TAXATION OF INCOME OF PARTNERSHIP FIRM

FINANCIAL YEAR 2014-15 (ASSESSMENT YEAR 2015-16) AND FINANCIAL YEAR 2015-16 (ASSESSMENT YEAR 2016-17)

What is Partnership Firm? 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. But, in respect of booking the expenditures, following points must be kept in mind for calculation of Income Tax on partnership firm:-

A) Deduction on Account of Interest to Partners on Capital

Though, any amount of interest can be paid to the partners on their capital and can be booked as business expenditure but as per Indian Income Tax Act, interest is allowed only at the rate of 12% per annum. It means if the interest is paid more than this permissible limit, the extra payment will be disallowed while calculating the income of partnership firm.

Illustration:

Mr. X and Mr. Y are the partners of M/s XY Enterprises. They had the credit balance of their capital on 01.04.14 Rs.300000/=. The interest on capital was paid to them for financial year @ 18%. The net income the firm after allowing the interest on capital of partners @ 18%, was Rs.260000/= Calculate the taxable income of the firm as per Indian Income Tax Act.

Solution:

Interest paid on capital (Rs. 300000/= @ 18% )   Rs.54000/=

Interest allowed as per income tax act @12% Rs.36000/=

Dis-allowance of interest (Rs.54000/= less Rs.36000/=)  Rs.18000/=

It means that Rs. 18000/= shall be added back to the income of firm for calculation of income tax. Therefore the taxable income of the firm during financial year 2014-15 shall be Rs.260000/= +Rs.18000/= i.e Rs.278000/=.

B) Salary & Other Remuneration to the Working partners

Partnership is an independent entity and is run by the partners. Therefore, the working partners are entitled for remuneration by way of salary, commission, bonus or whatever name called. Though, any amount can be given to partners as remuneration and can be booked in profit and loss account but for income tax purpose, there are certain restrictions in respect of remuneration paid to partners, according to Indian Income Tax Act. These restrictions are defined below:-

Particulars Remuneration Allowed
In case of loss before booking the partner’s remuneration. Maximum of Rs.150000/=
For the first Rs.300000/= of book profit 90% of the book profit or Rs.150000/= which ever is more
On the balance of book profit 60% of book profit

Notes:-

  1. Remuneration will be allowed to working partners only.
  2. Remuneration must be according to partnership deed only.
  3. Book Profit means profit before remuneration to partners and interest paid on capital in excess of 12% per annum.

Illustration:

For Financial Year 2014-15, the profit and loss account of M/s XYZ Enterprises shows net profit of Rs.100000/= after booking the salary to partners for Rs.500000/=. The firm also paid interest on capital in excess of 12% Rs.50000/=. Calculate net taxable income of Firm.

Solution:

a) Calculation of Book Profit

Net Profit of Firm after booking the remuneration of partners

Rs.100000/=

Add: Remuneration to partners

Rs.500000/=

Add: Interest on capital paid in excess of 12%

Rs.50000/=

Book Profit

Rs.650000/=

b) Calculation of Remuneration Allowed to Partners

Remuneration allowed on first Rs.300000/= @ 90%

Rs.270000/=

Remuneration allowed on balance Rs.350000/= @ 60%

Rs.210000/=

Total remuneration allowed

Rs.480000/=

c) Calculation of Taxable Income of Partnership Firm

Book Profit of the firm

Rs.650000/=

Less: Remuneration allowed to partners

Rs.480000/=

Net Taxable income of the firm

Rs.170000/=

 Rates of Income Tax for Partnership Firm for financial year 2014-15 (Assessment Year 2015-16)

  1. Partnership firms shall be taxed at flat rate 30%.
  2. Long Term Capital gain shall be taxed @ 20%.
  3. Short Term Capital gains from shares, mutual funds shall be taxed @ 15%.
  4. Surcharge is payable @ 10% in case of firm having its total income above Rs, 1 crore..
  5. Education Cess will be charged @ 2% on Income tax  plus surcharge payable.
  6. Secondary & Higher Education Cess will be charged @ 1% on Income Tax plus surcharge payable.

Filing of Income Tax Return by Partnership Firm

Partnership firm will have to file income tax return irrespective its income.

Assessment of Income of Partners

Any amount of interest, salary, commission, bonus and other remuneration, received by the partners from partnership firm, shall be shown by the partners under the head of “Income from business or profession”.

Note:

  1. Salary received from partnership firm shall not be shown by partner under the head “Income from Salary”.
  2. Any expenditure incurred by partner in respect of arranging money for his capital or loans to firm, shall be deducted from his income. For example interest paid by partner for borrowed money for investing in partnership firm.
  3. Any interest, salary, remuneration, commission or bonus which is disallowed at the time of calculation of income tax of partnership firm, shall not be added in the income of partners.
  4. Any share of the partner in the income of firm shall be fully exempt from income tax.
  5. In case of share of loss from partnership firm, can not be set off against any other business income of partner. It is simply ignored.
  6. Partnership firm is not liable to deduct the tax at source on interest on capital, salary, bonus, commission and remuneration paid to partner. However, the partners are liable to pay advance tax on the remuneration or interest etc, received by them from partnership firm, if payable.

Illustration:

Net profit of M/s X Y Enterprises for financial year 2014-15 after providing the interest on capital and remuneration to partners is Rs.76000/=. The firm has two partner namely Mr. X and Mr. Y. Capital of Mr. X is 500000/= and Capital of Mr. Y is Rs.300000/=. The firm has paid the interest on their capital @ 15% per annum i.e. Rs.120000/=. Both are the working partners of the firm and are entitled for equal share in income of the firm. The firm has paid a remuneration of Rs.200000/= to each partner.

Calculate (a) income tax  amount of firm and (b) income of  partners from partnership firm

Solution:

To solve the above illustration, we have to follow the following steps to understand it in easy way. Though, there may be difference in presentation of figures by different people but the result will be same.

a) Amount of Interest to be allowed by firm as per income tax act:-

 

Partner’s Name Capital employed InterestPaid @ 15% Interest allowed @ 12% Interest disallowed
Mr. X

Rs.500000/=

Rs.75000/=

Rs.60000/=

Rs.15000/=

Mr. Y

Rs.300000/=

RS.45000/=

Rs.36000/=

Rs.9000/=

Total

Rs.800000/=

RS.120000/=

Rs.96000/=

Rs.24000/=

b) Computation of Book Profit

Net Profit as Profit and Loss Account

RS.76000/=

Add: Interest in excess of 12%

Rs.24000/=

Add: Remuneration paid to partners(Rs.200000/= to each partner)

Rs.400000/=

Book profit of firm

Rs.500000/=

c) Amount of remuneration to be allowed by firm as per Income Tax Act

90% of first Rs.300000/= book profit

RS.270000/=

60% of  balance book profit of Rs.200000/=(Rs.500000/= minus Rs.300000/=)

Rs.120000/=

Total Remuneration allowed

Rs.390000/=

Total Remuneration disallowed

Rs.10000/=

d) Taxation of income of M/s X Y Enterprises

Net Profit of firm as per Profit & Loss Account

Rs.76000/=

Add: Interest disallowed in excess of 12%

Rs.24000/=

Add: Remuneration disallowed to partners

Rs.10000/=

Total Taxable Income

RS.110000/=

Income Tax payable by the firm @ 30% on Rs.110000/=

Rs.33000/=

Add: Education Cess @ 2% on Rs.33000/=

Rs.660/=

Add: Secondary & Higher Education Cess @ 1% on Rs.33000/=

Rs.330/=

Total Tax payable by the firm (33000+660+330)

RS.33990/=

e) Partner’s share of profit in the firm (exempt from income tax)

According to calculation under clause (d) above, taxable net profit of the firm, after all adjustment, is Rs.110000/=  an income tax paid on above amount is Rs.33990/=.  Balance amount of Rs. 76010/= shall be transferred to capital accounts of partners in 50-50 ratio.

Please note that the share of profit from partnership firm is tax free in hands of partner and no tax shall be paid on it. The logic of non-payment of income tax by partners on their share from taxable income from partnership firm is that the firm has already paid income tax on that amount and that is the highest income tax slab under all categories of the income tax payers and also to avoid the double taxation of income.

f) Taxable Income of Each Partner from Firm

Particulars

Mr. X

Mr. Y

Allowed Remuneration from firm

Rs.195000/=

Rs.195000/=

Allowed Interest on capital

Rs.60000/=

Rs.36000/=

Total taxable income from firm

Rs.255000/=

Rs.231000/=

 Note: Income of partners only includes  only the allowed payment to partners only. Because the disallowed income already is being taxed in hand of partnership firm.

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