Taxation of the Partnership Firm: Planning & Precaution

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Taxation of the Partnership Firm: Planning & Precaution

 

Partnership firm is one of the most common and easy modes of starting the business jointly with other persons. However, Partnership firms are liable for taxation at the flat rate of 30% and the benefit of slab wise taxation is not available to the partnership firm. There are various cases whereby proper planning & precaution could result in tax optimization. Let us have a look at some of the common planning aspects which can be implemented by few firms vis a vis its partners:

  1. Proprietary Firm Vs. Partnership Firm:
    From the taxation perspective, the proprietary firm is a better option as compared to the partnership firm. If the firm is intended to be formed with the family members alone then one may explore the option of running the business in a proprietary firm rather than going with the partnership firm. Even the existing partnership firm with only family members may explore the option of converting it into a proprietary firm for tax optimization. However, the income of the firm vis a vis individual income of the partners vis a vis overall impact of the surcharge may be compared before taking a call on this. In case of Individual & HUF, Surcharge is applicable @10% if income is in the range of Rs. 50 Lakhs to Rs. 1 Crore, @ 15% for income in the range of  Rs. 1 Crore to Rs. 2 Crores @25% for income in the range of Rs. 2 Crores to Rs. 5 Crores, @37% if income exceeds Rs.  5 crores. Surcharge in the case of a firm is @ 12% only if the income exceeds Rs. 1 crore.
  2. Interest to Partners:
    a) The partnership is allowed deduction @ 12% on the capital of the partners.
    b) There are cases wherein the partners have borrowed the amount at a higher rate and have given it to the firm. In such a case, the firm can pay interest @ 12% only to the partner even though the partner may be required to pay the higher interest. Availing the loan directly in the name of the firm is a better option in such a case instead of routing it through the partners account.
    c) The partnership deed may be amended so as to restrict the interest rate to lower rate or nil rate in case of there is a loss in the partnership firm. In case there is a loss in the firm, interest to partners further enhances the loss & the partners may be liable for payment of taxes on the interest income received from the loss making firm.
    d) If the partners are in a high tax bracket and are liable for a high rate of surcharge on their income, they may amend the partnership deed so as to provide that no interest shall be payable to the partners.
  3. Salary & Remuneration to the partners:
    a) There is a ceiling of maximum amount that can be given as Salary or Remuneration to the partner. The remuneration can be given only to the working partners. If the firm has high income then the number of working partners can be added so as to divide the amount of remuneration amongst more partners.b) Remuneration up to Rs. 1.50 Lakh can be paid even if there is a loss in the partnership firm. The partnership deed may be suitably amended so as to provide that no remuneration shall be payable in case of loss.c) If the partners are in a high tax bracket and are liable for a high rate of surcharge on their income, they may amend the partnership deed so as to provide that no remuneration shall be payable to the partners.
  4. Amending the Partnership Deed:
    Partnership deed can be revised or amended easily. The taxpayers may even amend the partnership deed every year with the tax planning aspects in mind for that year ahead.
  5. Withdrawals of Assets from the firm or Dissolution of the Firm:
    a) Any withdrawals of the assets like land, building, etc from the firm by the partner will attract the capital gain tax in the hands of the firm.
    b) In case of dissolution or reconstitution of the firm, the firm may be liable for capital gain tax. Even the excess amount received by the partner on retirement or reconstitution may be taxable in the hands of the firm in view of the amendment by the Finance Act-2021.
    b) The firm will be dissolved on the death of any of its partners unless there is a specific provision in the partnership deed that the firm would not be dissolved on the death of partner – CIT Vs. Ayyanarappan & Co (1999) 236 ITR 410 (SC). In case the firm is having any immoveable property, it is always advisable to have a clause in the partnership deed that the firm shall not dissolve on the death of the partner but it shall be continued with the legal heir of the deceased partner. In absence of this clause, the firm may be liable for capital gain tax on the death of the partners of the firm.
  6. Benefit of carry forward of the Loss in case of retirement of the firm

The partnership firm is also eligible for the benefit of the carry forward of the loss. However, the benefit is subject to the condition that the partners at the time of incurrence of the loss are continuing the firm. If any of the partners retires then the proportionate loss of the retiring partner is not allowed to be carried forward. In short, retirement of the partner may be postponed till the loss is fully set off by the firm.

  1. Presumptive Scheme of Taxation:
    The presumptive scheme of taxation which provides for taxation of income @ 8% or 6% is applicable even to the partnership firm. In short, if the turnover of the firm is not exceeding Rs. 2 Cr then a minimum 8% or 6% amount has to be offered for taxation. If the firm doesn’t wish to offer 8% or 6% as income then an audit is mandatory. This 8% or 6% rate is after interest and remuneration to the partner. As a tax planning measure, the firm opting for presumptive scheme of taxation may amend the partnership deed so as to provide that the firm shall not pay any interest and remuneration to the partners.
  2. Exemption from Capital Gain by investment in Bonds [Section 54EC]:
    The partnership firm cannot save tax by investing the capital gain amount for purchase or construction of the house property. However, the option to save by investing the amount in Specified Bonds issued by REC, PFC or IRFC is available even to the partnership firm.

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