What happens for tax when a partner leaves or the partnership firm is dissolved?

The Income Tax Ordinance, 2001 treats a change of partners and a dissolution differently, but in both cases the firm’s tax does not disappear. A partner leaving mid-year is handled by section 98A. A firm that stops business or is dissolved falls under sections 98B and 117, and the assets it hands to partners fall under section 79. The rules below are from the Ordinance as amended to 30 June 2026.

What does the law say when a partner leaves mid-year?

Section 98A covers a change in the constitution of an AOP during a tax year. Three things follow:

1. Who files. The liability to file the return for that tax year is on the AOP as constituted at the time the return is filed.
2. Whose income. The AOP’s income is apportioned among the members who were entitled to receive it, so a partner who left still has the share he was entitled to for his part of the year.
3. Recovery. Where tax assessed on a member cannot be recovered from him, it is recovered from the AOP as constituted at the time of filing.

A partner leaving can also affect the firm’s carried forward losses. Section 98 applies to an AOP that is taxed separately from its members. If there is a change of fifty per cent or more in its underlying ownership, losses from before the change are not deductible after it, unless the AOP keeps conducting the same business until the loss is fully set off and does not take on a new business or investment mainly to use the loss.

What does the law say when the firm is dissolved?

Section 98B is printed inside the section 98A block in the parsed text. It covers a discontinued business and a dissolved AOP:

• Section 98B(1), subject to section 117, applies all the provisions of the Ordinance, so far as may be, as if no discontinuance or dissolution had taken place. Assessments, recovery and penalties can still run.
• Section 98B(2) makes every person who was a member at the time of discontinuance or dissolution, and the legal representative of any deceased member, jointly and severally liable for the tax payable by the AOP.

Section 117 adds the procedure. A person discontinuing a business gives the Commissioner written notice within fifteen days. A return is furnished for the period from the first day of the tax year of discontinuance to the date of discontinuance, and that period is treated as a separate tax year. If no notice is given, the Commissioner can serve a notice requiring a return.

What happens to assets handed to partners?

Section 79(1)(f) says no gain or loss arises on a disposal by an AOP to its members on dissolution where the assets are distributed in accordance with their interests in the capital of the AOP. Section 79(3) then treats the partner as acquiring:

• an asset of the same character as it had in the firm’s hands, and
• at a cost equal to the firm’s cost at the time of the disposal.

Section 79(2) switches this off where the partner acquiring the asset is non-resident at the time of acquisition.

The gain is therefore deferred, not removed. When the partner later disposes of a capital asset, section 37(2) computes the gain as A minus B, where A is the consideration received and B is the cost, which is the firm’s cost carried over under section 79(3). Section 37 once contained a sub-section (4A) that gave assets received on dissolution a fair market value cost. The Finance Act, 2022 omitted it, and it is not part of the current text.

Worked example (illustrative figures)

Asma and Bilal run a Gujranwala firm with equal capital. They dissolve it on 31 December 2026. The firm owns a shop with a tax cost of Rs. 4,000,000 and a godown with a tax cost of Rs. 4,000,000. Assume both are worth the same, so giving the shop to Asma and the godown to Bilal matches their equal capital interests.

Step 1: the firm’s final period. Under section 117, the firm gives notice within fifteen days of discontinuance and furnishes a return for 1 July 2026 to 31 December 2026, treated as a separate tax year.

Step 2: the transfer. Both partners are resident. Section 79(1)(f) applies, so the firm has no gain or loss on handing over the shop and godown.

Step 3: Asma’s cost. Under section 79(3), Asma’s cost for the shop is Rs. 4,000,000, the firm’s cost.

Step 4: a later sale. Asma sells the shop in 2028 for a made-up Rs. 11,000,000. Under section 37(2): Rs. 11,000,000 minus Rs. 4,000,000 = Rs. 7,000,000 gain. Because the shop is immovable property in Pakistan, section 37(1A) charges that gain under the head Capital Gains at the rates in Division VIII of Part I of the First Schedule, which this page does not reproduce.

Step 5: old tax. If FBR later assesses the firm for tax year 2026, section 98B(2) lets it pursue Asma or Bilal for the full amount.

What if …?

What if a partner leaves and a new one joins in the same year? Section 98A still applies. The AOP as constituted when the return is filed files it, and income is apportioned among the members entitled to it.

What if one partner is non-resident when the assets are shared out? Section 79(2) disapplies the non-recognition rule for that partner’s acquisition. How the consideration on that disposal is measured is not set out in section 79, and this page does not resolve it.

What if assets are not shared in line with capital interests? Section 79(1)(f) is limited to distributions in accordance with the members’ interests in the capital. The section does not say how an uneven split is treated.

Common mistakes

• Assuming a departed partner is free of the firm’s old tax. Section 98B(2) makes members at the time of dissolution jointly and severally liable.
• Stepping up the partner’s cost to market value. The current section 79(3) uses the firm’s cost; the old section 37(4A) rule was omitted in 2022.
• Skipping the discontinuance notice. Section 117 sets a fifteen day notice and a return for the short period.
• Ignoring losses when a big share changes hands. Section 98 can bar pre-change losses after a change of fifty per cent or more in underlying ownership.

What to check in the official text

Read sections 98A and 98B (printed together), 117, 79, 37 and 98 in the official PDF. The Partnership Act, deeds of dissolution, stamp duty and provincial property transfer taxes are outside this corpus and are not covered here.