before going further. The 2025 Act abolishes “previous year” and “assessment year” and uses a single tax year, which is the financial year in which the income arises. So tax year 2026-27 is the year to 31 March 2027, which under the old vocabulary is previous year 2026-27 and assessment year 2027-28. Where a year matters in this note it is given as the year ending 31 March, to avoid the trap.

This note works through the tax implications of every permutation of a reconstitution of a partnership firm or LLP: admission of a new partner, retirement of a partner, dilution, a transfer of stake between partners, a revaluation with no payout, and dissolution. It sets out what each charge actually taxes, where the two overlap, what the capital account has to exclude, and which points are open. Statutory references lead with the Income-tax Act, 2025 and give the Income-tax Act, 1961 equivalent, because the 1961 Act governs every assessment and appeal now in progress.

Key points

• A reconstitution attracts two independent charges. Section 8 of the 2025 Act (section 9B of the 1961 Act) deems the firm to have transferred a capital asset or stock in trade at fair market value when a partner receives it. Section 67(10) (section 45(4)) separately charges the firm on the excess of what the partner received over his capital account balance. Explanation 2 to section 45(4) states that they operate in addition to one another and are worked out independently.
• Money is not within section 9B. It is within section 45(4). An all-cash exit is tested under one provision only.
• The capital account balance in the formula is computed without any increase due to revaluation of any asset, or due to self-generated goodwill or any other self-generated asset. This single clause is what converts a revaluation from a book entry into a tax event.
• Attribution under Rule 8AB (Rule 50 of the 2026 Rules) is the only route to a future deduction under section 48(iii) (section 72(5)). It is available only where the charge relates to a revaluation supported by a registered valuer’s report, and it requires Form No. 5C, which is Form No. 27 under the 2026 Rules.
• Rule 8AA(5) (Rule 6(3)) deems the charge short-term to the extent it is attributed to a block asset or to self-generated goodwill, whatever the firm’s age.
• The pre-2021 law still decides every appeal for a year before assessment year 2021-22, and it is not settled: CIT v. Mansukh Dyeing and Printing Mills (2022) 449 ITR 439 (SC) treated a revaluation credit as a distribution, while CIT v. Dynamic Enterprises (2013) 359 ITR 83 (Kar)(FB) held that money alone is not a distribution. The Supreme Court did not consider Dynamic Enterprises.
• No decision has yet applied section 9B or the substituted section 45(4) substantively. The orders that mention them decide only that they are prospective from assessment year 2021-22. Anyone structuring today is structuring against an untested statute.

What counts as reconstitution of a partnership firm or LLP?

The definition is in the Explanation to section 9B, and section 45(4) borrows it. Section 8(6)(c) of the 2025 Act carries it in the same words. There is a reconstitution of a specified entity where:

• one or more partners cease to be partners;
• one or more new partners are admitted, in circumstances where at least one person who was a partner before the change continues after it; or
• all the partners continue with a change in their respective shares, or in the shares of some of them.

Three things follow from the drafting, and each of them catches people out.

First, the third limb has no threshold. A change of one per cent in one partner’s share is a reconstitution. There is no de minimis.

Second, the second limb requires continuity of at least one partner. If every partner is replaced at once, that is not a reconstitution under this definition; it is a succession of one firm by another, dealt with by section 328 of the 2025 Act (section 188 of the 1961 Act) and assessed separately on predecessor and successor.

Third, the entity caught is a specified entity, defined as a firm or other association of persons or body of individuals, not being a company or a co-operative society. A limited liability partnership is a firm for this purpose, because section 2(45) of the 2025 Act (section 2(23) of the 1961 Act) says “firm” includes a limited liability partnership. The tax implications set out in this note therefore apply to an LLP in exactly the same terms as to a partnership firm, and an LLP that admits or retires a partner is reconstituted on the same test.

A specified person is a partner or member in any tax year. Note the words “in any tax year”: a person who was a partner at some point is a specified person, which is how a retiring partner remains within the charge in the year he receives his money even though he is no longer a partner when it arrives.

Why a reconstitution attracts two charges, and which comes first

Section 9B of the Income-tax Act, 1961 and the substituted section 45(4), which are sections 8 and 67(10) of the Income-tax Act, 2025, tax different things on the same reconstitution of a partnership firm or LLP, and they are not alternatives. This is the structural point that most treatments get wrong, so it is worth being precise.

Section 8 (section 9B) applies where a specified person receives, during the tax year, a capital asset or stock in trade or both from a specified entity in connection with the dissolution or reconstitution of that entity. The firm is then deemed to have transferred that asset to the partner in the year of receipt. The fair market value on the date of receipt is deemed to be the full value of the consideration. The resulting profit is taxed in the firm’s hands, under the head profits and gains of business or profession, or capital gains, according to what the asset was.

Note what is absent. Section 9B says nothing about money. A partner who takes only cash is outside it entirely.

Section 67(10) (section 45(4)) applies where a specified person receives money or a capital asset or both in connection with reconstitution. Note that dissolution is absent here, where it was present in section 9B. The charge is on the firm, under capital gains, and the amount is:

A = B + C − D

where B is the value of the money received on the date of receipt, C is the fair market value of any capital asset received on that date, and D is the balance in the specified person’s capital account in the firm’s books at the time of the reconstitution. If A is negative it is deemed to be nil.

Explanation 2 to section 45(4) removes any argument about the relationship, though note that it is framed by reference to the receipt of a capital asset and so does not in terms reach a money-only exit, where section 9B is not engaged anyway:

when a capital asset is received by a specified person from a specified entity in connection with the reconstitution of such specified entity, the provisions of this sub-section shall operate in addition to the provisions of section 9B and the taxation under the said provisions thereof shall be worked out independently.

The order of operation is not in the statute but follows from the arithmetic, and CBDT Circular No. 14 of 2021 dated 2 July 2021 works it through in three examples. Section 9B is applied first. The gain it generates in the firm’s hands is credited to the partners’ capital accounts in their profit-sharing ratio, and only then is D known. Applying the two provisions in the other order gives the wrong answer, and applying section 45(4) to pre-section 9B capital balances is one of the errors we see most often in computations prepared in-house.

The partner’s capital account, and what section 45(4) strips out of it

In the section 45(4) formula, D is the balance in the retiring or continuing partner’s capital account, and it is the only deduction. Everything in this area turns on how large D is allowed to be, and the second proviso to section 45(4) is where the legislature closed the obvious planning route:

the balance in the capital account of the specified person in the books of account of the specified entity is to be calculated without taking into account the increase in the capital account of the specified person due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset.

Read that against how firms actually behave and the design becomes clear. A firm about to admit a partner revalues its land and credits the surplus to the existing partners. Their capital accounts swell. The incoming partner pays in, an outgoing partner is paid out, and the payment looks fully covered by the capital account.

It is not. For the purpose of the formula the revaluation credit is stripped out. The payment stands at its full amount in B, and D is the pre-revaluation figure. The whole of the revaluation surplus paid out is charged.

“Self-generated goodwill” and “self-generated asset” are defined in Explanation 1(ii) to section 45(4), and in section 67(11)(b) of the 2025 Act, as goodwill or an asset acquired without incurring any cost of purchase, or generated in the course of the business or profession. A professional firm that recognises the value of its own client relationships on a partner’s admission has created a self-generated asset, and the credit is stripped out in the same way.

What remains in D is the partner’s real capital: what he contributed, plus his share of taxed profits that were left in the firm, less what he has drawn.

Attribution under Rule 8AB: the only route to a future deduction

Charging the firm on the revaluation surplus when the partner takes it out creates an obvious problem. The firm still holds the revalued asset. When it eventually sells that asset, the same appreciation is in the sale price. Without a corrective the firm pays tax on it twice.

The corrective is section 48(iii) of the 1961 Act, which is section 72(5) of the 2025 Act: the firm gets a deduction, in the year of sale, for so much of the amount charged under section 45(4) as is attributable to the asset being sold. Attribution is governed by Rule 8AB of the Income-tax Rules, 1962, which is Rule 50 of the Income-tax Rules, 2026.

The mechanics repay close reading, because there are three ways to lose the deduction entirely.

Attribution happens only where the charge relates to a revaluation or to a self-generated asset. Rule 8AB(2) attributes the charged amount across the assets remaining with the firm in the proportion that each asset’s increase in value on revaluation bears to the aggregate increase. Rule 8AB(3) provides that where the charged amount does not relate to any revaluation or valuation of a self-generated asset, it is not attributed to any capital asset at all. That is not a timing difference. It is a permanent loss.

Attribution does not happen for the asset that left. Rule 8AB(4) provides that where the amount charged relates only to the capital asset received by the partner, there is no attribution. That asset has gone; there is nothing left to carry a deduction.

Attribution requires a registered valuer. Explanation 1 to Rule 8AB provides that the charged amount relates to a revaluation only if the revaluation is based on a valuation report obtained from a registered valuer within the meaning of Rule 11U. A revaluation done on the partners’ own estimate, or on a circle-rate working, or on an architect’s letter, is not a revaluation for this rule. The charge still arises. The deduction does not.

Two further points. Explanation 2 to Rule 8AB states, for the removal of doubt, that a revaluation or a recognition of self-generated goodwill does not entitle the firm to depreciation on the increase. And the firm must file Form No. 5C, which is Form No. 27 under the Income-tax Rules, 2026, electronically, verified by the person authorised to verify the firm’s return, on or before the due date for the return of the year in which the amount is charged. A firm that pays the tax but never files the form has paid for a deduction it has not secured.

Short-term by deeming: why Rule 8AA(5) ignores how long the firm held the asset

Rule 8AA(5) of the 1962 Rules, which is Rule 6(3) of the 2026 Rules, decides the character of the section 45(4) gain by reference to the asset it is attributed to. The amount is treated as arising from the transfer of a short-term capital asset to the extent it is attributed to:

• a capital asset that was short-term at the time of the charge;
• a capital asset forming part of a block of assets; or
• a capital asset being a self-generated asset or self-generated goodwill.

It is long-term only to the extent attributed to a capital asset that is not within those three and was long-term at that time.

The second and third limbs do most of the damage. A firm that has held plant and machinery for twenty years holds it in a block, so anything attributed to it is short-term. Self-generated goodwill is short-term by definition, however old the practice. For a professional firm whose only real asset is its goodwill, the entire section 45(4) charge on a partner’s exit is short-term and taxed at the firm’s full rate of thirty per cent rather than at the twelve and a half per cent that applies to a long-term gain. Indexation is not the difference: for transfers on or after 23 July 2024 the Finance (No. 2) Act 2024 removed indexation and set a flat long-term rate. The contrast is thirty per cent against twelve and a half, and on a large exit it is the single biggest number in the computation.

Admission, retirement, dilution and transfer of stake: what each one attracts

The event	Section 9B / section 8	Section 45(4) / section 67(10)	The real question
Partner admitted, capital paid in, nothing paid out	No. Nobody receives an asset from the firm.	No. Nobody receives money from the firm.	Was anything revalued and credited first? Was any existing partner paid out of the incoming capital?
Partner admitted and an existing partner paid out of the incoming money	No, if the payment is money.	Yes, on the excess over that partner’s stripped-down capital account.	Whether the revaluation credit inflated the payment.
Partner retires taking only money, not exceeding his capital account excluding revaluation	No.	No. A is nil, because the first proviso deems a negative figure to be nil.	Whether D has been computed correctly, after section 9B effects and after stripping revaluation.
Partner retires taking money funded by a revaluation surplus	No.	Yes, on the whole surplus element.	Whether a registered valuer’s report exists, and whether Form 5C will be filed.
Partner retires taking a capital asset	Yes. Firm taxed on FMV less cost.	Yes, separately, with C at the same FMV.	The order of computation, and the section 56(2)(x) exposure in the partner’s hands.
Partner retires taking stock in trade	Yes, as business income of the firm at FMV.	Stock in trade is not a capital asset, so it does not enter C.	Whether the item is genuinely stock, and the GST consequence of the supply.
Dilution: all partners continue, ratios change	Only if an asset moves.	Only if money or an asset moves.	Usually nothing moves, so usually nothing is charged. But it is a reconstitution, and anything paid as consideration for the ratio change is within B.
Transfer of stake between partners, paid partner to partner	No. The firm gives nothing.	No. The receipt is not from the specified entity.	Whether the payment truly ran between the partners, or through the firm. Routing it through the firm invites the charge, and the answer that the account was a bare conduit is an argument rather than a concession.
Revaluation with no payout	No.	On the better view no, because neither provision operates without a receipt. But the point is open, and Mansukh Dyeing treated a revaluation credit as a distribution under the old law.	Whether the credit will be withdrawn later. It will be stripped from D whenever it is.
Dissolution	Yes. Section 9B expressly covers dissolution.	No. Section 45(4) refers only to reconstitution.	Whether the event is a dissolution or a reconstitution, which the deed and conduct decide.

Two rows deserve emphasis because they are the planning points.

A transfer of stake between partners, paid directly between them, is outside both charges. Neither the firm nor a specified entity is the payer. The retiring partner’s capital account is simply transferred to the incoming partner in the books. It is routinely spoiled by routing the money through the firm’s bank account for convenience.

It is not, however, outside tax. A partner’s interest in a firm is a capital asset, its assignment is a transfer within section 2(47), and the outgoing partner is chargeable under section 67(1) of the 2025 Act, which is section 45(1) of the 1961 Act, on the consideration he actually receives less his cost. What that cost is has never been settled for a partnership interest, and the answer is usually the amount standing to his credit. Separately, if the price is below the fair market value of the interest, the incoming partner is exposed under section 92(2)(m), which is section 56(2)(x). So the route avoids the two firm-level charges; it does not avoid a charge on the person who is actually being paid. That is the correct comparison, and it is often still the cheaper one, because the charge falls on a real receipt rather than on the firm.

Dissolution and reconstitution attract different provisions. A dissolution is within section 9B but, on the better view, outside section 45(4), which refers only to reconstitution. A reconstitution is within both. The Department argues the contrary, on the footing that the first limb of the definition of reconstitution, where one or more partners cease to be partners, is wide enough to cover a dissolution. The point is open. Whether a given exit is one or the other is a question of the deed, the intention and the conduct, and it is the sort of question an Assessing Officer decides against the assessee unless the documents are unambiguous.

Contribution in: section 45(3) and what survives of Sunil Siddharthbhai

The mirror image is a partner putting an asset into the firm. Section 67(9) of the 2025 Act, which is section 45(3) of the 1961 Act, covers the transfer of a capital asset by a person to a partnership firm or LLP in which he is or becomes a partner, by way of capital contribution or otherwise. The profits are charged as his income of the year of transfer. And the amount recorded in the firm’s books is deemed to be the full value of the consideration.

Before section 45(3) was inserted by the Finance Act 1987, the Supreme Court had held in Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC) that although such a contribution is a transfer, no capital gain arises, because the consideration cannot be evaluated:

It is impossible to conceive of evaluating the consideration acquired by the partner when he brings his personal asset into the partnership firm when neither the date of dissolution or retirement can be envisaged nor can there be any ascertainment of liabilities and prior charges which may not have even arisen yet.

Section 45(3) answered that by supplying a deemed consideration. The computation holding is therefore spent. Two parts of the judgment are not.

The first is the Court’s warning about a device:

If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income tax on a capital gain, it will be open to the Income-tax Officer to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction.

That reasoning has lost none of its force, and it is the obvious answer to a scheme that introduces land into a firm at book value and withdraws it as cash shortly afterwards.

The second is the recognition that the book entry is a notional figure, not a price. Section 45(3) adopts the notional figure anyway. That is a deliberate concession, and it is the reason contribution at book value remains the cheapest way to get an asset into a firm.

Two exposures sit alongside it and are frequently missed. Where the asset is land or a building and the recorded value is below the stamp duty value, section 78 of the 2025 Act (section 50C of the 1961 Act) has to be considered. That sets one deeming provision, which fixes the consideration at the book figure, against another, which fixes it at the stamp duty value. The Tribunal has taken the taxpayer’s side, holding that section 45(3) is the specific provision and prevails, but there is no High Court ruling and the Department continues to take the point. And the firm, as recipient of property for a consideration below fair market value, is exposed under section 92(2)(m) of the 2025 Act (section 56(2)(x) of the 1961 Act), which operates on a different person and does not offset.

Does section 56(2)(x) apply when a partner receives an asset from the firm?

Section 92(2)(m) of the 2025 Act, which is section 56(2)(x) of the 1961 Act, charges any person who receives property without consideration, or for a consideration below its stamp duty value or fair market value, on the shortfall. A firm is a person. A partner is a person. Nothing in the clause carves out the relationship between them.

The exclusions do not help. The principal exclusion is for a receipt from a relative, and “relative” is defined only in relation to an individual and a Hindu undivided family. A firm has no relative in law, so a firm receiving property from its partner cannot use it, and a partner receiving property from his firm cannot either, because the firm is not his relative. The exclusion for a transaction not regarded as a transfer operates by naming a closed list of clauses. Clause (IX) of the proviso to section 56(2)(x) lists clauses (i), (iv), (v), (vi), (via), (viaa), (vib), (vic), (vica), (vicb), (vid), (vii), (viiac), (viiad), (viiae) and (viiaf) of section 47. Section 92(3)(g) of the 2025 Act names the corresponding clauses of section 70(1). No clause of section 47 covers a transfer between a firm and its partner on reconstitution, so the exclusion has nothing to bite on in any event.

So on a retirement where the partner takes an asset:

• the firm is charged under section 9B on the fair market value less cost;
• the firm is charged again under section 45(4) on the excess over the capital account; and
• the partner may be charged under section 56(2)(x) on the difference between the fair market value and what he gave up.

Circular 14 of 2021 does not mention section 56(2)(x). There is no CBDT clarification on the point, and no reported decision either way.

The answer, when the point is taken, is that the receipt is not without consideration. A retiring partner who takes an asset surrenders his interest in the firm, and that interest is what he gave up. Whether it is worth as much as what he received is a question of fact, and there is no prescribed method for valuing a partnership interest at all, which cuts against the Department as much as against the assessee. The exposure is nonetheless real and unrelieved on the face of the statute, and it is a reason to pay a retiring partner in money rather than in kind wherever the commercial position allows.

The pre-2021 law on retirement of a partner, which decides every appeal for an earlier year

Section 9B and the substituted section 45(4) apply from assessment year 2021-22. Every assessment and every appeal for an earlier year is governed by the old law, and the old law is not settled.

The starting point is that a firm is not, in general law, an owner separate from its partners, whatever its status as a separate assessee under section 2(31). In Malabar Fisheries Co. v. CIT (1979) 120 ITR 49 (SC) the Supreme Court held that distribution of assets on dissolution is not a transfer by the firm to the partners, because the partners already own the assets jointly:

There is no transfer of assets involved even in the sense of any extinguishment of the firm’s rights in the partnership assets when distribution takes place upon dissolution.

Retirement was not a transfer either. In CIT v. Mohanbhai Pamabhai (1973) 91 ITR 393 the Gujarat High Court, in a judgment of Bhagwati J., held that what a retiring partner receives is his share in the net partnership assets after deducting liabilities and prior charges, and that this is a working out of pre-existing rights, not a conveyance for a price. The Supreme Court affirmed it at (1987) 165 ITR 166. This is the binding High Court authority in Gujarat, and it covers the goodwill element of the share as well. Note its limits: it answers whether a retirement is a transfer within section 2(47), on the law as it stood before the old section 45(4) was inserted and section 47(ii) omitted, both with effect from 1 April 1988. It is not by itself an answer to the deemed charge under the old section 45(4), and after Mansukh Dyeing a revaluation-credit case cannot be run on Mohanbhai Pamabhai alone.

But an excess payment was different. The Bombay High Court in CIT v. Tribhuvandas G. Patel (1978) 115 ITR 95 drew the distinction that where accounts are taken and the partner is paid the credit balance of his capital account there is no transfer, whereas if he is paid a lump sum expressly for transferring or releasing his interest to the continuing partners, there is an element of transfer. The Supreme Court partly overruled that decision at (1999) 236 ITR 515, preferring to follow its own decision in Mohanbhai Pamabhai. So the Bombay distinction between a retirement on taking accounts and a lump sum paid for releasing an interest did not survive at the level of the Supreme Court.

Two cautions on using that. The first is that the argument in those cases ran partly on section 47(ii), which exempted distribution on dissolution and which was omitted when the old section 45(4) was inserted with effect from 1 April 1988, so the statutory setting has changed twice since. The second is that all of this is about whether there is a transfer. The charges now in force do not depend on there being a transfer at all; they depend on a partner receiving something. A decision that a retirement is not a transfer answers a question that section 9B and the substituted section 45(4) no longer ask.

Then the word “otherwise”. The old section 45(4) charged profits arising from the transfer of a capital asset by way of distribution of capital assets “on the dissolution of a firm … or otherwise”. In CIT v. A.N. Naik Associates (2004) 265 ITR 346 the Bombay High Court refused to read “otherwise” ejusdem generis with dissolution, holding that even where the firm continues and a capital asset is transferred, the word bites.

Karnataka went the other way on facts. In CIT v. Dynamic Enterprises (2013) 359 ITR 83 (Kar) a Full Bench held that section 45(4) requires an actual distribution of a capital asset amounting to a transfer by the firm to the partner, and that where the retiring partners took only money, nothing was distributed and the charge did not arise.

And then the Supreme Court. In CIT v. Mansukh Dyeing and Printing Mills (2022) 449 ITR 439 (SC) the firm revalued its assets and credited the surplus to the partners’ capital accounts in their profit-sharing ratios on the admission of new partners. The Court held that this credit could be said to be, in effect, a distribution of the assets to the partners, chargeable under the old section 45(4) even though the firm was not dissolved, and it approved the Bombay High Court’s construction of “otherwise” in A.N. Naik Associates. The review petition was dismissed at (2023) 293 Taxman 516 (SC).

Two cautions on how that decision is used. It did not consider Dynamic Enterprises, which is not mentioned in the judgment, so it is wrong to say that Dynamic Enterprises has been overruled. And it pulls sharply against the line of decisions holding that a mere change in constitution or a revaluation without distribution is not a transfer, of which CIT v. Kunnamkulam Mill Board (2002) 257 ITR 544 (Ker) is the clearest statement:

Ownership of the property does not change with the change in the constitution of the firm. As long as there is no change in ownership of the properties of the firm there is no transfer of capital asset.

Anyone relying on the Kunnamkulam line in an appeal for a pre-2021 year must deal with Mansukh Dyeing squarely. On the facts, the difference between the two is the difference between a revaluation that stayed in the books and a revaluation that was credited to partners in their profit-sharing ratio.

What is still open on section 9B and section 45(4)

The honest position, and it is worth stating on a page that will be read by people making decisions, is that section 9B and the substituted section 45(4) have not been tested in any court.

On a search of the reported Tribunal and High Court decisions as at September 2026, we can find no decision applying section 9B or the substituted section 45(4) substantively. The orders that mention section 9B mention it only to hold it inapplicable because the year under appeal was earlier. The ITAT Chennai did exactly that in Gokulakrishna v. DCIT (ITA No. 1088/CHNY/2025, order dated 17 June 2025) for assessment year 2017-18, holding on the old law that a reduction in profit-sharing ratio on the admission of a new partner was not a transfer, and noting that the Finance Act 2021 amendments are prospective from assessment year 2021-22. Two later orders of the same Bench are to the same effect: DCIT v. Sathyabama Ramachandran (ITA No. 821/Chny/2025, order dated 23 September 2025) and ACIT v. Manikandan (ITA No. 2986/Chny/2025, order dated 16 February 2026).

Nor can we find any writ petition or constitutional challenge to either provision.

The questions that will be litigated, and on which there is currently no answer, are these:

• Is a credit to a capital account, without withdrawal, a “receipt”? Section 45(4) requires that the specified person “receives” money or a capital asset. A credit is not a payment. But Mansukh Dyeing treated a credit as a distribution under the old law, and the Department will say the same word covers the same conduct.
• Does the charge arise on the reconstitution or on the receipt? The formula takes D at the time of the reconstitution but takes B and C on the date of receipt. Where those are different years, the provision does not say which year the charge falls in, and the two dates are routinely months apart.
• What is the fair market value of an interest in a firm? Section 45(4) works on the fair market value of the asset received, which is determinable. But the Department’s valuation of what the partner gave up, for section 56(2)(x) purposes, has no prescribed method for a partnership interest at all.
• Is Rule 8AB valid so far as it denies attribution? Rule 8AB(3) denies any future deduction where the charge does not relate to a revaluation. A rule that converts a timing difference into a permanent loss, in a scheme whose stated purpose was to prevent double taxation, is open to challenge as going beyond section 48(iii).
• How do sections 9B and 56(2)(x) sit together? Nothing in the statute or in Circular 14 of 2021 prevents the same appreciation being taxed in the firm and in the partner.
• What is the partner’s cost of the asset he received? The Finance Act 2021 package inserted no provision stepping the partner’s cost up to the fair market value on which the firm has just been taxed under section 9B. On the face of it the same appreciation can be taxed a third time when the partner sells. There is no answer in the statute and none in the Circular.
• Can the section 48(iii) deduction work for a depreciable asset? An asset in a block is not sold as an identified capital asset; the gain is computed under section 50 of the 1961 Act, which is section 76 of the 2025 Act, on the block. Whether an amount attributed to plant under Rule 8AB can be delivered as a deduction at all is doubtful, and the rules do not say.

Worked example: retirement of a partner from a firm that has revalued

ABC & Co. is a firm of three partners, A, B and C, sharing equally. Each has a capital account balance of Rs 100 lakh. The firm owns land bought years ago for Rs 90 lakh and carried at that figure, and plant in a block with a written down value of Rs 60 lakh. It has no recorded goodwill.

A registered valuer reports the land at Rs 390 lakh, the plant at Rs 120 lakh, and the firm’s self-generated goodwill at Rs 90 lakh. The firm records the revaluation and credits the surplus, Rs 450 lakh in total, equally: Rs 150 lakh to each partner. Each capital account now shows Rs 250 lakh.

A retires, taking Rs 250 lakh in money.

Section 9B. A receives no capital asset and no stock in trade. Section 9B does not apply. Nothing is charged under it.

Section 45(4). B is Rs 250 lakh. C is nil. D is not Rs 250 lakh: the second proviso requires the revaluation credit of Rs 150 lakh to be stripped out, so D is Rs 100 lakh.

A = 250 + 0 − 100 = Rs 150 lakh, charged to the firm.

Attribution. The charge relates to the revaluation, so Rule 8AB(2) applies. The increases were land Rs 300 lakh, plant Rs 60 lakh, goodwill Rs 90 lakh, a total of Rs 450 lakh. The Rs 150 lakh is attributed in that proportion: Rs 100 lakh to the land, Rs 20 lakh to the plant, Rs 30 lakh to the goodwill.

Character. Under Rule 8AA(5) the Rs 20 lakh attributed to the plant is short-term, because the plant is in a block. The Rs 30 lakh attributed to goodwill is short-term, because goodwill is a self-generated asset. Only the Rs 100 lakh attributed to the land is long-term. Two thirds of the gain by value is long-term; one third is taxed at full rates.

Later. When the firm sells the land it deducts the Rs 100 lakh under section 48(iii). Form No. 5C has to have been filed by the due date for the year of the charge. The Department treats that filing as a condition of the deduction and will refuse it if the form is missing. Section 48(iii) itself does not say so, and a procedural default under a rule made under section 295 extinguishing a substantive statutory deduction is a point the assessee can fight; but it is a fight nobody should have to have, and the form takes an afternoon.

What actually caused the charge. It is worth being precise, because the usual summary is wrong. The charge of Rs 150 lakh was caused by paying A more than the balance standing to his credit after stripping the revaluation, not by the revaluation itself. Had the firm never revalued and had A still been paid Rs 250 lakh, from an incoming partner’s capital or from borrowings, D would still have been Rs 100 lakh and A would still have been Rs 150 lakh. Had the firm revalued and paid A only the Rs 100 lakh standing to his credit before the revaluation, A would have been nil.

The revaluation does two things, and only two. It makes the larger payment possible, by creating a credit balance that supports it commercially. And, because it was done on a registered valuer’s report, it is the only thing that allows the Rs 150 lakh to be attributed under Rule 8AB and recovered later as a deduction under section 48(iii). Without the revaluation, Rule 8AB(3) would deny attribution altogether and the whole Rs 150 lakh would be a permanent cost rather than a timing difference.

So the lesson is not that a revaluation is a decision to pay tax. It is that paying a partner more than his unrevalued capital account is a decision to pay tax, and that if it is going to be done, a registered valuer’s report obtained before the entries are passed is what turns a permanent loss into a deferred deduction. Note also that Rs 150 lakh is the amount charged, not the tax on it: on the split above, roughly Rs 100 lakh at the long-term rate and Rs 50 lakh at the firm’s full rate, plus surcharge and cess.

Carry forward of losses on retirement of a partner

Section 119(1) of the 2025 Act, which is section 78(1) of the 1961 Act, applies where a change has occurred in the constitution of a partnership firm or limited liability partnership. The firm is then not entitled to carry forward and set off so much of the loss as is proportionate to the share of a retired or deceased partner, to the extent it exceeds his share of profits in that year.

The loss attributable to the departing partner is simply lost. It does not follow him, and it does not accrue to those who remain. In a firm carrying substantial carried forward losses, the retirement of a one-third partner extinguishes up to a third of them, and that cost belongs in the negotiation over the exit price. Two qualifications. The disallowance bites only on so much of the proportionate loss as exceeds his share of profits in the firm for that year, so a profitable year softens it. And section 78 sits in Chapter VI and operates on losses carried forward under that Chapter; it does not reach unabsorbed depreciation carried forward under section 32(2) of the 1961 Act. For a firm whose carry-forward is mostly unabsorbed depreciation, the cost of a partner exit on this account is nil. It is computed on the profit-sharing share, not on the capital account, so a partner with a small capital balance and a large share takes a large part of the losses with him.

Section 119(2) (section 78(2)) deals with succession: where a person carrying on a business is succeeded otherwise than by inheritance, only the person who incurred the loss may carry it forward.

Watch the renumbering here. Section 78 of the Income-tax Act, 2025 is not the loss provision. It is the stamp duty value provision corresponding to section 50C of the 1961 Act. The loss provision is section 119. A submission that cites “section 78” without saying which Act is now ambiguous, and in a faceless proceeding it will be read the wrong way.

Assessment of a reconstituted firm, the partnership deed, and the machinery that is easy to forget

Change in constitution. Section 327 of the 2025 Act (section 187 of the 1961 Act) provides that where a change has occurred in the constitution of a firm, the assessment is made on the firm as constituted at the time of making the assessment. The definition of change in constitution mirrors the reconstitution definition. The 1961 Act carried a proviso excluding a case where the firm is dissolved on the death of a partner; the 2025 Act re-enacts it as section 327(3), a separate sub-section rather than a proviso, with the same effect.

Succession. Section 328 (section 188) applies where a firm is succeeded by another firm and the case is not one of change in constitution: separate assessments are made on predecessor and successor under section 313 (section 170). The dividing line between section 327 and section 328 is continuity of at least one partner, and it determines whether there is one assessment or two.

Dissolution and discontinuance. Section 330 (section 189) allows the assessment to be made as if no dissolution or discontinuance had taken place, and makes every person who was a partner at that time, and the legal representative of a deceased partner, jointly and severally liable for tax, penalty and any other sum. Section 188A of the 1961 Act, which is not confined to a dissolution, extends joint and several liability for tax, penalty and other sums to every person who was a partner during the relevant year, whether or not the firm is dissolved. For a limited liability partnership there is a further provision, section 331 of the 2025 Act (section 167C of the 1961 Act). It applies where tax due from the LLP cannot be recovered from it. Every person who was a partner during the relevant year is then jointly and severally liable, unless he proves that the non-recovery is not attributable to his gross neglect, misfeasance or breach of duty. Limited liability does not extend to tax.

The deed. Section 325 of the 2025 Act (section 184 of the 1961 Act) requires that the partnership be evidenced by an instrument and that the individual shares of the partners be specified in it, with a certified copy filed and a revised instrument filed on any change. Section 326 (section 185) sets out the consequence of non-compliance, and it is precise: no deduction for any payment of interest, salary, bonus, commission or remuneration to any partner, and correspondingly those sums are not chargeable in the partners’ hands under section 26(2)(g) (section 28(v)). Since 2004 non-compliance does not convert the firm into an association of persons. It disallows the partner payments, which in a firm distributing most of its profit as remuneration is a heavier penalty.

Remuneration and interest. Section 35(e) of the 2025 Act (section 40(b) of the 1961 Act) disallows remuneration to a non-working partner, any remuneration or interest not authorised by the deed or relating to a period before the deed, interest above 12 per cent simple, and remuneration above the statutory ceiling. The ceiling was raised by the Finance (No. 2) Act 2024 with effect from 1 April 2025 and now stands at the higher of Rs 3,00,000 or 90 per cent of book profit on the first Rs 6,00,000 of book profit or in case of a loss, and 60 per cent of the balance. The earlier figures were Rs 1,50,000 and Rs 3,00,000.

On a reconstitution the deed point becomes acute. A change in constitution requires a revised instrument, and remuneration paid under the old deed for a period after the change, or under a new deed for a period before it, is disallowed. The date on the deed is not a formality.

TDS on payments to partners. Section 393(3) of the 2025 Act, entry 7 in the Table, and section 194T of the 1961 Act, require a firm to deduct tax at 10 per cent on any sum in the nature of salary, remuneration, commission, bonus or interest paid to a partner, where the aggregate exceeds Rs 20,000 in the financial year. It applies from 1 April 2025. The trigger is credit or payment, whichever is earlier, and credit expressly includes credit to the capital account. A year-end entry crediting interest to partners therefore attracts the obligation with no money moving. It does not reach a partner’s share of profit, which remains exempt, and it does not reach the repayment of capital on retirement.

What the partnership deed and retirement documents have to show

Most of what is decided on a retirement, an admission or a change in profit sharing ratios is decided by four documents, and all four are usually drafted by someone who is thinking about the commercial deal rather than about section 9B and section 45(4).

• The valuation report. If a revaluation is to support attribution under Rule 8AB, it must come from a registered valuer within the meaning of Rule 11U. Obtain it before the entries are passed, not after the assessment begins.
• The retirement deed. It should say whether the firm is being reconstituted or dissolved, because they attract different provisions. It should state what the retiring partner receives and on what account: capital, undrawn profits, or consideration for relinquishment. The pre-2021 case law turned on exactly this distinction and the Department still reads deeds for it.
• The capital account working. Prepare the section 45(4) computation with D shown in two columns: the book balance, and the balance after stripping revaluation and self-generated asset credits. An Assessing Officer who has to construct that working himself will construct it unfavourably.
• Form 5C, now Form 27. Diarise it to the due date for the return of the year of charge. The Department treats it as a condition of the section 48(iii) deduction, and the deduction is too valuable to litigate over a form.

One further discipline is worth the effort. Where a stake is to move between partners, let the money move between the partners. Where an asset is to leave the firm, ask whether it can stay and the departing partner be paid in money instead. Both choices are usually available at the negotiation stage and almost never available afterwards.

Which Act applies to your matter

The Income-tax Act, 2025 came into force on 1 April 2026 and governs tax year 2026-27 onwards. Everything before it is governed by the Income-tax Act, 1961, and because a reconstitution is taxed in the year the partner receives the money or the asset, an exit completed before 1 April 2026 remains under the old Act however long the appeal takes.

Income-tax Act, 1961	Income-tax Act, 2025
s.2(23) firm includes LLP	s.2(45), with s.2(74) and s.2(75)
s.9B deemed transfer on receipt	s.8
s.45(3) contribution to firm	s.67(9)
s.45(4) receipt on reconstitution	s.67(10), definitions in s.67(11)
s.48(iii) attribution deduction	s.72(5)
s.50C stamp duty value	s.78
s.56(2)(x) receipt without consideration	s.92(2)(m), exclusions in s.92(3)
s.78 loss on change in constitution	s.119(1) and (2)
s.184 assessment as a firm	s.325
s.185 consequence of non-compliance	s.326
s.187 change in constitution	s.327, old proviso becomes s.327(3)
s.188 succession of one firm by another	s.328
s.189 dissolution or discontinuance	s.330
s.167C liability of LLP partners	s.331
s.40(b) remuneration and interest	s.35(e)
s.194T TDS on partner payments	s.393(3), Table entry 7
Rule 8AA(5), 1962 Rules	Rule 6(3), 2026 Rules
Rule 8AB, 1962 Rules	Rule 50, 2026 Rules
Form 5C	Form No. 27

Two of those rows are traps rather than translations. Section 9B becomes section 8, a number low enough that it looks like a definition provision. Section 78 means opposite things in the two Acts: carry forward of losses in the old, stamp duty value in the new.

The conversion routes, where a partnership firm becomes an LLP or a company, or a company becomes an LLP, raise a different set of provisions and a different set of failures. They are dealt with separately in Conversion of a firm, company or LLP: the conditions that get breached.

Related reading: Conversion of a firm, company or LLP: the conditions that get breached, the companion note on changing the legal form rather than the partners; Slump sale taxation: section 50B, section 77 and the disputed issues, where the business is sold out of the firm instead; Family arrangement: why it is not a transfer, where the partners are family and the rearrangement is a settlement; and Will, trust, LLP or HUF partition: the tax overlay, on choosing the holding structure in the first place.

This note is general commentary on the law as at 23 September 2026 and is not advice on any matter. The position in a particular case depends on its own facts.