What is a partnership firm?
A partnership firm or a Limited Liability Partnership (LLP) is a form of organization wherein two or a few persons come together to run a business with a view of earning profits. Each such person is known as a partner, individually and a partnership firm collectively.
As per Section 2(23)(i) of the Income Tax Act, 1961 (‘the Act’), the ‘firm’ shall have the meaning assigned to it in the Indian Partnership Act, 1932, and shall include a limited liability partnership (LLP) as defined in the Limited Liability Partnership Act, 2008.
Partners in exchange for their service/capital receive the following from the firm:
a. Share of profit
b. Remuneration
c. Interest on capital or loan
Income of the firm is offered to tax at the following rates:
| Particulars |
Tax rate |
| A. Net Taxable Income |
30% |
| B. Add: Surcharge if net taxable income exceeds INR 1 crore. |
12% |
| C. Total tax including A & B |
A+B |
| D. Add: Health & Education cess on C |
4% |
The firm’s losses shall be carried forward by the firm and shall not be allocated to the partner.
Taxability of share of profit
The profit of the firm is taxed in the hands of the firm. Therefore, the partner's share in the total profit of the firm is exempt from tax in the hands of the partners as per section 10(2A) of the Act.
Taxability of remuneration
Payment of salary, commission, bonus, or remuneration (by whatever name called) shall be treated as remuneration paid to the partners.
If the remuneration paid to partners is within the permissible limits as per section 40(b): The firm can claim a deduction from its taxable income, and the same shall be taxable in the hands of the partners.
If the remuneration exceeds the permissible limits, The firm cannot claim it as a deduction and shall be liable to pay tax. However, it will be exempt in the hands of the partner receiving such remuneration under the head 'Profits & Gains of Business or Profession.'
Conditions for claiming deduction under section 40(b)
The remuneration paid by the firm to its partners can be claimed as a deduction from the total income of the firm as per section 40(b) of the Act, provided the following conditions are fulfilled:
- The remuneration is paid to a working partner.
("working partner" is an individual actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner)
- The remuneration should be authorized by the partnership deed, and the deed should also provide for the amount or the manner of computation of such amount.
- The remuneration paid does not relate to a period before the date of the partnership deed.
- The remuneration paid does not exceed the permissible limits given under section 40(b) of the Act.
It is pertinent to note that deduction of remuneration is not allowed if the firm’s income is offered to tax on a presumptive basis under section 44AD or 44ADA under the Act.
The permissible limits specified under section 40(b)
Remuneration paid to all partners must be within permissible limits. Otherwise, the deduction of such payment will not be allowed to the firm.
The limit applies to the total remuneration of all partners collectively and not individually.
The permissible limit is as:
a. If book profit is negative: INR 1,50,000
b. If book profit is positive: Remuneration allowed on a book profit basis is as follows;
| Book Profits |
| On the first INR 3 lacs of book profit: |
On balance book profit |
i) INR 1.5 lacs or INR 1.5 lacs
ii) 90% of the book profit xxx whichever is more
|
60% of book profit |
E.g., If the book profit is INR 15 lacs, the remuneration permissible is calculated below:
| Book Profit |
Permissible limits of remuneration |
| On the first three lacs of book profit |
a. INR 1.5 lacs or
b. INR 2.7 lacs (90% of INR 3 lacs),
c. whichever is more
d. Therefore, INR 2.7 lacs
|
| On the balance book profit |
INR 7.2 lacs (60% of INR 15 lacs - INR 3 lacs) |
| Remuneration allowed as per section 40(b) |
INR 9.9 lacs |
Calculation of Book Profits
| Particulars |
Amount |
| Profit as per Profit & Loss a/c |
XXX |
| Add: Remuneration and interest paid to Partners only if debited to Profit & Loss a/c |
XXX |
| Add: Brought forward business loss |
XXX |
| Add: Deduction under section 80C to 80U only if debited to Profit & Loss a/c |
XXX |
| Less: Income under house property, capital gain, other sources only if credited to profit and loss a/c |
(XXX) |
| Less: Interest up to 12% as per section 40(b) |
(XXX) |
| Book Profit |
XXX |
TDS on remuneration
The firm is not required to deduct the tax at source under section 192- ‘TDS on Salary’ with respect to such remuneration paid. The same shall be treated as the partner’s income under the head 'Profits & Gains of Business or Profession'(section 28(v)) and, therefore, does not fall under the head ‘Salaries.’
Taxability of interest
The interest paid by the firm to its partners on their capital or loan shall be allowed as a deduction in accordance with section 40(b) of the Act.
If the interest paid exceeds the permissible amount, the firm cannot claim it as a deduction and will have to discharge tax on such excess amount. However, such excess amount will be exempt in the hands of the partner receiving such interest under the head 'Profits & Gains of Business or Profession.'
Permissible amount and conditions for claiming deduction
The Act restricts the amount of interest paid to partners to 12% per annum simple interest. Any amount over 12% shall be disallowed as an expense. Unlike in the case of remuneration, the firm can make interest payments to both working and non-working partners. However, the same should be authorized by the partnership deed and should not relate to a period before the date of the partnership deed.
It is pertinent to note that deduction of interest is not allowed if the firm’s income is offered to tax on a presumptive basis under section 44AD or 44ADA under the Act.
Further, it is to be noted that the interest received by the firm from the partners on their drawings cannot be set off against the interest paid by the firm to the partners on capital/ loan.
Interest received in a representative or individual capacity
A partner in a representative capacity is an individual who is a partner in a firm on behalf of or for the benefit of, any other person. For example, a partner representing his HUF shall be called a partner in a representative capacity. The taxability of interest received by them shall depend on whether it is received in a representative capacity or their individual capacity. The tax positions are summarised as follows:
| Partner in a representative capacity |
Interest received in an individual capacity |
The limit of section 40(b) is not applicable, i.e. interest more than 12% is allowed, but it should be reasonable. |
| Partner in an individual capacity |
Interest received in a representative capacity |
|
TDS on Interest
Section 194A(3)(iv) excludes the payment of interest by the firm to its partners explicitly from the ambit of TDS. Therefore, TDS is not required to be done on such payments.
Deduction allowed for Partnership Firm
When calculating income tax, it's essential to consider available deductible incomes. Some deductible incomes related to partnerships include:
- Remunerations or Interest Paid Against Partnership Terms: Deductions can be claimed for remunerations or interest paid to partners that do not align with the terms specified in the partnership agreement.
- Salaries, Bonuses, Remunerations, Commissions for Non-Working Partners: Deductions are allowed for salaries, bonuses, remunerations, or commissions paid to partners who do not actively participate in the day-to-day operations of the firm.
- Pre-Existing Partnership Deed Transactions: If remunerations paid to partners align with the terms of the partnership deed, but such transactions relate to matters predating the partnership deed, they may still be eligible for deduction.
Understanding these deductible incomes ensures that partners can optimize their tax positions while adhering to the specific conditions and terms outlined in the partnership agreement. It's important to comply with tax regulations and utilize available deductions appropriately.
How to File Tax Returns for a Partnership Firm?
Filing tax returns for a partnership firm involves several steps and considerations. Here’s a general overview:
Gather Information:
Collect all financial records, including income statements, balance sheets, profit and loss statements, details of expenses, deductions, and any other relevant documents.
Form 1065 - U.S. Return of Partnership Income:
Partnerships in the United States typically file Form 1065. This form reports the firm's income, deductions, gains, losses, and other information. Additionally, Schedule K-1 (Form 1065) is issued to each partner, showing their share of the partnership's income, deductions, credits, etc.
Prepare Form 1065:
Fill out Form 1065 accurately. Include information on the partnership's income, deductions, credits, and distributions to partners.
dule K-1:
Provide each partner with Schedule K-1, which outlines their share of the partnership's income, deductions, and credits. Partners use this information for their individual tax returns.
File State Tax Returns:
Partnerships may need to file state tax returns depending on the state’s tax requirements. States might have their own partnership tax return forms or require additional filings.
Due Dates:
The deadline for filing Form 1065 is typically March 15th, though extensions may be available. Schedule K-1s should be provided to partners by the filing deadline.
Tax Payments:
Partnerships usually don’t pay income tax directly. Instead, profits and losses flow through to the partners, who report them on their individual tax returns. However, some states may require partnerships to pay state taxes.
Consult a Tax Professional:
Partnership tax returns can be complex. Consulting a tax professional or accountant can ensure compliance with tax laws, deductions, and credits that might benefit the partnership, as well as accurate filing of returns. Our Tax Advisory Service can be a game changer for managing your taxes.
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