Special provisions relating to assessment of companies

Firm is an association of two or more than two persons, who came together to do a business and share profits thereof. Section 4 of the Partnership Act, 1932 defines Partnership as “relationship between persons who have agreed to share the profits of business carried on by all or any of them acting for all.”

The persons who have agreed to do business together are personally called “Partners” and collectively called a “Firm”. They are abiding by a deed called “Partnership Deed”. A Partnership Deed for partnership is same as Articles of Association, Trust Deed for companies and Trust respectively.

From Assessment Year 1993-94 the Partnership Firms are classified as;

  1. Partnership Firms Assessed as Such (PFAS)
  2. Partnership Firms Assessed as an Association of Person (PFAOP)

Scheme of Taxation of Firms:

  1. The firm is taxed as a separate entity i.e. separate from its partners. No matter whether the firm is registered or not.
  2. The definition of firm includes a Limited Liability Partnership and LLP is treated same as firm.
  3. The share of partners in the income of the firm is exempted, while computing his individual income or share of partners in the firm is exempted in his hand.
  4. Salary, Bonus, Commission or remuneration (by whatever name called) paid /payable to partners is allowed as deduction to the firm and same will be taxable in the hand of partners. These expenses are allowed as deduction subject to certain restriction under the Income Tax Act, 1961.
  5. The interest to partners paid by firm is deductible subject to maximum rate of interest @12% pa. The amount is taxable in the hand of partners.
  6. The firm is taxed at flat 30% plus 4% Cess plus Surcharge at 12% of taxable income if net income exceed 1 crore. However, the surcharge shall be subject to marginal relief (where income exceeds one crore rupees, the total amount payable as income-tax and surcharge shall not exceed total amount payable as income-tax on total income of one crore rupees by more than the amount of income that exceeds one crore rupees).

Conditions should Be Fulfilled By A Firm To Be Assessed As Such (PFAS):

Section 184; of the Income Tax Act, 1961 governs the taxation and assessment of Firm. A firm has to satisfy these conditions to be assessed as a firm;

Section 184(1) (i): The Firm should be evidenced by an instrument called “Partnership Deed” and;

  1. It should be in writing;
  2. It should not be by conduct or oral;
  3. The deed may contains following clauses; Name of the Firm, Place of Business, Nature of Business, Date of Commencemence of Business, Duration of Partnership(if any), Capital Clause, Profit Sharing Ratio, Remuneration payable to partners, Interest Payable to partners, Arbitration Clause( if any), drawing, power to operate bank account, method of calculation of profit and keeping of books of accounts, management of business, duties of partners, valuation of goodwill , increase of capital of partners, removal or inclusion of partners and some other clauses as agreed among the partners.

Calculation of Tax:

  1. First find out incomes under various heads;
  2. Adjustment of losses of Current as well as earlier years according to provisions of Sections 70 to 78 of the Income Tax Act, 1961. We find Gross Total Income;
  3. From Gross Total Income deduct specified deductions under Chapter VIA, we find Net Income;
  4. Net Income apply tax @30%
  5. Add: Surcharge @10% if Net Income increase Rs. 1.0 Crore;
  6. Add: Education cess and Special Education cess;
  7. Deduct rebate if any under Sections 86,90,90A and 91;
  8. Add: Interest payable if any;
  9. Deduct: Advance Tax paid/TDS deducted if any;
  10. Balance will be amount of tax to be paid

Claiming Deduction of Interest Paid/Payable to Partners:

The interest to partners will be deductible after complying provisions of Section 184 and 40(b) of the Income Tax Act, 1961.

Section 40(b); following conditions should be complied;

  1. Payment of interest should be authorised by Partnership Deed;
  2. Payment of interest should pertain to the period after Partnership Deed;
  3. Rate of interest should not exceed @12pa.

Book Profit Calculation

  1. First we have to calculate the net profit or take net profit from profit and loss account;
  2. Make adjustments (that is required to convert the net profit of profit and loss account into taxable business income shall be applied) as provided by Sections 28 to 44DB.
  3. Add remuneration paid to partners if debited to the profit and loss account.

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