TWO TYPES OF TRANSFERS INVOLVED:

A. Transfer by Partner to Firm (Section 45(3))

When a partner contributes capital asset to the firm then Section 45(3) is applicable which says that: “The amount recorded in the books of the firm for such asset shall be deemed to be the full value of consideration for computing capital gain in the hands of the partner.”

✅ Computation in hands of Partner:

📌 Capital gain is taxed in the year of contribution.

B. Transfer by Firm to Partner (Section 45(4) & Section 9B)

Applicable when firm reconstitutes (retirement/admission/death) or distributes assets (including dissolution).

Section 45(4): Capital Gain in Hands of Firm Inserted by Finance Act, 2021 (effective from AY 2021–22) says that “If a specified person receives capital asset or money from firm upon reconstitution and value exceeds balance in capital account, then capital gain shall be taxed in the hands of the firm.”

🔹 Computation (Section 45(4)):

Capital Gain = A – B

Where:

• A = Value of money + FMV of capital asset received

• B = Balance in capital account of partner (without revaluation/self-generated goodwill)

➡️ Tax is in the hands of the firm.

Summary:

As per Section 45(2) “Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion of a capital asset into stock-in-trade… shall be chargeable to income-tax as income of the previous year in which such stock-in-trade is sold or otherwise transferred.”

TWO-PART TAXATION MECHANISM:

Part A – Capital Gain under Section 45(2)

This portion represents appreciation in value till the date of conversion.

Capital Gain = FMV on date of conversion – Indexed Cost of Acquisition

• FMV = Fair Market Value on date of conversion (as per Section 45(2))

• Indexed Cost = Original cost adjusted using Cost Inflation Index (CII)

💡 Long-Term or Short-Term?
✔️ Depends on the holding period till date of conversion.

Part B – Business Income under Section 28(i)

This portion represents appreciation after conversion, i.e., the gain between FMV on conversion date and actual sale price.

Business Income = Sale Price – FMV on date of conversion

💡 Taxed as business profit in the year of actual sale.

hough the term “Notional Cost of Acquisition” is not explicitly defined in the Income Tax Act, it is judicially and administratively recognised in cases where:

No actual purchase price exists, and the cost of acquisition has to be deemed or inferred by law, for the purpose of computing capital gains.

We can take the reference of the below sections:

Section 49(1):

Where the capital asset becomes the property of the assessee under a gift or will, the cost of acquisition shall be deemed to be the cost for which the previous owner acquired it.

Section 55(2)(a):

In the case of goodwill, trademark, brand name, tenancy rights, loom hours, right to manufacture/produce, etc., the cost of acquisition shall be taken as Nil, if self-generated.

Section 55(2)(b):

For assets acquired before 01.04.2001, the assessee has the option to take:

“the cost of acquisition shall, at the option of the assessee, be the fair market value of the asset as on 1st day of April, 2001.”

Summary:

Practical Scenarios of Notional Cost:

Indexation benefits allow taxpayers to adjust the purchase price of assets for inflation, thereby reducing taxable capital gains. However, there are certain cases where indexation is not available for long-term capital gains (LTCG) under the Income Tax Act:

1. Equity Shares and Equity-Oriented Mutual Funds

   • LTCG on listed equity shares and equity-oriented mutual funds is taxed at 10% (without indexation) under Section 112A if the gain exceeds ₹1 lakh in a financial year.
   • Indexation benefit is not available for these assets.

2. Gains Taxed Under Special Provisions

   • LTCG on bonds or debentures (except capital indexed bonds and sovereign gold bonds) does not qualify for indexation.
   • Securities held by Foreign Institutional Investors (FIIs) are also taxed without indexation benefits under Section 115AD.

3. Budget 2025 Changes (If Implemented)

   • From July 23, 2024, indexation may no longer be available on real estate, gold, and debt mutual funds.
   • LTCG on these assets may be taxed at a revised rate (e.g., 12.5%) instead of the earlier 20% with indexation.

Thus, while indexation helps reduce tax liability, it is not available for specific asset classes, particularly equity shares, certain bonds, and securities taxed under special provisions.

Capital assets are classified as short-term or long-term based on their holding period. The taxation rules for both categories differ under the Income Tax Act, 1961.

1️⃣ Short-Term Capital Assets (STCA)

✔️ Assets held for ≤ 36 months (≤ 3 years) before transfer.
✔️ For listed shares, equity mutual funds, and certain securities – holding period ≤ 12 months is considered short-term.
✔️ Gains taxed as per slab rates (for individuals) or flat 15% (for equities under Section 111A).
✔️ No indexation benefit available.

2️⃣ Long-Term Capital Assets (LTCA)

✔️ Assets held for > 36 months (or > 12 months for equities & specified assets).
✔️ Taxed at 20% with indexation (except equities, which are taxed at 10% without indexation if gains exceed ₹1 lakh under Section 112A).
✔️ Eligible for exemptions under Sections 54, 54F, 54EC, etc.

🚨 Key Budget 2024 Updates Considered

📌 Debt Mutual Funds – Always taxed as short-term, no LTCG benefit.
📌 Market-Linked Debentures (MLDs) – Always short-term, regardless of holding period.
📌 REITs & InvITs – Capital repayment now taxable.