Valuation of a partner's interest in a firm. - Income Tax - 1063/CBDT

INSTRUCTION NO. 1063/CBDT Dated : may 30, 1977 The question of valuation of a partner's interest in a firm may arise in any one of the following circumstances: (i) When new partners are admitted to an existing firm and consequent upon the allotment of specified shares to them in profit/loss of the firm, the shares of the existing partners are reduced and the shares given to the new partners are without adequate consideration in money or moneys worth; (ii) When there are changes in the profit-sharing ratio of the existing partners of a firm and the allotment of higher shares to one or more partners is without adequate consideration in money or money's worth. (iii) When a sole proprietary concern is converted into a partnership and the shares in profits allotted to the partners other than the one who was the sole proprietor of the business prior to its conversion into partnership, are without adequate consideration in money or money's worth. 2. The partner's interest in a firm may be of two types: (i) the right to share the profits of the firm as well as the right to share the assets; and (ii) the right to share the profits of the firm without the right to share the assets. As far as the former is concerned, detailed instructions have already been issued by the Board vide Instruction No.942 dated 26th March, 1976. It was clarified therein that while valuing the gift arising in the case of a partner who has a right to share the assets of the firm, the Gift-tax Officer should, in accordance with Rule 10(3) of the Gift-tax Rules, add the value of goodwill- an intangible asset-to the market value of other assets of the firm (in case it possessed goodwill) irrespective of whether goodwill was reflected in the balance-sheet or not. As regards the types of the cases covered by item (ii) above, it was stated in para 3 of the same Instruction that the value of interest of those partners who had no right to share the assets but have only a right to share the profits of the firm might be determined by following the method of capitalisation of income. Those instruction should be considered as partially superseded by Circular No.219 dated 30th May, 1977, which will govern valuation of interest of those partners who have no right to share the assets but have only a right to share the profits of the firm. 3. It may be clarified that for determining whether there was any gift involved in the transfer of such interest, as contemplated by any of the type mentioned in para 1 above, the Gift-tax Officer should take into account the consideration following from the person in whose favour the interest has been transferred. The consideration could be in the form of the capital introduced in business or in the form of labour, as in the case of working partner, or both. The Gift-tax Officer would have to consider the adequacy of the consideration.