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Assessment of Firm - Taxation

Learning Sections

Section 10(2A)	Share of profit from firm is exempt in the hands of partners.
Section 28	Interest and remuneration treated as business income in the hands of partners.
Section 37	Interest and remuneration to partners is allowed as deduction in the hands of firm.
Section 40b	Restriction of deduction on interest and remuneration to partners.
Section 184	Assessment of firm.

Introduction

a. A partnership firm is treated as separate entity under the Income Tax Act.

b. It is assessed in respect of its own income and not in respect of the income of its partners.

c. The partners, on the other hand, are liable for their own income and not of the income of the firm in which they are partners.

Section 184. Assessment of Firm

A firm shall be assessed as a firm, if

(i) the partnership is evidenced by an instrument. (written agreement amongst partners); and

(ii) the individual shares of the partners are specified in that instrument.

(iii) A certified copy of the partnership deed shall accompany the return of income in respect of which assessment as a firm is first sought.

Optional agreement

(a) Interest on capital & loan contributed by partners.

(b) Remuneration payable to partners If the above conditions of section 184 are satisfied then interest and remuneration payable to partners are allowed as deduction in the hands of firm.

If above conditions of section 184 are not satisfied then interest & remuneration to partners shall not be allowed as deduction, though such firm shall be continued to be assessed as a firm and not as an Association of Persons.

The income of firm is subjected to 30% flat rate of tax. Surcharge is levied @ 12% if total income exceeds Rs 1 Cr. if applicable and education cess @ 3% shall be levied accordingly.

Tax Treatment in The Hands of Firm and Partners

Business income of the firm shall be computed by applying sections 28 to 44D. The firm is also entitled to following deduction under section 37.

a. Interest on capital / loan contributed by partners.

Section 40b allows a maximum deduction of 12% p.a. simple interest in the hands of firm. The deduction allowed in the hands of firm is treated as business income in the hands of partners.

b. Remuneration payable to partners.

In addition to capital contributed by partners to its firm it also provides certain services. Services rendered by partners are entitled to remuneration. Following conditions should be satisfied.

i. Remuneration by whatever name called is payable to working partner.

ii. Remuneration payable to partner is specified in partnership deed. (X : 5,000 p.m. Y : 10% of turnover. Z : 5% of profits)

Section 40b also specifies maximum remuneration which can be paid to partners. The amount of remuneration allowed as deduction in the hands of firm is treated as business income in the hands of partners. Remuneration to partners shall be distributed in remuneration ratio.

Section 40b computation of maximum remuneration payable to partners

a. Maximum remuneration payable to partners depends upon ‘book profit’.

b. Book profit is computed under the head ‘Business’ by making all adjustments under section 28 to 44D except remuneration allowed to partners.

Computation of Book Profit

Net profit as per P & L A/c after making all adjustments u/ss 28 to 44D except section 40b	A
Less : Interest allowed to partners under section 40b	(B)
Book profit	C

Note : Brought forward losses which falls under section 70 to 80 is not subtracted in computing book profit. Deduction u/s 80C to 80U is not subtracted in computing book profit.

Book Profit	Limit
First ? 3,00,000	Rs 1,50,000 or 90% of book profit whichever is more
Balance	60%

P1: (A) The firm is engaged in the business of selling computers. Compute remuneration payable to partners u/s 40b which shall be allowed as deduction.

	case 1	case 2	case 3	case 4
Book Profit	5,00,000	3,00,000	(70,000)	1,60,000
Remuneration as per partnership deed :
A (working partner)	1,00,000	1,00,000	100,000	50,000
B (working partner)	2,00,000	50,000	60,000	40,000
C (working partner)	1.00.000	1,00,000	10,000	50,000
Total	4,00,000	2,50,000	1,70,000	1,40,000

(B) Solve Case 1 if A is a sleeping partner and Case 3 if B is sleeping partner.

Ans: (A) 3,90,000; 2,50,000; 1,50,000; 1,40,000; (B) 3,00,000; 1,10,000.

Solution

Computation of Remuneration as per section 40b

Case 1 : Book profit Rs 5,00,000. [Remuneration = 90% of 3,00,000 + 60% of 2,00,000 = 3,90,000] therefore remuneration u/s 40b Rs 3,90,000 or Rs 4,00,000 (remuneration allowed to working partner) whichever is less. Therefore Rs 3,90,000 is deductible remuneration.

Case 2 : Book profit = Rs 3,00,000, therefore remuneration u/s 40b Rs 2,70,000 or Rs 2,50,000 (remuneration allowed to working partner) whichever is less. Therefore Rs 2,50,000 is deductible remuneration.

P2: (A) X, Y and Z are partners in Armani & Co. (Firm) sharing profit in ratio of 1 : 4 : 2 satisfying the requirement of section 184 furnishes following P & L A/c for the previous year.

Particulars		Amount	Particulars		Amount
Purchases		31,00,000	Sales		31,73,000
Remuneration to partners X (working partner) Y (Sleeping partner)	25,000 5.000	30,000	Interest on drawings X @ 5% Y @ 4%	400 600	1,000
Interest to partners
X @ 15%	3,000
Y @ 10%	1,000	4,000
Net Profit		40,000
Total		31,74,000	Total		31,74,000

Additional Information :

1. Entertainment expenses of Rs 4,300 not debited to P / L A/c.

2. Interest on capital allowed to Z (working partner) is @ 16% on capital contribution of Rs 1,20,000 and remuneration allowed to him is Rs 15,000. Both the amounts are not debited to P & L A/c.

Compute 1. Book Profit 2. Remuneration allowed as deduction under section 40b 3. Profit of Business of Firm

4. Tax Liability of Firm 5. Taxable income of partners (no other individual income).

(B) Compute profit from business of firm if the conditions of section 184 is not satisfied.

Solution

Computation of profit from business

Net profit			40,000
(+) Remuneration to partners			30,000
(+) Interest to partners treated separately			4,000
(-) Entertainment expenses			(4,300)
Profit from business before S 40b			69,700
(-)	Interest to partners allowed as deduction
	X @ 12% (3,000 - 15 x 12)	2,400
	Y @ 10%	1,000
	Z @ 12%	14,400	(17,800)
(-)	Remuneration to partners (Note 1)		(40,000)
Profit from Business			11,900
Tax @ 30.9% of 11,900			3,677

Note 1 : Computation of book profit and remuneration

Profit after making all adjustment u/s 28 to 44D except section 40b	69,700
Less : Interest to partners allowed as deduction	(17,800)
Book Profit	51,900

Remuneration allowed as deduction is 90% of 51,900 = Rs 46,710 or Rs 1,50,000 whichever is more but limited to Rs 40,000. Maximum remuneration allowed as per partnership deed is Rs 40,000.

Computation of income in the hands of partners

	X	Y	Z
Remuneration to partners	25,000	nil	15,000
Interest upto 12%	2,400	1,000	14,400
Profit from Business u/s 28	27,400	1,000	29,400

(B) If conditions of section 184 is not satisfied deduction on account of interest and remuneration to partners is not allowed. Therefore profit of business of firm is Rs 69,700.

P3: Profit of a partnership firm is Rs 3,00,000 after charging interest on capital @ 20% of its total capital of Rs 5,00,000. Remuneration as per partnership deed is Rs 4,00,000. Compute profit of the firm ?

Ans: 46,000.

P4: A firm has incurred a loss of Rs 1,00,000 after providing for remuneration of Rs 1,80,000. Compute profit of the firm.

Ans: (70,000)

P5: Profit and Loss of R Co. (a partnership firm) for the year ending 31-3-2017 is as follows

Cost of goods sold	10,00,000	Sales	15,00,000
Remuneration to partners	2,49,000	Rent of house property	60,000
Interest to partners @ 18% p.a.	60,000	Dividend from Indian Company	1,70,000
Municipal taxes of house property	25,000
Other expenses	2,36,000
Net profit	1,60,000
Total	17,30,000	Total	17,30,000

Other Information :

(i) Out of the other expenses, Rs 18,400 is not deductible under section 36, 37(1) and 43B.

(ii) On 15-1-2017, the firm pays an outstanding sales tax liability of Rs 54,700 of the previous year 2015-16. This amount pertains to the previous year 2016-17, it has not been debited to the aforesaid profit and loss account.

Calculate the net income of the firm.

Ans: 1,60,000 + 2,49,000 + 60,000 + 25,000 + 18,400 – 60,000 – 1,70,000 – 54,700 = 2,27,700 – 40,000 – 1,68,930 = 18,770 + HP 24,500 = 43,270.

P6: PQ & Associates, a partnership firm engaged in the business of civil construction, has a gross receipt Rs 38,00,000.

The partnership deed provides for payment of salary to each of the partners P & Q (per month / partner)	Rs 15,000
The firm uses machinery (Rate of depreciation 25%) for the purpose of its business and the WDV of the machinery is	Rs 4,00,000

Compute the profits of the firm if the firm opts for the scheme under Section 44AD.

Ans: 3,04,000.

Extra Topics

Assessment of limited liability partnership. [LLP]

1 The word ‘firm’ shall include within its meaning limited liability partnership.

2. The word ‘partner’ shall include within its meaning partner of limited liability partnership.

3. The word ‘partnership’ shall include within its meaning limited liability partnership.

4. A partner who is designated partner shall sign the income tax return of LLP.

5 Residential status of an LLP shall be determined u/s 6(2) which determines residential status of firm.

6. LLP shall be assessed as Firm if it fulfill conditions of section 184. 7.

Section 45(3) : Capital gain arising in case of admission of partner.

Section 45(4) : Capital Gain arising on dissolution of LLP.

Section 78 : Retired partner business loss gets extinguished.

8. The computation of income of an LLP is in the same manner as is applicable in case of any other Firm.

9. Interest of a partner in an LLP is a capital asset and hence its transfer could trigger capital gain tax.

10. Since LLP is not a company, the distributions to a partner will not be regarded as dividend.

11. Rates of tax 30% flat + surcharge @ 12% if TI exceeds Rs 1 Cr. + education cess @ 3% = 33.99%.

12. LLP cannot opt for presumptive basis of taxation.

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FAQs on Assessment of Firm - Taxation - Income Tax for assessment (Inter Level)

1. What are the main types of taxes that a firm needs to consider?

Ans. A firm needs to consider various types of taxes, including income tax, sales tax, property tax, payroll tax, and excise tax. Each tax has its own rules and regulations that a firm must comply with.

2. How can a firm minimize its tax liability?

Ans. A firm can minimize its tax liability by taking advantage of tax deductions and credits, structuring its business operations in a tax-efficient manner, and seeking professional advice from tax experts. Additionally, implementing tax planning strategies, such as deferring income or accelerating deductions, can help reduce a firm's overall tax burden.

3. What are the consequences of non-compliance with tax laws?

Ans. Non-compliance with tax laws can lead to severe consequences for a firm, including penalties, fines, and even criminal charges. Additionally, the tax authorities may conduct audits or investigations to ensure compliance, which can result in further financial and reputational damage for the firm.

4. How does international taxation impact a firm's tax obligations?

Ans. International taxation can significantly impact a firm's tax obligations, as it involves understanding and complying with the tax laws and regulations of multiple jurisdictions. Issues such as transfer pricing, foreign tax credits, and double taxation treaties must be considered to ensure that a firm's global operations are tax-efficient and compliant.

5. What are the recent tax reforms that firms should be aware of?

Ans. Firms should stay updated on recent tax reforms, as they can have a significant impact on their tax obligations. For example, changes in tax rates, deductions, or credits can affect a firm's overall tax liability. It is crucial for firms to consult with tax professionals or stay informed through reliable sources to understand and adapt to any new tax legislation or reforms.

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