Assessment of partnership firms

Objectives & Agenda :

To understand the assessment of partnership firms. To know the conditions to be satisfied to be assessed as a firm. To understand how partnership firms are assessed in various situations. To gain knowledge with regards to the deductions allowed to partnership firms during assessment.To know how to calculate book profit.

1. Assessment of Partnership Firms CA. Jugal Gala

2. Credits and Acknowledgments Anand N Krishna

3. Legends used in the Presentation AO Assessing Officer AY Assessment Year HUF Hindu Undivided Family LLP Limited Liability Partnership PY Previous Year

4. Presentation Schema

5. Partnership Firm – Sec 2(23) As per Section 2(23) of the Income Tax Act 1961, "firm" shall have the meaning assigned to it in the Indian Partnership Act, 1932, and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 Section 4 of Indian Partnership Act, 1932 Partnership is the relationship between persons who have agreed to share the profits of a business carried on by all or any of them. Limited Liability Partnership means a partnership formed and registered under this Act Section 2(n) of Limited Liability Partnership Act, 2008

6. Assessment of Firm

7. Conditions for Assessment – Sec 184

8. Manner of Assessment In case of reconstitution of the firm at the time of assessment, then the assessment shall be done only on the reconstituted firm When there is a failure on account of Section 144 on the part of firm, no deduction of interest, salary, bonus, commission or remuneration shall be allowed in the hands of the firm

9. Contravention of Conditions – Sec 185

10. Change in Constitution of Firm – Sec 187 At the time of scrutiny assessment under Section 143 or best judgement assessment under Section 144, when it is found that there is change in the constitution of a firm, the assessment shall be made on the firm as constituted Where the firm is dissolved on the death of any of its partners, it shall not tantamount to change in constitution

11. Succession of Firm – Sec 188

12. Joint and Several Liability for Tax Payable – Sec 188A However, in case of Limited Liability Partnership, the liability for a partner shall be restricted to its capital contribution

13. Dissolution of Firm – Sec 189 Partners at the time of dissolution or discontinuance, or the legal representative of deceased partner, shall be jointly and severally liable for the amount of tax, penalty and any other sum payable under the Act Where discontinuance or dissolution takes place after any proceedings have commenced, the proceedings may be continued for the persons referred above from the stage at which they stood at the time of such dissolution or discontinuance If the AO or the Commissioner (Appeals) in the course of any proceeding, in respect of any such firm, is satisfied that the firm was guilty of any of the acts specified in Chapter XXI (failure to furnish returns, failure to maintain books of accounts), he may impose or direct the imposition of a penalty However, the above provisions does not affect the extent of liability of the legal representatives specified in section 159(6) i.e. liability shall be limited to the extent of estate capable of meeting the liability

14. Deduction of Interest to Partners – Sec 40(b) However the above provision is not applicable if interest is paid to a person, acting otherwise than in a representative capacity, not being a partner (like Karta of HUF)

15. Illustration 1 M/s. A HUF is a partner in a firm, represented by Mr. A. Mr. A is not a partner in that firm in his personal capacity. Mr. A in his personal interest gave a loan of Rs.1,00,000 and the M/s. A HUF gave a loan amounting to Rs.4,00,000. The firm pays interest on the above loans as follows: A - Rs.15,000 HUF - Rs.50,000 Interest paid to Mr. A ( otherwise than as partner in a representative capacity ) Interest paid to HUF (in representative capacity) The amount paid to Mr. A as interest in his personal capacity will not attract provisions of Section 40(b) and so Rs.15,000 will be allowed as deduction to the firm Provisions of Section 40(b) will be applicable in case of Rs.50,000 and only Rs.48,000 (400000*12 %) will be allowed as deduction to the firm Explanation – 2 to Section 40(b) Explanation – 1 to Section 40(b)

16. Deduction of Remuneration to Partners – Sec 40(b) *Explanation 4 - Working partner means an individual who is a partner of a firm such an individual is actively engaged in conducting the affairs of the business/profession of the firm CBDT Circular No. 739, dated 25-3-1996 states that the partnership deed must specify either the quantum of remuneration to partners or lay down manner of quantifying such remuneration

17. Permissible Limit The maximum amount of deduction for remuneration to all the partners during the previous year should not exceed the limits given below Book Profit Amount deductible u/s 40(b) Book Loss Rs.1,50,000 Book Profit: On first Rs.3,00,000 of Book Profit Rs.1,50,000 or 90% of Book Profit, whichever is higher On the remaining Book Profit 60% of Book Profit Explanation – 3 to sec. 40(b) Book profit means the net profit, as shown in the P&L account for the relevant PY, computed in the manner laid down in Chapter IV-D (computation for profits & gains of business) as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit

18. Computation of Book Profit for Remuneration Particulars Amount Profit as per Profit & Loss a/c XXX Add: Remuneration to partners if debited to Profit and loss a/c XXX Add: Brought forward business loss, deduction under section 80C to 80U if debited to profit and loss a/c XXX Less: Income under house property, capital gain, other sources if credited to profit and loss a/c (XXX) BOOK PROFIT XXX

19. Transfer of Assets from Partner to Firm – Sec 45(3) However, no capital gains shall arise on transfer of a personal asset which does not fall within the purview of definition of capital asset

20. Transfer of Assets from Firm to Partner – Sec 45(4)

21. Illustration 2 ABC & Associates is a partnership firm with a net profit of Rs.5,00,000 for the year ended 31.03.2019 . The salaries paid to partners B and C, being working partners, was Rs . 2,00,000 each. The firm paid interest on capital at the rate of 15% which amounts to Rs.1,50,000. The interest earned by the firm on bank deposits is Rs.50,000 (credited to P&L A/c). The firm transferred its land to A, one of the partners, on 31.03.2019 at Rs. 20,00,000 for which the market value as on 31.03.2019 was Rs.25,00,000. The land was acquired by the firm on 01.04.2001 for Rs . 8,00,000. The sale consideration was not credited to P&L A/c. Compute capital gains, book profit and maximum remuneration allowable Particulars Amount (in Rs) Sale consideration as per Section 45(4) 25,00,000 Less: Indexed cost of acquisition (8,00,000*280/100) 22,40,000 Long Term Capital Gain 2,60,000 Computation of Long Term Capital Gain in the hands of firm

22. Contd.. Particulars Amount (in Rs) Profit as per Profit & Loss a/c 5,00,000 Add: Salary paid to partners if debited to Profit and loss a/c 4,00,000 Add: Interest paid in excess of 12% {(1,50,000 /15%)*(15%-12%)} 30,000 Less: Interest on Deposits credited to profit and loss a/c (50,000 ) Book Profit 8,80,000 Computation of Book Profit

23. Contd.. Maximum amount deductible in respect of total remuneration to partners Rs.2,70,000 Rs.3,48,000 Rs.6,18,000 Maximum Deduction

24. Caveats and Issues

25. Judicial Precedents M/s Durga Dass Devki Nandan vs Income-tax Officer, Palampur [2011] 12 taxmann.com 156 (Himachal Pradesh) The assessee, a firm, provided in the partnership deed that its partners would be “working partners within the meaning of section 40(b)” and “be paid a monthly salary as per the income-tax provisions” Section 40(b)(v) does not lay down any condition that the partnership deed should fix the remuneration or the method of quantifying remuneration CBDT circular No. 739 requires that either the amount of remuneration payable to each individual should be fixed in the agreement or the partnership agreement deed should lay down the manner of quantifying such remuneration The CBDT cannot issue a circular which goes against the provisions of the Act . The CBDT can only clarify issues but cannot insert terms and conditions which are not part of the main statute So a partnership deed which states that the remuneration would not exceed the maximum remuneration provided in the Act is valid and deduction is admissible

26. Contd.. Chalasani Venkateswara Rao v ITO [2012] 25 taxmann.com 378 (AP.) Where assessee, being a partner of a firm, on dissolution of firm, received a lump sum amount from another partner in full and final settlement towards his share and all assets and liabilities of firm were vested in said other partner, there was no transfer by assessee to other partner. Moreover, in case of dissolution of a firm only the firm is taxable on capital gains under Section 45(4) and not the partner Commissioner of Income-tax v Dynamic Enterprises [2013] 40 taxmann.com 318 (Kar) It was held that where retiring partner took cash towards value of his share in partnership firm and there was no distribution of capital assets among partners, there was no transfer of capital asset and, therefore, no profits or gains chargeable to tax under Section 45(4) arose in hands of firm

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