Tax Implications U/S 56(2)(X) On Capital Asset Contributions To Partnership Firms And LLPS

This article analyses the tax implications of Section 56(2)(x) of the Income-tax Act when a partner contributes capital assets to a partnership firm or LLP. The author argues that this "gift-tax" provision, originally designed to prevent money laundering, is being incorrectly applied to bona fide business transfers where the recorded book value is less than the fair market value. Drawing on various Supreme Court precedents, the article explains that such transactions should not be taxed because the actual consideration received by a partner is legally indeterminate and only matures upon retirement or dissolution. Since the firm and its partners share a joint interest in the property, the firm cannot be viewed as a distinct recipient of a gift. Ultimately, the article concludes that without a specific legislative fiction to value these contributions, the tax charge fails due to an impossible computation mechanism. This reasoning applies equally to Limited Liability Partnerships, which are treated as traditional firms for tax purposes.

BACKGROUND

Section 56(2)(x) of the Income-tax Act, 1961 (“the Act”) — often referred to as the gift-tax provision — seeks to bring to tax, under the head Income from Other Sources, any sum or specified property received without consideration or for inadequate consideration. Section 56(2)(x)(c) provides that where any