Assessment of Partnership

Firms
CA. Jugal
Gala
Credits and Acknowledgments
Anand N Krishna
Legends used in the Presentation
AO Assessing Officer
AY Assessment Year
HUF Hindu Undivided Family
LLP Limited Liability Partnership
PY Previous Year
Presentation Schema

Assessment of Conditions for Manner of Contraventions

Partnership Firm
Firm Assessment Assessment of Conditions

Deduction of
Change in
Dissolution of Interest and Computation of
Constitution of Succession of Firm
Firm Remuneration to Book Profit
Firm
Partners

Transfer of Assets Transfer of Assets

from Partner to from Firm to Illustrations Caveats and Issues Judicial
Firm Partner Precedents
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 is the relationship between persons who have agreed to
Partnership Act, share the profits of a business carried on by all or any of them.
1932

Section 2(n) of
Limited Liability Limited Liability Partnership means a partnership formed
Partnership Act, and registered under this Act
2008
Assessment of
Firm
The firm is taxed as a separate entity irrespective of whether the firm is registered or not.

The definition of firm includes a Limited Liability Partnership and therefore the assessment of
LLP is treated same as that of a firm.

There are certain conditions which are required to be satisfied by a partnership firm to be assessed
as a firm
Conditions for Assessment – Sec
184
Along with the first return of income, the firm shall

Individual shares of profits of the partners are

File certified copy of the Partnership deed and known
Manner of Assessment

it shall be assessed in the if there is no change in the

Once a firm is assessed as a constitution of the firm or
same capacity for
firm for any AY, share of the partners
subsequent AYs
every

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
Contravention of Conditions – Sec
185
In case of contravention of the provisions of Section 184,

any payment of interest, salary, bonus, commission or remuneration

to the partners shall be fully disallowed

If disallowed, such interest, salary, bonus, commission or remuneration

won’t be taxable in the hands of partner
Change in Constitution of Firm – Sec
187
Change in the
Change in Retirement of
Admission of a profit sharing
constitution of the an existing
new partner ratio of the
firm means partner
partners

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
Succession of Firm – Sec
188
Where a firm carrying on a business or profession is succeeded by another firm,

and the case is not one covered by section 187,

separate assessments shall be made on the predecessor firm and the successor
firm
Joint and Several Liability for Tax Payable –
Sec 188A

shall be jointly and and all the provisions

During the PY,
severally liable along of this Act shall apply
partner, and the legal
every with the firm for the to the assessment of
representative of
amount of tax, penalty such tax or imposition
such partner who is
any or other sum payable or levy of such penalty
deceased, by the firm or other sum

However, in case of Limited Liability Partnership, the liability for a partner shall be restricted to its capital
contribution
Dissolution of Firm – Sec
189
Where a firm is dissolved the firm shall be assessed by the
on its total income as if no such
dissolution or
or business discontinued, AO
had taken place
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

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

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
Deduction of Interest to Partners – Sec 40(b)

Conditions to be satisfied
to claim interest to
partners as deduction

Interest should be Interest must be allowed Rate of interest does not

authorised by only from the date of exceed 12% simple interest
the partnership partnership deed per annum
deed

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)
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

Interest paid to HUF (in
than as partner in a representative
representative capacity)
capacity)

The amount paid to Mr. A as Provisions of Section 40(b) will be

interest in his personal capacity will applicable in case of Rs.50,000 and
not attract provisions of Section only Rs.48,000 (400000*12%) will
40(b) and so Rs.15,000 will be be allowed as deduction to the
allowed as deduction to the firm firm

Explanation – 2 to Section 40(b) Explanation – 1 to Section 40(b)

Deduction of Remuneration to Partners – Sec
40(b)
Conditions to be
satisfied to claim
remuneration to
partners as deduction

Remuneration must be Allowed only from the Remuneration must be

paid only to a *working Authorised by the date of partnership within the permissible
partner partnership deed deed limit

*Explanation 4 - Working partner means

CBDT Circular No. 739, dated 25-3-1996 states
an individual who is a partner of a firm
that the partnership deed must specify either
such an individual is actively engaged in
the quantum of remuneration to partners or lay
conducting the affairs of the
down manner of quantifying such remuneration
business/profession of the firm
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

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
Explanation –
business) as increased by the aggregate amount of the remuneration paid or payable to
3 to sec. 40(b)
all the partners of the firm if such amount has been deducted while computing the net
profit
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 XXX
loss a/c
Add: Brought forward business loss, deduction under XXX
section 80C to 80U if debited to profit and loss a/c
Less: Income under house property, capital gain, other (XXX)
sources if credited to profit and loss a/c
BOOK PROFIT XXX
Transfer of Assets from Partner to Firm – Sec
45(3)
The profits or gains arising from the transfer of a capital asset by a person to a firm
in which he is or becomes a partner, by way of capital contribution or otherwise,

shall be chargeable to tax as his income and the amount recorded in the books
of account of the firm as the value of the capital asset

shall be deemed to be the full value of the consideration received or accruing

as a result of the transfer of the capital asset

However, no capital gains shall arise on transfer of a personal asset which does not fall within the purview of
definition of capital asset
Transfer of Assets from Firm to Partner – Sec
45(4)

The profits or gains arising

shall be chargeable to tax shall be deemed to be the
from the transfer of a
as the income of the firm full value of the
capital asset by way of
and the fair market value consideration received or
distribution of capital
of the asset on the date of accruing as a result of the
assets on the dissolution
such transfer transfer
of a firm or otherwise,
Illustration
2ABC & 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

Computation of Long Term Capital Gain in the hands of firm

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
Contd.
.
Computation of Book Profit

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
Contd.
.Maximum amount deductible in respect of total remuneration to partners
Rs.1,50,000 or
On first Rs.3,00,000 of Rs.2,70,000
Rs.2,70,000
book profit (3,00,000*90%)
Book Profit – whichever is
Rs.8,80,000 higher
On remaining book Rs.3,48,000
Rs.3,48,000
profit of Rs. (5,80,000*60%)
5,80,000

Maximum
Rs.2,70,000 Rs.3,48,000 Rs.6,18,000
Deduction
Caveats and
Issues
The share of the partner in the income of the firm is not to be included in computing the total income of the
said partner – Section 10(2A)

Can the income of a partner be taxed on presumptive basis under section 44AD?

Any asset used for personal purposes by a partner (say a motor car) is not a capital asset (movable personal
effects are not capital assets under Section 2(14)) in the hands of a partner even though it may be a capital
asset for the firm
 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
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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