TAXATION OF PARTNERSHIP FIRM

PROJECT SUBMITTED TO:

MR. V. SURYA NARAYANA RAJU

(FACULTY: CORPORATE TAX)

PROJECT SUBMITTED BY:

SHRADDHA BHAGAT

SEMESTER-VIII, SECTION-B

ROLL NO-155

SUBMITTED ON: 06.04.2018

HIDAYATULLAH NATIONAL LAW UNIVERSITY

UPARWARA POST, ABHANPUR, NEW RAIPUR, C.G

 DECLARATION
I hereby declare that the work reported in this project report entitled “Taxation of Partnership
Firm” submitted at Hidayatullah National Law University, Raipur is an outcome of my work
carried out under the supervision of Mr. V. Surya Narayana Raju. I have duly acknowledged
all the sources from which the ideas and extracts have been taken. To the best of my
understanding, the project is free from any plagiarism issue.

Shraddha Bhagat

Semester-VIII,

Section-B, Roll No-155

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 ACKNOWLEDGEMENTS
I would like to take this opportunity to express my deep sense of gratitude towards my course
teacher, Mr. V. Surya Narayana Raju for giving me constant guidance and encouragement
throughout the course of the project.

I would also like to thank the University for providing me the internet and library facilities
which were indispensable for getting relevant content on the subject, as well as subscriptions
to online databases, which were instrumental in writing relevant text.

And finally I would like to thank my friends for their constant encouragement.

Shraddha Bhagat

Semester-VIII,

Section-B, Roll No-155

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 CONTENT

i. Declaration…………………………….………………………………………….01
ii. Acknowledgements……………………………………………………………….02
1. Introduction……………………………………………………………...05
2. Literature Review.......................................................................................06
3. Statement of problem.................................................................................06
4. Hypothesis..................................................................................................06
5. Research Question......................................................................................06
6. Objective………………………………………………………………….07
7. Research Methodology…………………………………………………...07
8. Provisions for Taxation of partnership firms.........…………………….…10
9. Essential elements of partnership...............................................................11
10. Assessment of partners of a firm................................................................11
11. Compute taxable income of a firm.............................................................12
12. Partnership firm dissolution.......................................................................15
13. Case Laws………………………………………………………………..16
14. Conclusion………………………………………………………………..17
15. References……………………………………………………………..…18

INTRODUCTION
When two or more person agree to start a business which will be carried on by all or any of
those partners acting for all, with an aim of earning profit out of the activities of the business,
will be called as partnership firm. But the partnership firm is an independent entity like other
individuals. Therefore the income of the partnership firm is calculated separately. Income of
partners does not have any relation with the income of partnership firm. It means that the tax
liability is calculated separately for on income of partners and partnership firm. The accounts
of partnership firm are maintained like other business firms. All the expenses relating to the
partnership firms are booked within the permission limit of law.

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Partnership is the most common form of business organisation in India. Partnership firms are
governed by the provisions of the Indian Partnership Act, 1932. The Act lays down the rules
relating to formation of partnership, the rights and duties of partners and dissolution of
partnership. It defines partnership as a "relationship between persons who have agreed to
share the profits of business carried on by all or any of them acting for all".1

Under the Act, persons who have entered into partnership with one another are individually
called as 'partners' and collectively as 'firm' and the name under which they run their business
is called the 'firm name'.

LITERATURE REVIEW

According to the Indian Partnership Act, 1932.

Partnership is the most common form of business organisation in India. Partnership firms are
governed by the provisions of this act. The Act lays down the rules relating to formation of
partnership, the rights and duties of partners and dissolution of partnership. It defines
partnership as a "relationship between persons who have agreed to share the profits of
business carried on by all or any of them acting for all".

1 Section-4 of Indian Partnership Act,1932

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Though it is not mandatory for any firm to get its accounts audited under act, but other Acts
like VAT, Excise or Income tax act may require the firm to get its accounted audited under the
applicable act.
Although it is always recommended to get the accounts audited for each financial year so as
to maintain the integrity and avoid issues on profit sharing and dissolution.

According to Income Tax act, 1961.

Partnership firm is subjected to taxation under this act. It is the umbrella Act for all the
matters relating to income tax and empowers the Central Board of Direct Taxes (CBDT) to
formulate rules (The Income Tax Rules,1962) for implementing the provisions of the Act.
Under the Income Tax Act, the Partnership firm is taxed as a separate entity, distinct from the
partners. In the Act, there is no distinction between assessment of a registered and
unregistered firms. However, the partnership must be evidenced by a partnership deed. The
partnership deed is a blue print of the rights and liabilities of partners as to their capital, profit
sharing ratio, drawings, interest on capital, commission, salary, etc, terms and conditions as to
working, functioning and dissolution of the partnership business.

According to Limited Liability Act 2008.

A firm possesses N number of feature. Some of them are:

 Unlimited Liability of Partners

 Division of Profit and Losses

In order to avoid this unlimited liability risk, one can consider the option of Limited Liability
Partnership, as per LLP Act 2008.

Saharay, Madhusudan; 2010 figured out that a Partnership contains three elements viz., an
agreement entered into by all the persons concerned; the agreement must be to share the
profits of a business; and the business must be carried on by all or any of the persons
concerned acting for all.2

According to the act, two essentials conditions to be satisfied are: (1) that there should be an
agreement to share the profits as well as the losses of the business; and (2) the business must
be carried on by or any of them acting for all within the meaning of the definition of
‘Partnership’ under section 4 of the act. The fact that the exclusive power and control by

2 Mohd. Hafeez Khan vs. S.T.A.T. Gwalior, AIR 1978 MP 116 (FB)

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agreement of the parties is vested in one partner or the further circumstances that only one
partner can operate the bank accounts or borrow on behalf of the firm are not destructive of
the theory of partnership provided two essential conditions as above are satisfied.3

Jain, Mansi ;2017 argued that taxability of partner’s share, where the income of the firm is
exempt under Chapter III/ deductible under Chapter VI-A [Circular No. 8/2014 dated
31.03.2014]

Section 10(2A) provides that a partner’s share in the total income of a firm which is
separately assessed as such shall not be included in computing the total income of the partner.
In effect a partner’s share of profits in such firm is exempt from tax in his hands.

P. V. Raghavan, R. Vaithianathan, V. S. Murali; 2011, With regard to taxation of

partnership firm, the complicated procedure for differentiating between registered and un-
registered firm have been dispensed with and rules governing this taxation have been
substantially modified in the 1992 Finance Act. This has resulted in more tax compliance by
partnership firms.

STATEMENT OF PROBLEM
Unlimited Liability: One of the biggest demerits of a partnership is that its partners have
unlimited liability. This means that personal assets or property of the partners may be used for
paying companies debts. A single wrong decision by one partner can lead other partners in
heavy losses and liabilities.

HYPOTHESIS

3 Kamath & co. Vs. I.T. Commr., Maysore, 1972 Tax LR 197 (SC)

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Unlimited liability will have an effect on partner’s personal property or assets in the form of
debts.

RESEARCH QUESTION
How taxation of partnership firm is computed?

OBJECTIVES
 The objective of the project is to present a detailed study of taxation of partnership
firm and its provisions.
 To study the essential element of partnership.
 To study the assessment of partners of a firm.
 To compute taxable income of a firm.

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RESEARCH METHODOLOGY

This research is descriptive and analytical in nature. Secondary and Electronic resources have
been largely used to gather information and data about the topic. Books and other reference
as guided by Faculty have been primarily helpful in giving this project a firm structure.
Websites and dictionaries have also been referred.

Provisions for taxation of Partnership Firms

Partnership firm is subjected to taxation under the Income Tax Act,1961. It is the umbrella
Act for all the matters relating to income tax and empowers the Central Board of Direct Taxes
(CBDT) to formulate rules4 for implementing the provisions of the Act. The CBDT is a part
of Department of Revenue in the Ministry of Finance. It has been charged with all the matters
relating to various direct taxes in India and is responsible for administration of direct tax laws
through the Income Tax Department. The Income Tax Act is subjected to annual amendments

4 The Income Tax Rules, 1962

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by the Finance Act, which mentions the 'rates' of income tax and other taxes for the
corresponding year.

Under the Income Tax Act, the Partnership firm is taxed as a separate entity, distinct from the
partners. In the Act, there is no distinction between assessment of a registered and
unregistered firms. However, the partnership must be evidenced by a partnership deed. The
partnership deed is a blue print of the rights and liabilities of partners as to their capital, profit
sharing ratio, drawings, interest on capital, commission, salary, etc, terms and conditions as to
working, functioning and dissolution of the partnership business.

Under the Act, a partnership firm may be assessed either as a partnership firm or as an
association of persons (AOP). If the firm satisfies the following conditions, it will be
assessed as a partnership firm, otherwise it will be assessed as an AOP:-

 The firm is evidenced by an instrument i.e. there is a written partnership deed.

 The individual shares of the partners are very clearly specified in the deed.

 A certified copy of partnership deed must accompany the return of income of the firm
of the previous year in which the partnership was formed.

 If during a previous year, a change takes place in the constitution of the firm or in the
profit sharing ratio of the partners, a certified copy of the revised partnership deed
shall be submitted along with the return of income of the previous years in question.

 There should not be any failure on the part of the firm while attending to notices given
by the Income Tax Officer for completion of the assessment of the firm.

It is more beneficial to be assessed as a partnership firm than as an AOP, since a

partnership firm can claim the following additional deductions which the AOP cannot
claim :-

 Interest paid to partners, provided such interest is authorised by the partnership deed.

 Any salary, bonus, commission, or remuneration (by whatever name called) to a

partner will be allowed as a deduction if it is paid to a working partner who is an

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 individual. The remuneration paid to such a partner must be authorised by the
partnership deed and the amount of remuneration must not exceed the given limits.

Essential Elements of Partnership:

The following three elements are necessary in partnership;
a. There must be at least two or more persons who must have entered into in agreement.
b. The agreement must be to carry on business and share profits.
c. The business must be carried on by all or any of the persons concerned, acting for all.

Assessment of Partners of a firm:

 The share of the partner (including a minor admitted for the benefit of the firm), in the
income of the firm is not included in computing his total income i.e. his share in the
total income of the firm shall be exempt from tax [section 10(2A) of the Act].

 If conditions of section 184 and section 40(b) of the Act are satisfied, then any
interest, salary, bonus, commission or remuneration paid/payable by the firm to the
partners is taxable in the hands of partners (to the extent these are allowed as
deduction in the hands of the firm).

The points to be noted are :-

 Remuneration from a firm is not taxable under the head "Salaries". Hence,
standard deductions cannot be claimed in respect of such remuneration.

 Any expenditure incurred in order to earn such income can be claimed as a

deduction from such income. For example, if a partner borrows money to
make his capital contribution to the firm and he is paid interest on his capital
contribution, the amount of such interest will be taxed under the head "Profits
and gains of business or profession", but the interest paid by him on the
borrowed money will have to allowed as a deduction.

 If the whole or a part of salary/interest is not allowed as deduction in the hands

of the firm, than the whole or that part of salary/ interest is not taxable in the
hands of the partners. In other words, in the hands of partners the entire

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 remuneration/ interest (excluding the amount disallowed under section
40(b) and/or section184 of the Act) is chargeable to tax.

Compute Taxable Income of a firm:

Steps for Computation of taxable income of a firm:

 Find out the firms income under the different heads of income, ignoring the
prescribed exemptions. The heads of income are:-

 Income from House Property

 Profits and Gains of Business or Profession

 Capital Gains

 Income from other sources including interest on securities, winnings from

lotteries, races, puzzles, etc. ('Salary' income head is not included)

 The payment of remuneration and interest to partners is deductible if

conditions of section 184 and section 40(b) of the Income Tax Act are
satisfied. Any salary, bonus, commission or remuneration which is due to or
received by partners is allowed as a deduction from income of the partnership
firm and the same is taxable in the hands of partners.

 Make adjustments on account of brought forward losses/ disallowances of

interests, salary, etc paid by firm to its partners. The total income so obtained
is the "gross total income".

 From the "gross total income", make the prescribed deductions and the
balancing amount is the "net income" of the firm.

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Conditions as per section 184 are as follows:
1. The partnership should be evidenced by an instrument in writing;
2. The shares of each partner should be specified in such instrument;
3. A copy of the partnership instrument as certified by all the partners should be enclosed
with a return of income in respect of the first assessment year;
4. If there is a change in the constitution of the firm, certified copy of the revised instrument
should be filed along with the return of income of the year in which such change has taken
place;
5. There should not be any failure in terms of section 144.
Note: If these conditions are not satisfied, payments made by the firm like salary,
remuneration, interest, bonus, commission etc will not be allowed.

Conditions as per section 40(b) are as follows:

A. Remuneration paid to partners shall be allowed (in the hands of the firm) if the following
conditions are satisfied:
(i). It should be authorized by and in accordance with the partnership deed;
(ii). It should relate to the period falling after the date of the partnership deed;
(iii). It should be within the prescribed limits. The limit is given below:
BOOK PROFIT REMUNERATION ADMISSIBLE
On the first Rs 3,00,000 or in case of a Rs 1,50,000 or 90% of Book Profit
loss. whichever is more
On the balance 60% of Book Profit
(iv). It should be paid to a working partner. (Working partner means who is actively engaged
in conducting the affairs of the business or profession of the firm of which he is a partner).
B. Interest paid to partners shall be allowed (in the hands of
the firm) if the following conditions are satisfied:
(i). It should be authorized by and in accordance with the
partnership deed;
(ii). It should relate to the period falling after the date of the
partnership deed;
(iii). It should be restricted to 12% p.a. simple interest, if it is more.

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Conditions for allowance of remuneration and interest to partners
1. Remuneration should be to a working partner.
2. Payment of remuneration and interest should be authorised by and should be in accordance
with the terms of the partnership deed and should relate to any period falling after the date of
such partnership deed.
3. No deduction5 will be admissible unless the partnership deed either specifies the amount of
remuneration payable to each individual working partner or lays down the manner of
quantifying such remuneration6.
Conditions for assessment as a firm
1. The partnership should be evidenced by an instrument in writing specifying individual
shares of the partners.
2. A certified copy of the instrument signed by all the partners (not being minors) shall
accompany the return of the firm for the first assessment as a ‘firm’.
3. In case of any change in the constitution of the firm or shares of the partners in any
previous year, the firm shall furnish a certified copy of the revised instrument of partnership
signed by all the partners (not minors) along with the return of income for that A.Y.
4. If any default is made in compliance with the above provisions, the firm will be assessed as
a firm without deducting interest and salary to partners from A.Y. 2004-05 onwards and as an
AOP up to A.Y. 2003-04.
5. If any failure is made as mentioned in S. 144 (ex parte assessment) the firm shall be
assessed as a firm from A.Y. 2004-05 without deducting interest and salary to partners and as
an AOP up to A.Y. 2003-04.
Partners’ assessments
1. Once tax is paid by firm, no tax will be payable by the partners on share of income from
the firm.
2. Amount of Interest and/or remuneration etc. received by a partner will be taxed in his
hands as ‘Business or Professional Income’, excluding the amount disallowed in the hands of
the firm being in excess of limits laid down in S. 40(b) and from A.Y. 2004-05 amount
disallowed in the event of any failure as mentioned in S. 144 or non compliance of S. 184.
Losses of the firm
Unabsorbed loss including depreciation in respect of A.Y. 1993-94 onwards of the firm will
not be apportioned amongst the partners and will be carried forward by the firm only.

5 Under Section-40(b)(v)
6 Circular No. 739 dt. 25-3-1996.

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Allow ability of remuneration and interest vis-a-vis presumptive taxation
Remuneration and interest will be allowed as deduction from the presumptive income
computed at prescribed rate u/ss. 44AD, 44AE & 44AF.

Due dates for filing return of firm

a. 30th September, where accounts of the partnership firm are required to be audited under
Income- tax Act or under any other law for the time being in force.
b. 31st July in any other cases.

Due dates for filing of returns of partners

a. 30th September in case of a working partner of a firm (whether or not he is entitled to
remuneration) where due date for filing return of firm is 30th September.
b. 31st July for other partners.

Partnership firm Dissolution:

Dissolution of a Partnership and dissolution of a Partnership firm are two different things. In
case of Partnership dissolution, the agreement of Partnership is terminated. Whereas
dissolution of a Partnership means the closing down or the dismissal of the firm.
 Dissolution of a firm by the order of the court
Dissolution order is issued by the court in the circumstances like if a Partner becomes of
unsound mind, or if he is unable to perform his duties or if he is found guilty of misconduct
etc.
The court can also issue a dissolution order if it satisfied that the firm cannot be carried
except with a loss.
 Dissolution of a firm without the order of the court
If all the partners agree to dissolve the Partnership or the happening of a certain contingencies
like death of a partner or in the case if a Partner gives his assent in writing to all the other
partners of his intention to dissolve a firm, a court’s order is not needed to dissolve the firm.
Upon dissolution, the assets are sold, the liabilities are paid off, and the account of the
partners are settled.

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Case laws:

1. Dulichand Laxminarayan v. CIT7,

a. All the three elements are essential.
b. Firm cannot be a partner
2. 2.J.K. Hosiery Factory v. CIT8
a. Charitable Trust can be a partner
3. 3.Chandrakant Manilal Shah v. CIT9
a. Karta & member can form partnership.
4. Malabar Fisheries Co. v. CIT10
a. Firm is not a distinct legal entity from its partners .

CONCLUSION
Partnership registration can be done under the provisions of the partnership act. It came into
existence with a legally enforced agreement in which all the terms and conditions, rules and
regulations are written. The partners of the partnership have unlimited liability. This means
that personal assets of the partners may be used for paying debts of the company. After the

7 (1956) 29 ITR 535 (SC)

8 (1971) 81 ITR 557 (All.)
9 (1992) 193 ITR 1 (SC)
10 (1979) 120 ITR 49 (SC)

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death, insolvency or retirement of any partner, the partnership comes to its end. However, if
the remaining partners want to continue the business, they can continue but on the basis of a
new agreement. Minimum numbers of members to start a partnership is 2 while the
maximum number in case of the banking industry is 10 and in any other case are 20.

Partnership firms is easy to form as well as to close without many formalities. It can be
formed with an agreement and registration is also not mandatory for it. As there are two or
more partners, therefore, funds raised can be more. It gives an advantage over various other
forms such as sole proprietorship where an amount of capital is limited. As per the
provisions, the risk is shared by all the partners. The burden of losses doesn’t come on one
individual. Partnership firms is not required to publish its accounts which lead to the secrecy
of its operations. Confidentiality of information is maintained.

One of the biggest demerits of a partnership is that its partners have unlimited liability. This
means that personal assets or property of the partners may be used for paying companies
debts. Partnership comes to an end with the death, insolvency or retirement of any of its
partner. This results in the lack of continuity. However, if the remaining partners want to
continue with the business then they have to form a fresh agreement. Possibility of conflicts
always arises when two or more persons are involved. The difference in opinion or some
issues may lead to disputes between partners. This comes in the way of a successful
partnership. Resources are limited as there is the restriction on the number of partners. As a
resulting partnership, firms face problems in expansion beyond a certain size.

REFERENCES
ARTICLES

Article 1

https://archive.india.gov.in/business/taxation/partnership.php

Article 2

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http://www.commercevilla.com/partnership-firm.html

Income Tax Act 1961,Sec 2(23)

https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

Limited Liability Partnership Act 2008

www.mca.gov.in/Ministry/actsbills/pdf/LLP_Act_2008_15jan2009.pdf

Partnership Act 1932 Sec 2

http://www.mca.gov.in/Ministry/actsbills/pdf/Partnership_Act_1932.pdf

BOOKS

Dr. Madhusudan Saharay. (2010). Text on Indian Partnership Act alongwith Limited Liability
Partnership Act. P.21. Retrieved from https://books.google.co.in/books?
id=AJ5G8BNhEE4C&pg=PA43&dq=taxation%20of%20partnership%20firm%20in
%20india&hl=en&sa=X&ved=0ahUKEwiwhNbfrPbZAhWLQo8KHdApDJUQ6AEIUzAI#v
=onepage&q=taxation%20of%20partnership%20firm%20in%20india&f=false

Mansi Jain. (2017). Direct Tax: Income Tax for CA CS CMA Bcom and Mcom Students. P.8.
Retrieved from https://books.google.com.pk/books?
id=RODwCwAAQBAJ&lpg=PA1&dq=taxation%20of%20partnership%20firm
%20india&pg=PA1#v=onepage&q=taxation%20of%20partnership%20firm
%20india&f=false

P. V. Raghavan, R. Vaithianathan, V. S. Murali, General Economics for the CA Common

Proficiency Test (CPT).P 143-B. Retrieved from https://books.google.com.pk/books?
id=awl6Zm190ngC&source=gbs_navlinks_s

WEBSITES

 http://www.legalserviceindia.com/income%20Tax/partnership_firm.htm
 http://www.letslearnaccounting.com/taxation-of-income-of-partnership-firm
 https://archive.india.gov.in/business/taxation/partnership_computetaxable.php
 http://www.commercevilla.com/partnership-firm.html
 http://www.tnkpsc.com/Image/Taxation_of_Partnership_Firms_1_.pdf
 https://www.legalraasta.com/partnership-firms/

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