On withdrawal of property by partners from a partnership firm, capital gains tax is triggered at the firm level under Section 9B of Income Tax Act and Section 45(4) of Income Tax Act (as amended by the Finance Act, 2021). The firm is deemed to have transferred the asset at Fair Market Value (FMV), and tax is computed accordingly, including any excess distribution to partners. However, for accounting purposes, the capital withdrawal is recorded in the books at book value (i.e., partners’ capital account balance) and not at FMV. Thus, while FMV is used for tax computation, the actual withdrawal entry in books continues at book value, creating a difference between accounting treatment and tax treatment.
 
 “On withdrawal of property, capital gains are computed in the hands of the firm based on FMV under Sections 9B and 45(4), while the accounting entry for capital withdrawal is generally recorded based on partners’ capital balance (book value), leading to a difference between tax and book treatment.”
 
📌 Capital Gain on Withdrawal of Property from Partnership Firm
🧾 Query Summary
A partnership firm (X) has two partners, A and B. They introduced a jointly owned property worth ₹3 crore (₹1.5 crore each) as capital in FY 2021–22. Now in FY 2025–26, they want to withdraw the same property from the firm.
👉 The key question is: Will capital gains tax arise, and in whose hands?

🔍 1. Tax at the Time of Introduction of Property
At the time when A & B introduced the property into the firm:

• As per Section 45(3) of Income Tax Act, this is treated as a transfer
• Capital gains are taxable in the hands of the partners (A & B)
• The value recorded in the firm’s books (₹1.5 crore each) is deemed as sale consideration

✔ Hence, tax implication already arises at the time of introduction.

🔍 2. Tax at the Time of Withdrawal (FY 2025–26)
Post Finance Act, 2021, taxation of partnership firms has significantly changed. Now, two key sections apply together:

✅ (A) Tax under Section 9B – Deemed Transfer by Firm
As per Section 9B of Income Tax Act:

• When a partner receives a capital asset (like property) from the firm
• On reconstitution or dissolution

👉 The law deems that the firm has transferred the asset to the partner at Fair Market Value (FMV)
✔ Taxable in the hands of the firm

✅ (B) Tax under Section 45(4) – Tax on Excess Distribution
As per Section 45(4) of Income Tax Act:

• If a partner receives:
  • Money OR
  • Money + capital asset
• And the value exceeds the partner’s capital account balance

👉 Then the excess amount is also taxed
✔ Again, taxable in the hands of the firm (not partner)

⚠️ Important Clarification (Very Common Confusion)

• ❌ Partners are NOT taxed merely for receiving property or excess value
• ✔ Entire tax liability is on the firm under Sections 9B and 45(4)

👉 The 2021 amendment was specifically introduced to:

• Avoid disputes
• Shift taxation to firm level
• Prevent tax avoidance through asset distribution

📊 Practical Understanding of Your Case
✔ Scenario 1: Property returned equal to capital

• A & B receive property worth ₹1.5 Cr each
• No excess

👉 Firm pays capital gains tax under Section 9B
👉 No tax in partners’ hands

✔ Scenario 2: Property + extra cash received

• Example: Property ₹1.5 Cr + ₹50 lakh

👉 ₹50 lakh = excess distribution
👉 Firm pays additional tax under Section 45(4)
👉 Still no tax in partners’ hands

🔎 Other Important Points

• FMV determination is crucial (stamp duty value may apply)
• Nature of gain (LTCG/STCG) depends on firm’s holding period
• Indexation benefit is not available for immovable property transferred after 23 July 2023 (as per Finance Act 2024)
• Proper capital account tracking is essential to compute “excess”

✅ Final Conclusion
✔ Yes, capital gain tax will arise on withdrawal of property

• Tax is payable by the firm, not the partners
• Section 9B → taxes FMV-based deemed transfer
• Section 45(4) → taxes excess distribution (if any)
• Partners are generally not taxed at the time of receipt