Special provisions relating to assessment of companies

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Special Provisions Relating to the Assessment of Companies and Firms

1. Partnership Firms: Overview

A partnership firm is a business arrangement where two or more individuals agree to operate a business and share its profits. The partnership is formalized through a Partnership Deed, similar to the Articles of Association for companies.

Key Characteristics:

  • Partnership Deed: A written document outlining the firm's terms, such as the firm's name, business nature, capital contributions, profit-sharing ratio, and management responsibilities. It is essential for the firm to be recognized as such under tax laws.

Types of Partnership Firms for Taxation:

  • Partnership Firms Assessed as Such (PFAS): Treated as a distinct tax entity separate from its partners.
  • Partnership Firms Assessed as an Association of Persons (PFAOP): Taxed similarly but may have different implications based on the nature of income and partnership.

2. Taxation of Partnership Firms

Taxation Framework:

  • Separate Entity: The firm itself is subject to income tax as a distinct entity from its partners. The firm must file its own tax return.
  • Limited Liability Partnerships (LLPs): LLPs are also taxed similarly to traditional partnerships. The tax treatment of LLPs aligns with that of partnership firms.

Tax Benefits and Deductions:

  • Partners' Share: Income distributed to partners is exempt from tax in the hands of the partners, as the firm already pays tax on this income.
  • Salaries and Remuneration: The firm can deduct salaries, bonuses, commissions, and other forms of remuneration paid to partners. This deduction is subject to limits defined by the Income Tax Act. These amounts are taxable in the hands of the partners.
  • Interest on Capital: Interest paid to partners on their capital is deductible by the firm. The rate of interest should not exceed 12% per annum. The interest is taxable in the hands of the partners.

Tax Rate:

  • Base Tax Rate: Partnership firms are taxed at a rate of 30% on their taxable income.
  • Cess: An additional 4% health and education cess is applicable.
  • Surcharge: A 12% surcharge applies if the firm's net income exceeds ₹1 crore. However, this surcharge is subject to marginal relief, meaning the total tax payable (including surcharge) should not exceed the tax on a ₹1 crore income plus the amount by which the income exceeds ₹1 crore.

3. Conditions for PFAS (Section 184)

To be assessed as a PFAS, a firm must fulfill specific conditions:

  • Partnership Deed: The firm must have a written Partnership Deed. This deed must be formal and cannot be oral or implied by conduct.
  • Contents of the Deed:The deed should include the following details:
    • Name of the Firm
    • Place of Business
    • Nature of Business
    • Date of Commencement
    • Duration (if any)
    • Capital Contributions
    • Profit-Sharing Ratio
    • Remuneration and Interest to Partners
    • Management Rules
    • Duties and Powers of Partners
    • Methods for Profit Calculation
    • Other relevant clauses

4. Calculation of Tax

Steps for Calculation:

  • Determine Incomes: Aggregate all sources of income under various heads (e.g., business income).
  • Adjust for Losses: Apply provisions for the set-off of losses from current and previous years (Sections 70 to 78).
  • Calculate Gross Total Income (GTI): Sum of all income after adjustments for losses.
  • Apply Deductions: Deduct specified deductions under Chapter VIA to determine Net Income.
  • Apply Tax Rate: Tax Net Income at 30%.
  • Add Surcharge: Add 12% surcharge if Net Income exceeds ₹1 crore.
  • Include Cess: Add 4% health and education cess.
  • Apply Rebates: Deduct any applicable rebates (Sections 86, 90, 90A, 91).
  • Adjust for Payments: Include any interest payable, subtract advance tax or TDS.
  • Determine Final Tax Payable: Calculate the amount of tax due after all adjustments.

5. Claiming Deductions for Interest Paid/Payable to Partners

Conditions for Deductibility (Section 40(b)):

  • Authorization: The payment of interest must be authorized by the Partnership Deed.
  • Period: The interest payment should be for the period after the Partnership Deed has been executed.
  • Interest Rate: The rate of interest should not exceed 12% per annum.

6. Book Profit Calculation

Process:

  • Net Profit Calculation: Start with the net profit as per the profit and loss account.
  • Adjustments: Adjust for items required to convert the net profit to taxable income. This includes applying provisions from Sections 28 to 44DB, which govern income computation and adjustments.
  • Add Remuneration: Add any remuneration paid to partners if it was debited to the profit and loss account.

Key Points:

  • Separate Entity Status: Firms are taxed separately from their partners, with specific rules for deductions and taxation.
  • Partnership Deed: A formal document that governs the terms of the partnership and is crucial for tax purposes.
  • Deductions and Exemptions: There are specific rules for deducting interest and remuneration, and the rate of interest is capped.

This detailed guide outlines the taxation framework for partnership firms, including their assessment, tax calculation, and specific provisions under Indian tax laws.