TAXATION ON PARTNERS
Partnership firm is a very common method of doing business in India. The Income tax has recognized the Partnership firm and its members as separate legal entity and has defined provisions for the taxation of the Partnership and its partners.
- Taxation on partner at the time of Admission:
At the time of joining the firm, the partner contributes by way of cash or brings in asset in kind or both. Income tax is applicable when the partner contributes asset to the firm.
When the asset is transferred or relinquished by one assessee to another assessee, it is regarded as transfer under section 45.
Section 45(3) of Income Tax Act:
The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co- operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body 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.
Therefore capital gain arising on transfer of capital asset to the firm is taxable in the hands of assessee. Section 45(3) of Income Tax Act provides the calculation of the same.
NOTE: Section 50C and Section 56(2)(x) will not be applicable in the above case as these both are deeming provisions and two deeming provisions cannot be applied on a single transactions.
- 2. Taxability when the firm is continuing the firm:
The partners of the firm receive interest on capital, share of profit and remuneration.
As per section 28(v) of Income Tax Act
The remuneration received by the partners, is to be taxed under the head“Income from Business and Profession” since the partners are the employers of the firm. The amount of salary or bonus, commission etc disallowed in section 40(b) cannot be added to the income of the partner again. The income of the partner should be adjusted accordingly.
NOTE: Tax Audit under section 44AB is applicable when the turnover limit exceeds 2 crore. If remuneration of partners taxable under the head “income from Profits and gains’ exceeds the limit, tax audit is applicable and tax audit report is to be filed. While calculating the limit of 1 crore, profits and gains should not be clubbed as the same is exempt under subsection 2A of section 10.
- Taxation on cash settlement at the time of Retirement:
The partner can retire from firm at any time after complying with their partnership deed. The partner may agree to settle his accounts by cash or by taking some of the assets.
The cash received by the partner in his capital account will not be again subject to tax even though if he receives in excess of the capital or current account balance. In the case of Ajay Kumar Doshi v/s ACIT [TS-6396-ITAT-2015(Kolkata)-O], the Honorable ITAT Kolkata held that, the amount received by the partner is capital receipt and not liable for tax.
- Dissolution of Partnership firm:
At the time of dissolution, the account of the firm is to be prepared till the date of dissolution. The profit or loss after making provision to income tax is to be distributed. The assets and liabilities may be shared in their profit sharing ratio or it can be taken by any partner/s.
As per section 45(4)
The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co- operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place.
- Slump Sale and Dissolution:
Slump sale means transferring assets and liabilities as a going concern basis. If any asset or liability is not transferred under slump sale, it will be taken by any partner. The firm has to pay tax under section 50B which states that, the profit on slump sale is taxable in the hands of the firm after deducting net worth.
Net worth = Total assets (-) Total liability of the firm.
- 6. The firm is used as a media to transfer the asset
The old partners want to retire from the firm, and the firm is having immovable property in its name. New partners will join to continue the business of the firm.
The Honorable Karnataka High Court in the case of CIT V/s Gurunath Talkies 328 ITR 59 (2010) has held that, the firm is liable to be assessed to capital gain tax since it is colorable devise to evade the tax.
Conclusion:
For the purpose of income tax even LLP is also equal to firm and all provision related to firm is equally applicable.
