Introduction
In a significant ruling addressing the perennial controversy surrounding taxation of revaluation surplus received by retiring partners, the Ahmedabad Bench of the Income Tax Appellate Tribunal (ITAT) has partly allowed the appeal in Anilkumar Bhikhabhai Virani v. Deputy Commissioner of Income Tax, Circle-1, Bhavnagar (ITA No.2343/AHD/2025) for Assessment Year 2011-2012. The order, pronounced on 01.09.2026 by a Division Bench comprising Dr. B.R.R. Kumar, Vice President, and Shri Rahul Chaudhary, Judicial Member, clarifies the interplay between Section 10(2A) and Section 45(4) of the Income Tax Act, 1961. While the Tribunal refused to extend the benefit of Section 10(2A) to a partner receiving his share of enhanced land value upon retirement, it firmly held that such surplus could not be taxed in the hands of the partner in light of the Supreme Court’s decision in CIT v. Mansukh Dyeing & Printing Mills. The addition of Rs.1,37,70,000 made by the Assessing Officer in the partner’s hands was consequently deleted. This commentary explores the legal reasoning, the pivotal Supreme Court precedent, and the implications for similar disputes.
Facts of the Case
The Assessee, Anilkumar Bhikhabhai Virani, was a partner in M/s Aum Developers. Upon his retirement from the partnership firm, he received a sum of Rs.1,37,70,000 as his share in the enhancement in the value of land arising on account of revaluation of the firm’s assets. Before the Assessing Officer, the Assessee contended that this amount was not taxable in his hands. The Assessing Officer rejected this submission and brought the amount to tax, holding that the receipt was neither in the nature of share of profit nor remuneration received by a partner, and therefore did not qualify for exemption under Section 10(2A) of the Act. The Assessing Officer observed that the amount was over and above the Assessee’s capital and ought to have been offered to tax.
Aggrieved, the Assessee appealed before the National Faceless Appeal Centre (NFAC), Delhi, which acted as the CIT(A). Before the CIT(A), the Assessee reiterated his earlier stand and additionally contended that, in view of the provisions of Section 45(4) of the Act, the amount could only be taxed as income in the hands of the firm, relying on the Supreme Court ruling in Mansukh Dyeing and Printing Mills v. CIT. The CIT(A), however, dismissed the appeal. The Assessee then approached the ITAT, raising grounds challenging both the reopening of assessment under Section 147 r.w.s. 148 of the Act and the disallowance of exemption of Rs.1,37,70,000 claimed under Section 10(2A).
Reasoning and Legal Analysis
The central issue before the ITAT was twofold: first, whether the amount received by the Assessee on retirement could be claimed as exempt under Section 10(2A) of the Act, and second, if not exempt, whether such amount was taxable in the hands of the partner or the partnership firm. The Tribunal commenced its analysis by examining the plain language of Section 10(2A), which mandates that to claim exemption, the amount in question must qualify as the partner’s ‘share in the total income of the firm.’ The Tribunal observed that the amount received by the Assessee was admittedly on account of revaluation of assets of the firm and not an integral part of the firm’s total income computed under the Act. Consequently, the benefit of Section 10(2A) was not available to the Assessee. This finding aligned with the Assessing Officer’s view that a revaluation surplus credited to a partner’s account is not a share of the firm’s taxed income.
However, the Tribunal’s analysis did not end there. It carefully distinguished between the character of the receipt and the entity liable to tax on such receipt. The Tribunal referred to the Supreme Court’s decision in CIT v. Hind Construction Ltd (1972) 83 ITR 211 (SC), wherein it was held that when assets are revalued and effect is given by crediting partners’ accounts, no actual sale or transfer to an independent person takes place, and hence no profit arises that can be taxed as business income. The Supreme Court in that earlier era had observed that revaluation of assets is not a taxable event by itself and does not create ‘profit’ in the ordinary commercial or tax sense, thereby holding that distribution of surplus arising from revaluation of capital assets among partners did not result in taxable income in the partners’ hands.
The legal landscape, however, underwent a significant shift with the insertion of Section 45(4) by the Finance Act, 1987, along with the simultaneous omission of Section 2(47)(ii) of the Act. Section 45(4) provided for taxation of capital gains arising on transfer of a capital asset by way of distribution of assets of a firm on dissolution or otherwise, in the hands of the firm rather than the partners. The Tribunal next examined the Bombay High Court decision in CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom), which held that transfer of partnership assets to retiring partners amounts to transfer of capital assets, thereby attracting capital gains tax under Section 45(4). This established that retirement, though distinct from dissolution, could trigger the deeming fiction of transfer under Section 45(4) when assets are distributed to a retiring partner.
The decisive authority, however, was the subsequent Supreme Court judgment in CIT v. Mansukh Dyeing & Printing Mills (2022) 449 ITR 439/145 taxmann.com 151 (SC). The Tribunal noted that the Supreme Court had held that revaluation of assets of a partnership firm, followed by the credit of the revaluation surplus to partners’ capital accounts, is, in effect, a distribution of the increased value of the firm’s assets amongst the partners. Such distribution, according to the Supreme Court, constituted a ‘transfer’ attracting the provisions of Section 45(4) of the Act. Consequently, the income arising from such transfer is to be computed and taxed as capital gains in the hands of the firm itself. Applying this ratio to the facts of the present case, the ITAT found that the Assessee’s retirement receipt of Rs.1,37,70,000, being the revaluation surplus attributable to land, was taxable, if at all, in the hands of M/s Aum Developers under Section 45(4).
The Tribunal was careful to note that Section 45(4) has since been substituted and a new Section 9B has been inserted by the Finance Act, 2021. However, those amended provisions are effective only from 01/04/2021. Since the present appeal pertains to Assessment Year 2011-2012, the amended provisions had no application, and the pre-substitution Section 45(4), as interpreted by the Supreme Court in Mansukh Dyeing & Printing Mills, governed the matter. The Tribunal thereby found merit in the Assessee’s contention that the surplus, if taxable, was taxable in the hands of the partnership firm and not the partner.
Additionally, the Tribunal reinforced its conclusion by relying on CBDT Circular No.8 of 2014, dated 31/03/2014, which clarified that income of a firm is to be taxed only in the hands of the firm and not in the hands of its partners. This circular, read with the statutory scheme of the Act—which treats a firm as a separate taxable entity distinct from its partners—led the Tribunal to hold that the Assessing Officer had erred in making the addition in the hands of the Assessee. Though the benefit of Section 10(2A) could not be extended to the Assessee because the amount was not his share of the firm’s total income, the same amount could not simultaneously be taxed in his hands as a partner, because the deeming fiction under Section 45(4) placed the tax liability on the firm. Thus, the addition of Rs.1,37,70,000 made by the Assessing Officer was deleted. Ground No.2 was partly allowed on merits, while the remaining grounds challenging the validity of the reassessment proceedings under Section 147 r.w.s. 148 were dismissed as having become academic since the substantive addition had already been deleted.
Conclusion
The ITAT’s order in Anilkumar Bhikhabhai Virani is a well-reasoned synthesis of judicial precedent and statutory construction. It underscores a crucial nuance: denial of exemption under Section 10(2A) does not automatically render the receipt taxable in the partner’s hands. Instead, the Tribunal correctly channelised the taxability inquiry to the firm under Section 45(4) based on the Supreme Court’s binding ratio in Mansukh Dyeing & Printing Mills. The decision prevents double taxation and protects retired partners from assessment on revaluation surplus when the statutory scheme and CBDT circular place the incidence of capital gains tax on the firm. By deleting the addition and limiting the ancillary grounds as academic, the Tribunal has provided clarity for similar disputes arising in pre-2021 assessment years. Taxpayers and tax administrators alike must take note that the taxing entity for revaluation surplus distributed to partners is the firm, not the partner, under the old Section 45(4) regime.