Discontinuance of business of firm will not vest ownership of firm’s property with partners

Discontinuance of business of partnership firm will not result in vesting ownership of firm’s property with individual partners for capital gain taxation

In a recent judgment, ITAT Visakhapatnam has held that discontinuance of the business of partnership firm will not result in vesting ownership of firm’s property with individual partners and no part of the capital gain on the sale of the property by the firm is liable to be assessed in the hands of the individual partners.

ABCAUS Case Law Citation:
4964 (2025) (12) abcaus.in ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A), National Faceless Appeal Centre in confirming the action of the Assessing officer in determining the Long Term / Short Term Capital Gain in the hands of firm instead of individual partners of the firm.

The appellant was a Partnership Firm. The firm had filed its return of income for the subject year wherein it had under the head “income from capital gain” disclosed the sale consideration but had claimed that the long-term capital gains arising on the said sale transaction was disclosed in the hands of the partners of the assessee firm (discontinued business), and thus not offered for tax any part of the capital gains on the aforesaid sale transaction in its returned income.

On the other hand, partners of the assessee firm had in the returns of income disclosed their respective shares in the capital gain on the sale transaction based on their profit-sharing ratio in the firm. Also, the said partners had against the amount of capital gains claimed exemptions under section 54F and 54EC of the Act, as a result whereof the resultant income under the said head was substantially scaled down.

The case of the assessee firm was selected for “limited scrutiny assessment” for verifying its claim for deduction of “capital gains”.

The Assessing Officer (AO) observed that the assessee firm was constituted vide a partnership deed and had claimed to have carried on its business activity only up to first week of the February of the relevant Assessment Year.

It was the claim of the assessee firm that due to losses it had discontinued its business and for the last two years was only collecting rent from its immovable property and had no other stream of income.

It was submitted by the assessee that pursuant to discontinuance of the business the assessee firm had lost its identity as a partnership firm and was transformed into an Association of Persons (AOP). It was stated by the assessee firm that the property was thus sold by the AOP despite that the buyer had deducted the tax at source (TDS) using the PAN of the firm.

It was contended that though the capital gains on the sale of the subject property were offered in the name of the individual members of the AOP, but since TDS was deducted in the hands of the firm, the firm has claimed latter credit of TDS in its return of income.

The AO was of the view that the capital gain arising on the sale of the subject property was liable to be assessed only in the hands of the assessee firm and could not be brought to tax in the hands of any other entity, i.e., either in the hands of the AOP and/or the partners of the assessee firm.

The AO observed that the assessee firm in its return of income had while computing the long term capital gains on the sale of the subject property had raised claim for deductions, viz., cost of acquisition (indexed), cost of improvement (indexed), and expenses related to transfer. However, there was no documentary evidence which would substantiate its aforesaid claim for deductions.

Accordingly, the AO declined the assessee’s claim for deduction of cost of improvement (indexed) and also the expenses related to transfer and brought to tax the capital gain on sale of property in the hands of the partnership firm.

The Tribunal noted that the partners of the assessee firm had in the returns of income disclosed their respective shares in the capital gain on the sale transaction based on their profit-sharing ratio in the firm. However, against the amount of capital gains the partner’s had claimed exemptions under section 54F and 54EC of the Act, as a result whereof the resultant income under the said head was substantially scaled down.

The Tribunal observed that though it was the claim of the assessee firm based on a letter filed with the Commercial Tax Officer, that it had discontinued its business, but the same will not conclusively prove that the said business was actually discontinued as assessee firm had not filed any application intimating the discontinuance of its business with the concerned Assessing Officer as required per the mandate of section 176(3) of the Act.

The Tribunal held that the discontinuance of the business of the assessee firm would by no way result to vesting the ownership of the subject property held by the partnership firm with the individual partners, either in the status as that of individual partners of the firm or members of an AOP.

The Tribunal noted that assessee had relied upon the judgment of the Hon’ble Jurisdictional High Court of Andhra Pradesh but the same was distinguishable on facts as the Hon’ble High Court had observed that as the firm before them was not actually carrying on business, there was no valid partnership for the subject assessment year before them. In this backdrop the Hon’ble High Court had observed that the rental income derived by the partnership firm in the absence of carrying of any actual business was to be assessed in the hands of the individual partners as co-owners.

Further the Tribunal pointed out that the registered sale deed by which the subject property had been sold by the firm, firm had been shown as the vendor-owner, therefore, the capital gain on the transfer of the subject property without any choice has to be offered for tax in the hands of the assessee firm.

The Tribunal held that when the assessee firm is the “right person” in whose hands the capital gain on the transfer of the subject property could have been assessed, therefore, by no means any part of the said capital gain could have been assessed in the hands of the individual partners and this view is supported by the judgment of the Hon’ble Supreme Court.

The Tribunal held that (a) the property sold by firm was liable to be assessed only in its hands; (b) discontinuance of the business of the firm will not result to vesting of the ownership of the property with the individual partners as owners (c) no part of the capital gain on the sale of the subject property is liable to be assessed in the hands of the individual partners.

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