Taxpoint: Income Tax Applicability on partnership firms : Taxation of firms

Income Tax Applicability on partnership firms : Taxation of firms

MEANING OF REMUNERATION :-

Remuneration in case of partnership means the consideration paid by the partnership firm to the partners. The term remuneration includes any payment made by the partners in the form of salary, bonus or commission. The provisions relating to the extent of allowability of any amount paid as remuneration and interest on partner’s capital is contained in section 40(b) of the Income Tax Act, 1961.

In this regard, the following points are relevant:-

Interest & Remuneration paid by firm/LLP is allowed as deduction if the following conditions are satisfied:-

Remuneration is paid only to working partners. (Remuneration paid to sleeping partners will not be allowed as deduction).
Remuneration & Interest should be authorized by Partnership deed.
Remuneration & Interest should relate to period falling after the date of partnership deed. That means it should not be retrospective.
Interest on partner’s capital &loan is allowed upto a maximum of 12% (simple interest). Balance amount in excess of 12%, if any will be disallowed.
Remuneration is allowed on the basis of book profits, i.e. On first ₹3 lakhs of book profits or in case of book loss: 90% of book profits or ₹1,50,000, whichever is higher.
On balance book profits: At the rate of 60%

For example : The book profits of a firm is ₹5,00,000. Actual remuneration paid by the firm to the partners is ₹4,50,000. Then the remuneration will be allowed to the following extent :-

On first ₹3,00,000 of book profits @ 90% i.e. ₹2,70,000

On balance (₹5,00,000-3,00,000) @ 60% i.e. ₹1,20,000

Hence, a total of ₹ ₹3,90,000 will be allowed as deduction in the hands of the firm. Balance ₹60,000 (₹4,50,000-3,90,000) will be disallowed (taxable) in the hands of the firm. Also this ₹60,000 will be exempt in the hands of the partners.

MEANING OF BOOK PROFITS :-

The term book profits can be calculated in the following manner :-

Net profit under the head PGBP	XXXX
Less: Depreciation (current year plus brought forward).	XXXX
Add: Remuneration (if it is debited to P&L A/C)	XXXX
Book Profits	XXXX

In simple terms, Book Profits means PGBP before remuneration.

Apart from the above mentioned provisions, the following points are also relevant for the Taxation of firms :-

The income of firm is taxable at the rate of 30% (plus 12% surcharge, if net total income of the firm is more than ₹1 crore, plus 4% health and education cess)
Share of partners in the total income of the firm is exempt in the hands of the partners under section 10(2A).
The long term capital gains of the firm is taxable at the rate of 20% (except those referred to in section 112A)
The short term capital gains referred to in section 1111A are taxable at the rate given therein i.e. 15%
Losses of the firm shall be carried forward by the firm and shall not be allocated to the partners.
In case of firm, all the partners are jointly and severally liable for the tax liability (tax liability for the year in which such person was partners at any time during the year) of the firm.