s.45(4) — Capital gains on money or assets received by a partner on reconstitution
When a partner or member receives money or a capital asset from a firm, association of persons or body of individuals on its reconstitution, the excess over his capital account is taxed as the entity's capital gain.
Substituted by the Finance Act, 2021 with effect from 1 April 2021, replacing the earlier sub-section that taxed the distribution of capital assets on the dissolution of a firm or otherwise. The counterpart in the Income-tax Act, 2025 is section 67(10), with the definitions in section 67(11).
Income-tax Act, 1961
s.45(4)
Income-tax Act, 2025
s.67(10)
In force from 1 April 2026, but s.536(2)(c) preserves the 1961 Act for tax years beginning before that date.
In short
Section 45(4) of the Income-tax Act, 1961, as substituted by the Finance Act, 2021, provides that where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with its reconstitution, the profits or gains arising from the receipt are chargeable as income of the specified entity under the head capital gains of the previous year of receipt, computed by the formula A = B + C - D. B is the money received, C the fair market value of the capital asset received on the date of receipt, and D the balance in the person's capital account in the entity's books at the time of reconstitution. If A is negative it is deemed to be zero, and the capital balance is taken without any increase from revaluation of an asset or from self-generated goodwill or any other self-generated asset. The meanings come from section 9B: a specified entity is a firm or other association of persons or body of individuals, not being a company or a co-operative society; a specified person is a partner or member of one; and reconstitution means a partner or member ceasing, a new one being admitted while an existing one continues, or all continuing with a change in their shares. Explanation 2 says the sub-section operates in addition to section 9B, which deems the entity to have transferred any capital asset or stock in trade received by the partner at its fair market value, and the two charges are worked out independently. Section 48(iii) then lets the entity deduct, in computing its gain on an asset it is deemed to transfer, the amount charged under section 45(4) that is attributable to that asset, calculated in the prescribed manner, and section 9B(4) and (5) allow binding Board guidelines. For joint development the sub-section reaches a landowner firm or association that receives flats or money under an agreement and pays out a partner who retires or whose share changes. Section 45(5A) never applies to such an entity. The counterpart in the Income-tax Act, 2025 is section 67(10), with the definitions in section 67(11), and the 2025 text states that the provision operates in addition to section 8 of that Act.
What the provision does
Taxes the firm, association of persons or body of individuals, not the partner, when a partner or member takes out money or assets worth more than his capital account on reconstitution, by a formula that ignores revaluation credits and self-generated assets. It runs alongside section 9B, which taxes the deemed transfer of an asset handed over, and section 48(iii) lets the entity deduct the attributable part of this charge from its gain on that asset.
Threshold questions
- Is the payer a firm, other association of persons or body of individuals, and not a company or a co-operative society
- Has there been a reconstitution: a partner ceasing, a new partner admitted while an existing one continues, or a change in shares
- Did the partner receive money or a capital asset in connection with that reconstitution, and in which previous year
- What was his capital account balance at the reconstitution, leaving out increases from revaluation or self-generated goodwill or assets
- What was the fair market value, on the date of receipt, of any flat, plot or land the partner takes
- Is the asset received also a deemed transfer by the entity under section 9B, so that the section 48(iii) attribution is needed
In practice
The recurring disputes.
Flats received under a joint development agreement and handed to a retiring partner
A landowner firm that receives flats under an area-sharing agreement and gives some to a retiring partner faces two charges: section 9B on the flats as a deemed transfer at fair market value, and section 45(4) on the amount by which that value exceeds the partner's capital account. The Revenue's argument is that Explanation 2 makes the two independent and that each must be computed in full. The firm's argument is that section 48(iii) exists so that the part of the section 45(4) gain attributable to the flats is deducted in the section 9B computation, and that the firm's own cost of flats received outside section 45(5A), the value of the land given for them on the exchange view, must be recognised before any gain is found. How much is attributable depends on the prescribed manner of calculation, and no decision on flats received under a development agreement was traced.
Land contributed under section 45(3) and later taken back
A partner who brought land into the firm at a recorded value was taxed under section 45(3) on that value, and his capital account carries it. On retirement he may take back flats built on that land. The partner's argument is that the contribution credit is genuine capital that has already borne tax, so it forms part of D in full and only a real excess is charged. The Revenue's argument is that where the land went in at a low book value the credit is small, so almost the whole value of the flats is charged, and that any later upward revaluation of the land is excluded from D by the second proviso. Firms that revalued land ahead of a development to enlarge partners' accounts therefore gain nothing under section 45(4). The words favour the Revenue on revaluation; no decision on contributed land was traced.
Admitting developer partners into a landowner firm
A common structure is for a firm holding land to admit the developer's nominees as partners while some landowner partners retire. The firm's argument is that admission or retirement alone is not taxed, because the formula applies only where a person receives money or a capital asset from the entity, and that money paid by an incoming partner directly to an outgoing one is not received from the firm. The Revenue's argument is that where the incoming partner's capital is paid into the firm and drawn out by the outgoing partner, the outgoing partner has received money from the specified entity in connection with its reconstitution, and the excess over his capital account is the firm's gain. The flow of funds decides the case, and no decision on such a structure was traced.