A partnership firm M/s. XYZ & Co. was formed in 1960. The firm purchased a land parcel of ~ 5 acres in industrial area in the name of the firm and built superstructures thereon to run a factory manufacturing foam and mattresses. The land was purchased for Rs.5 lakhs. The firm was running its factory and filing compliances regularly with distribution of profits to partners while all the while the balance sheet of the firm showed the land asset at purchase price book value along with building and machineries at WDV year on year.
In 2007 X expired and the firm was reconstituted as a going concern with Y and Z as equal partners being the only two sons of the deceased X. The new partnership deed between Y and Z comprised the following provisions inter-alia:
CAPITAL CONTRIBUTION:
…..Each party hereto shall contribute and provide capital in the business of the firm according to as may be agreed upon by the parties. The amount of capital/invested may be varied from time to time in the manner as may be agreed upton between the parties to this partnership.
RETIREMENT:
That any of the partners of the firm may retire from the partnership business giving three months notice in writing ot the other partner…….. Provided that on such retirement and payment of all dues of the retiring parter, the continuing/remaining parter shall be entitled to continue the said partnership firm as a proprietorship concern and/or the business shall not be dissolved by such retirement but the continuing partner in such event, shall be at liberty to admit any other party to the said partnership. But in no event shall such retiring partner lay any claim to the land, factory building, machinery and plant or assets therein or forming part thereof or any appreciation whatsoever.
DISSOLUTION:
That this partnership shall be a partnership at will. That in case of death of any of the partner(s) hereto of the partnership, the partnership shall not stand dissolved but the same shall be continued by the surviving partner and the legal heir of the deceased partner shall be admitted to the said partnership in place and stead of the deceased. That in case of dissolution of the firm, the assets of the firm comprising land, building, machinery, equipments, fixtures and fittings, goodwill and all movable and immovable goods and/or properties shall vest in equal proportions to the parties hereto at book value of the respective assets/block as per the balance sheet of financial year ended immediately preceding the year of such dissolution…...
As on 31st March 2026, following were the relevant extracts from the firm’s balance sheet: ~
Y capital Rs.170 lakhs
Z capital Rs.36 lakhs
Land asset Rs.5 lakhs
Building asset WDV Rs.200 lakhs
Machinery asset WDV Rs.23 lakhs
(Y capital was more because he had inducted money for rehabilitation of buildings. Accordingly he was getting more interest on capital at the rate decided among the partners as the skewed capital was otherwise not supposed to influence the profit ratio.)
In 2025 dispute arose among the partners. The land market value by this time had become ~ 50 cr. None of the partners have the liquidity to purchase the value entitlements of the other party. Z wanted that the firm be dissolved and he gets his share of the land parcel registered in his name along with other assets as per valuation to be taken over by Y. Alternatively, Z wanted to sell the portion of land that he would be entitled to on dissolution and leave the firm to be continued by Y as a proprietor ship or in partnership with some new party.
Z is advised by auditors as under:
Upon dissolution and distribution of land (now valued @ ~50 cr) the firm would become liable to capital gain tax under section 9B. Besides, section 45(4) might also entail additional tax by way of present land value share less the capital account nominal balance of the respective partners thereby suggesting double whammy for the firm and/or partners. Neither the firm nor the partners have the liquidity to pay any such taxes given that there is no external sale of any asset. Given the restrictive clause in the partnership deed, it goes without saying that Z would be shooting his own feet if he were to retire from the firm. Y is not interested in selling the land in particular his share thereof even if Z sells or moves out.
What are the options for Z to move out with full entitlements including the land present value with least taxation if he
a) wishes to retain the land portion in his name or
b) wishes to sell his portion while moving out
Y has suggested that he might be inclined to sell the land 7-10 years down the line (the land parcel as a single piece is likely to fetch a better price vis-a-vis being sold in parts)
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