Assessment Of Firms Aop

ASSESSMENT OF FIRMS AND A.O.P.s – Assessment of Firms _________________|_______________ | | PFAS PFAOP • Partnership Firm Assessed as such (PFAS) – To be assessed as PFAS, a firm should fulfil the following conditions (h) It should be evidenced by a Partnership Deed. (i) Shares of partners should be specified in the Partnership Deed.

(c) A copy of the Partnership Deed certified by all the partners shall be filed with the Return of Income of the P. Y. in which it comes into existence. (d) In case of change in the constitution of the firm or in the Profit Sharing Ratio, a certified copy of the revised Deed shall be filed with the Return of Income of the relevant A. Y. (e) There should not be a failure on the part of the firm of the nature specified in S. 144 of the I.T. Act.

Where a certified copy of the Deed was not filed with the Return, Revised Return with such copy may be filed. Once assessed as PFAS, it will continue to be assessed as such in case of no change in the constitution or PSR and no failure u/s. 144. Computation of Income – In computing income of PFAS under the head Business or Profession, the following deductions are allowable – • Remuneration to Working Partners – The following conditions u/s. 40(b) should be satisfied.

(a) Remuneration should be paid to a working partner – Working partner – Individual partner actively engaged in conducting the business or profession of the firm. Where H.U.F. is a partner in a firm and remuneration is paid to the karta, remuneration shall be taxable in the hands of the karta, if karta has rendered services and the salary has no connection with the investment of H.U.F. assets in the firm. Such remuneration shall be deductible in the hands of the firm. Rasik Lal & Co. v. C.I.T. 229 ITR 248 (S.C.) C.I.T. v. Trilok Nath Mehrotra 231 ITR 278 (S.C)

(b) Should be authorised by the Partnership Deed – The deed should provide for remuneration in clear terms and not in vague terms. (c) It should be prospective in effect. (d) Prescribed Limit u/s. 40(b) – In the case of a firm engaged in Profession – On first Rs.100000 of book – Rs.50,000 or 90% profit or in case of loss of book profit whichever is more On the next Rs.100000 of – 60% of book book profit profit

On the balance of book Profit – 40% of such book profit In the case of any other firm – On first Rs.75,000 of book - Rs.50,000 or 90% of profit book profit whichever is more On next Rs.75,000 of book - 60% of such book profit profit On the balance of book - 40% of such book profit profit Book profit means book profit computed under Chapter IV D before allowing remuneration to partners as deduction.

Application of s. 40A(2) – As per assurance given by the F. M. while moving the Finance Bill, 1992, CBDT was supposed to instruct the A.O.s to ensure that the power should not be used in the case of small firms and even otherwise, it should be sparingly used. Interest allowed to partners – Interest on capital to partners is allowed subject to the following conditions – (v) Capital introduced by partners is used for the business or profession of the firm. (vi) Interest is authorised by the Partnership Deed.

(iii) Interest is for the period subsequent to the date of Partnership Deed. (iv) rate of interest should not exceed 12% p.a. – simple interest. (v) Where an individual is a partner in representative capacity, interest on his personal loan to the firm not disallowable u/s. 40(b). (vi) Where an individual who is a partner in the firm, is chargeable to tax on interest u/s. 64, e.g. minor son, such interest not disallowable u/s. 40(b).

Interest received by the firm on debit balance of a partner is chargeable to tax in the hands of the firm. Application of S. 40A(2) – If interest to partners is considered unreasonable or excessive by the A.O., although it is within 12% p.a., he can disallow interest considered excessive u/s. 40A(2). Assessment in the hands of partners – • Share of Profit – Exempt u/s. 10(2A) • Remuneration and/or Interest – (i) Taxable to the extent allowed as deduction to the firm under the head Business or profession

(ii) Expenses deductible u/ss. 30 to 37. (II)Partnership Firm assessed as AOP – PFAOP – When assessed as A.O.P.? (d) Firm not evidenced by Partnership Deed (e) Shares of partners not specified in Partnership Deed. (f) A certified true copy of Partnership Deed not submitted with Return of Income of the first A.Y. (g) A certified true copy of revised Partnership Deed not submitted with the Return of Income of the A.Y. in which change of constitution or profit sharing ratio has taken place.

(e) Where there is failure of the nature specified in S. 144 for any A.Y. Computation of Income – The following shall not be allowed as deduction in computing the income of a PFAOP u/s. 40(ba) (d) Remuneration to partners. (e) Interest on capital/loan to partners. Expln. 1 to S. 40(ba) – Where PFAOP pays interest to and receives interest from a partner, only net interest shall be disallowed.

Expln. 2 to S. 40(ba) – Where an individual is a partner in representative capacity, any interest paid to him on his personal loan to the firm not disallowable u/s. 40(ba). Expln. 3 to S. 40(ba) – Where an individual is a partner in a firm and he receives interest in a representative capacity on behalf of any person, the same cannot be disallowed u/s. 40(ba).

Circular No. 739 dated 25.3.1996 – The above circular of the CBDT clarifies that deduction in respect of remuneration to partners and interest on capital of partners shall be allowed u/s. 40(b), only if the provision authorising these payments in the Partnership Deed is very specific and not vague. Mere reference to limit specified u/s. 40(b) will not be enough.

Some Decisions • (1) If there is no provision in the Partnership Deed that the firm shall not result in dissolution on death of a partner, it shall stand dissolved and two assessments have to be made for the period before and after the date of death. • CIT v. Empire Estate 218 ITR 355 (S. C.)

• (2) Stock in trade of the firm cannot be valued at cost or market value whichever is less on dissolution of the firm. It has to be valued on real basis. Real rights of partners cannot be adjusted on any other basis and the surplus, if any, shall be considered as chargeable profit of the firm. • ALA Firm v. CIT 189 ITR 285 (S.C.)

• (3) Where a partnership is dissolved as a result of death of one of the partners, but it is reconstituted and continued by the remaining partners, stock in trade shall be valued at cost or market value whichever is less as the firm continues to carry on the same business. • Sakthi Trading Co. v. CIT 250 ITR 871(S.C.)

• (4) Where Partnership Deed provided for continuance of the firm by sons of senior partner subject to payment of 25% share of net profits to their mother on his death, it had the effect of creating diversion of income by overriding title. • CIT v. Nariman B. Bharucha &Sons 130 ITR 863(M.P.)

• (5) Where on dissolution of a firm, lumpsum amount has been paid to a partner waiving his debit balance, such waiver is not to be treated as income of the firm. • CIT v. Ganesa Chettiar 133 ITR 103 (Mad.) • (6) H.U.F. cannot be a partner in law and if any remuneration is paid to karta it is taxable in his hands as a partner. S. 40(b) will apply. • Rasiklal & Co. v. CIT 229 ITR 458(S.C.)

• (7) Remuneration paid to a partner is governed by limits prescribed u/s. 40(b). Where S.40(b) applies, S.40A(2) has no application. • Chhajed Steel Corpn. V. ACIT 77 ITD 419(Ahd.) Binit Corpn. V. ITO 24 TTJ 571(Ahd.) • (8) Loans taken by partners against their L.I.C. Policy and introduced in firm as capital. The firm paid interest to L.I.C. directly. It is interest paid to partners and shall be disallowed u/s. 40(b), if Partnership Deed does not provide for interest on capital to partners. • CIT V. A. Gratannery 179 ITR 44 (P&H)

• (9) All partners of a firm were members of H.U.F.. H.U.F. gave loans to the firm. On partial partition of H.U.F. loan given to firm was divided among members. As partial partition is not recognised, interest paid by firm on loan is interest paid to H.U.F.and, therefore, not hit by S.40(b). • CIT v. B. S. Sundaravadivel Mudaliar & Sons 260 ITR 662(Mad). (10) Interest received by firm from one partner cannot be adjusted against interest paid to another partner. Interest paid to partner subject to S. 40(b). • Sugar Dealers v. CIT 122 ITR 826(All)