TaxTMI 
TaxTMI 
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.
Retiring Partner receiving amount in excess of amount due to him
28 Jan 2011 
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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. (AI Summary)
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. (AI Summary)