Retiring Partner receiving amount in excess of amount due to him

[Basavaraj S]

Mr. 'A' a partner of a firm had invested say Rs.5 lakhs. The firm have been incurring losses for several years. Due to loss the Capital balance of the partner has reduced to say Rs.2 lakhs. The firm is now contemplating to pay the original investment of Rs. 5 lakhs on retirement of Mr. A. Is the excess amount paid by the firm of Rs. 3 lakhs amounts to a taxable income or is this treated as a Capital receipt? If so please provide us the relevant section/caselaw/article. 

[MOHAN S]

Mr.Basavaraj, 

Your query is not clear as to how the payment of Rs.5 lacs is accounted in the books of the firm. If the amount lying to the credit of the retiring partner is less than Rs 5 lacs then certainly the difference has to be explained. For example if the firm treats the excess payment as "goodwill" then certainly it will be taxed in the hands of the retiring partner as Capital Gains u/s 45 of the I.T Act. Hence, unless the facts are clearly stated, it is not possible to give a view or case law.

[Shivaji Lokre]

In the above case stated by Mr.Basavaraj, assuming the firm was making profits and the retiring partner was given amount more than what is being credited to his capital account , on account of following situations;

1) Siuation1: The excess payment was due to revaluation of Assets and there was no clause in the Deed of Partnership as to revaluation of assets.

2) Siuation2: The excess payment was due to computation of Goodwill paid to the retiring partner and there is no such clause in the partnership deed as to payment of such Goodwill.

My qestion  in the above stated case is:

a) Taxability in respect of amount received by the retiring partner and  whether such excess payment made to retiring partner by firm is allowed as deduction in the hands of the firm or will be treated as capital payment and hence not allowed as deduction. Further, if it is treated as capital payment then, will such amount be capitalized as asset or distributed to capital accounts of the gaining partners.

 

b) Having a clause for payment of Goodwill to retiring partner  is  pre-requisite to pay good will to the retiring partner.

 

Please resolve Mr.Mohan S  sir.

AI Summary

Characterisation of excess retirement payment as goodwill determines capital gains treatment rather than revenue taxation. Whether an excess payment to a retiring partner is taxable or a capital receipt turns on its characterisation. If the excess is payment for goodwill, it is a capital receipt for the partner and may attract capital gains treatment under s.45; if recorded as revenue, different tax consequences and deductibility issues for the firm arise. The partnership deed and the manner of accounting (revaluation entry, goodwill recognition, or capital adjustment) determine whether the firm may deduct the payment or must capitalise it and adjust partners' capital accounts.