Income Tax

Dissolution of a Partnership Firm: How Asset Distribution to Partners Is Taxed Under Section 45(4)

CA Nikhil Gupta·June 2026·8 min readIncome Tax

Reviewed by CA Nikhil Gupta · Last reviewed 17 June 2026

When partners decide to wind up a firm, or even when a single partner retires and takes assets in settlement of their capital account, the firm itself can end up with a capital gains tax bill, even though no sale to an outside party has taken place. Sections 9B and 45(4), introduced together, govern this often-overlooked tax trigger.

Why Dissolution or Asset Distribution Triggers Tax at the Firm Level

When a partnership firm (or an LLP, which is treated similarly for this purpose) is dissolved, or when assets are otherwise distributed to a partner (for example, on a partner's retirement, where the retiring partner is given certain firm assets in settlement of their capital account balance), this is treated as a deemed transfer of those assets by the firm, even though the assets are simply moving from the firm to one of its own partners.

Section 9B: Deemed Transfer on Receipt of Assets by a Partner

Section 9B provides that where a specified person (a partner) receives any capital asset or stock-in-trade from a specified entity (the firm/LLP) in connection with the dissolution or reconstitution of the entity, this is deemed to be a transfer of that capital asset or stock-in-trade by the firm to the partner, and the firm is deemed to have made profits or gains from such transfer, chargeable as income of the firm in the year in which such asset is received by the partner. The fair market value of the asset on the date of receipt by the partner is deemed to be the full value of consideration for this transfer.

Section 45(4): Taxing the Firm on Distribution to Partners' Capital Accounts

Section 45(4) deals specifically with money or other assets received by a partner from the firm in connection with reconstitution (which includes a partner's retirement or a change in profit-sharing ratios), to the extent it exceeds the balance in that partner's capital account (computed without considering any revaluation of assets or self-generated goodwill). This excess is deemed to be capital gains of the firm in the year in which such money or asset is received by the partner, taxed in the hands of the firm.

How the two provisions interact: Section 9B applies first, to compute the firm's income from the deemed transfer of the specific asset received by the partner at its fair market value. Section 45(4) then separately addresses any excess of money/value of assets received by the partner over their capital account balance, attributing this excess as capital gains of the firm. Both provisions can apply to the same set of facts depending on how the settlement is structured, and the computations are designed to avoid double counting the same amount under both sections.

Worked Example

What Happens to the Partner Receiving the Asset?

For the partner who receives the asset, the fair market value on the date of receipt (the same value used for the firm's Section 9B computation) becomes that partner's cost of acquisition for the asset going forward, for any future capital gains computation when the partner eventually sells it.

Why This Matters for Family Businesses and Professional Firms

These provisions are particularly relevant for family-run partnership firms and professional firms (such as CA firms, law firms, or family businesses structured as partnerships) holding significant appreciated assets like real estate, where a partner's retirement, death (leading to settlement with legal heirs), or a firm's dissolution can trigger a substantial tax liability at the firm level that the partners may not anticipate, particularly if the asset's book value is far below its current market value due to historical cost accounting.

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Frequently Asked Questions

Do these provisions apply if a new partner is simply admitted to the firm, without any asset distribution? ▼

Sections 9B and 45(4) are specifically triggered by the receipt of money or assets by a partner from the firm in connection with dissolution or reconstitution. The mere admission of a new partner, without any corresponding distribution of money or assets to existing partners, does not by itself trigger these provisions. The trigger is the outflow of assets or money from the firm to a partner, not changes in partnership composition alone.

Is the capital gains tax under Section 9B/45(4) paid by the firm or by the partner who received the asset? ▼

The capital gains computed under both Section 9B and Section 45(4) are taxed in the hands of the firm (or LLP), as income of the firm for the relevant year, not in the hands of the receiving partner. The receiving partner's tax position is affected separately, in terms of their cost of acquisition for the asset received, which becomes relevant when that partner eventually sells the asset.

How does this affect a sole proprietor converting their business into a partnership and later dissolving it? ▼

If a sole proprietorship is first converted into a partnership (which itself may have tax implications depending on how the conversion is structured) and the partnership later dissolves with assets being distributed to partners including the original proprietor, the dissolution-stage distribution would generally be examined under Sections 9B and 45(4) based on the facts at the time of dissolution, regardless of how the firm originally came into existence. Each stage (formation, operation, dissolution) is examined on its own facts for tax purposes.

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Primary category: Income Tax
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