Partnership Firm Taxation

TAXATION OF A PARTNERSHIP FIRM
1. Introduction
Human beings call themselves to be social animals, as they can socialise with other of their species.
But in reality every species of the world require to be in a group or pack. Coordination and
Cooperation is important for survival. Partner is a person who takes part in an undertaking with
another or others, especially in a business or firm with shared risks and profits. Partnership is a type
of business organisation, in which two or more persons come together for jointly carrying on some
business. Indian Partnership Act, 1932 purports to define and amend the laws relating to
partnership. According to the said act any two or more persons can join together for creating
partnership and a partnership shall be terminated by mutual agreement only1. The Companies Act,
2013 imposes a limit on number of partners in a partnership firm.
2. Partnership firm- Separate Legal enity?
Section 2(23) of the Income Tax Act, the term ‘firm’ meaning is assigned in the Indian Partnership
Act, 1932. And according to the said Act persons who have entered into partnership are individually
called ‘partners’ and collectively ‘firm’. Therefore a firm is a mere collective name of individuals
entered into a partnership agreement2. The position of a firm is very contrary to that of a Company
which is treated as a legal person distinct from its members. The Finance Act, 1992 brought some
changes to the taxation system of the firm with effect from the assessment year 1993-94.
Following Conditions must be fulfilled for a partnership firm to be assessed as a firm:

1. The partnership is evidenced by a partnership deed.
2. The shares must be specified in the said instrument.
3. Copy of the said instrument must be certified by all the partners in writing must be submitted.
4. Return of income in respect of which assessment as a firm is first sought.
Even though partnership firms are not considered to be a separate entity but for the tax purposes it
is considered as a separate taxable unit separate from its partners. Therefore, under tax laws
partnership firm is a person, there can be a possibility of there being two different firms though they
1
. Moss V/s Elsphick, (1910) 1 K.B. 486.
2
Dulichand Laxminarayan Vs. Commissioner of Income Tax, (1956) 29 T.L.R. 535
consists of the same partners3. Partnership firm irrespective of being registered or unregistered have
to register with the Income Tax Department and must apply to obtain for a separate PAN No.
As per Section 10 (2A) of the Income Tax Act, 1961 any person who is a partner of a firm which is
assessed as such, his share in the total income of the firm will not be included in computing his total
income.
The following conditions must be looked upon for assessment of the partners:
1) Once the tax is paid by the firm the partners will not be subjected to pay tax for the business
transactions of the firm.
2) The remunerations and interests of the partners would be taxed under the ‘Income from
Business and Profession’. However, if such salary, remuneration, interest, bonus has not
been allowed as deduction as per Section 40(b) in the hands of the firm, the amount not
allowed as deduction shall not be charged to tax in the hands to the partners.
Assessment of a firm for an assessment year must be done in the same capacity for every
subsequent year. The firm must submit a copy of change if made4 after the first assessment year and
the assessment will be done on the partnership firm at the time of assessment. The change is made
in the constitution of a partnership firm when:
1) When there is admission of one or more partners of when one or more partners cease to be
partners of the firm. This clause will not be applicable where the firm is dissolved on the
death of one or any of the partners.
2) Where there would be a change in the respective shares or the shares of some of the shares
of the respective partners.
3. Provisions for Partnership firms

1) Succession of one firm by another firm5.
Where a firm carrying on its business if succeeded by another firm, and this case is not
covered by section 187 it is known to be Succession of one firm by another. E.g. ABC is a firm
which is dissolved and some of the partners have taken over the business or carrying on a
similar business with or without the partners, this would be the case of succession of
partners.
3
Dr. R.K. Bangia, Contracts-II, pg-181 (2nd ed. 2016); Income tax Commissioner Vs G.P. Naidu and sons
4
Section 187, Income Tax Act, 1961
5
The Case of CIT V/s K.H. Chambers6, the honourable Supreme Court of India Laid the
following essentials of a succession:
a. There is a change of ownership.
b. The whole business is transferred.
c. Substantially the identify and the continuity of the business were preserved.
In case where there is no provision specified for continuance of the firm on death of a
partner, the constitution could not amended but it would be subject to succession7.
Assessments are made by the successor and predecessor in accordance with the provisions
of section 170. The successor firm is entitled to recover any previous pending tax by the
predecessor firm.
2) Special provisions for retail trade
Where the assessee was into the retail trade under section 44AF of Income Tax Act, 1961,
then 5% of his/her total turnover in the previous year shall be deemed to be his business so
long as his turnover from such business does not exceed Rs. 40 lac for the corresponding
period. Deductions can be claimed under Section 30 and 38.
4. Charge of Tax in case of a firm

The charge of income tax in case of a firm is determined under section 167 (A) of the Income Tax
Act, 1960.
1) In case of a partnership firms and LLPs, income tax of 30% is levied
2) Surcharge @ 12% where the total income exceeds Rs. 1 crore8
3) Education cess @ 3 % and SHEC @ 1%.
4) The sale of assets are also taxable9.
5) The sale of shares and mutual funds are also taxable10 @ 15%. In case where there is holding
of shares for more than one year, the said income can be exempted for a tax levy11.
6) The shares of the partners from the total income of the firm is not subjected to taxation.
7) Tax deduction in case of interests and remuneration to partners are subjected to some
limitations and conditions.
6
(1965), 55 ITR 674
7
Additional CIT Vs. Thyagasundara Mudaliar (1981), 127 ITR 520
8
. Tax slab AY 2018-19; Taxmann, tax and corporate laws of India
https://www.taxmann.com/blogpost/2000000208/tax-rates-income-tax-slab-for-ay-2018-19.aspx
9
10
Section 111a, Income tax Act, 1961
11
Section 10(38), Income Tax Act, 1961
a. Interest more than 12% will not be allowed.
b. On the balance of the book profit it must not exceed 60% of the book profit.
c. In case of loss Rs. 150000 or 90% of the book profit whichever is more.
8) The unabsorbed loss in respect of the assessment year of 1993-94 onwards of the firm will
not be apportioned amongst the partners and should be carry forward by the firm only.
9) The firms must pay the alternate minimum tax @ 18.5% of the ‘Adjusted Total Income’
10) In a scenario where capital is introduced by any of the partners by transfer of asset to the
partnership firm then the provision of Section 45 (2) would be applicable and the respective
amount mentioned in the book of accounts of the firm would convert to sale consideration
received in the hands of the partner and the taxes would be levied in the hands of the
partner on the basis of the sale consideration received.
If there is failure in payment of tax, the partners can be held liable for recovery of the tax dues.
Every person who during the previous year was a partner of a firm or legal representative of any
such person of a deceased partner, shall be jointly and severally liable along with the firm for the
amount to tax, penalty etc payable by the firm for the assessment year to which such previous year
is relevant12. Under section 24 of the Partnership Act, 1932 the liability of partners is both joint and
several. The partners are liable for the tax liability of the firm, the firm doesn’t have an existence
away from its partners13. Even the partners of a discontinued firm would be liable to pay penalty of
other sum.
12
Section 188A, Income Tax Act, 1962
13
Sahu Rajeshwar Rao Vs. ITO AIR 1959 SC 667; Ashutosh Vs State of Rajasthan

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TAXATION OF A PARTNERSHIP FIRM

2. Partnership firm- Separate Legal enity?

Following Conditions must be fulfilled for a partnership firm to be assessed as a firm:

3. Provisions for Partnership firms

4. Charge of Tax in case of a firm

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