Understanding Firm, Partner, and Partnership in Indian Income Tax Law
In Indian income tax law, the term "firm" is defined under section 2(23) of the Income Tax Act, 1961. A firm is considered a partnership firm, and the partners of the firm are individually taxed on their respective share of the firm's income. The term "partner" is defined under section 2(23A), and "partnership" is defined under section 2(23, 23A) of the Income Tax Act.
A partnership firm is a popular form of business organization in India, where two or more individuals come together to carry on a business with a view to making a profit. It is essential for individuals involved in a firm, partnership, or as partners to understand the tax implications under the Income Tax Act.
Taxation of a Firm
A firm is taxed as a separate entity under the Income Tax Act. The income of the firm is computed in the same manner as an individual's income, with certain specific provisions applicable to firms. The firm's income is taxed at a flat rate of 30% (plus applicable surcharge and cess), irrespective of the quantum of income. The income tax return of the firm is filed in Form ITR-5.
A firm is not liable to pay tax on the distributed income to its partners as the partners are taxed individually on their share of the firm's income. However, a firm is required to deduct tax at source if the distributed income exceeds the prescribed threshold and the sum of the income tax and surcharge is likely to exceed ₹5,000.
Taxation of Partners
Each partner of the firm is taxed individually on their respective share of the firm's income. The share of the firm's income is calculated in accordance with the partnership deed, and each partner is required to pay tax on their share as per their individual income tax slab rates. The share of profit or loss for each partner is disclosed in their individual income tax return.
Computation of Firm's Income
The income of the firm is computed in accordance with the provisions of the Income Tax Act. The firm's income is assessed after deducting allowable business expenses, depreciation, interest, and any other expenditure incurred for the purposes of the firm's business. The income tax return of the firm is required to be filed annually on or before the prescribed due date.
Registration of Partnership Firm
Under the Income Tax Act, a partnership firm can be registered with the income tax department by making an application in Form No. 12 with the Assessing Officer having jurisdiction over the firm. The partners are required to furnish their individual PAN (Permanent Account Number) at the time of registration. On approval of the registration, the partnership firm is allotted a unique PAN.
Tax Audit for Partnership Firms
The Income Tax Act requires a partnership firm to get its accounts audited if the total sales, turnover, or gross receipts in the previous year exceeds ₹2 crore. In case of a profession, the total gross receipts in the previous year should exceed ₹50 lakh to trigger the requirement for tax audit. The tax audit report is required to be filed along with the income tax return.
Taxation of LLP (Limited Liability Partnership)
In addition to partnership firms, the Income Tax Act also provides for the taxation of Limited Liability Partnerships (LLPs). LLPs are considered separate legal entities, and their income is taxed separately. The partners of an LLP are not individually taxed on the income of the LLP. The income tax return of an LLP is filed in Form ITR-5.
Taxation of Partner's Remuneration
In the case of a partnership firm, the partnership deed may provide for the payment of remuneration to the working partners. The remuneration paid to the partners is allowed as a deduction while computing the firm's income. The remuneration received by the partners is taxed in their hands as "profits and gains from business or profession."
Taxation of Interest on Capital and Loan to Partners
The partnership deed may provide for the payment of interest on the capital contributed by the partners or on any loan given by the partners to the firm. The interest paid by a partnership firm to its partners is allowed as a deduction while computing the firm's income. The interest received by the partners is taxed in their hands as "income from other sources."
Conclusion
Understanding the taxation of a firm, partners, and partnership under the Indian Income Tax Act is crucial for individuals involved in a partnership firm or LLP. It is advisable for partners and firms to seek professional advice to ensure compliance with the legal provisions and to optimize their tax liabilities. By understanding the legal framework and adhering to the requirements, individuals can ensure smooth operations and better tax planning for their partnership arrangements.
