May 27, 2012

MF0012 [Taxation Management] Set1 Q3

Q.3 Explain the essential conditions to be satisfied by a firm to be assessed as firm under Section 184. 


Answer:


Position of Firm under the Income Tax Act: Legally, a partnership firm does not have a separate entity from that of the partners constituting the firm as the partners are the owners of the firm. However, a firm is treated as a separate tax entity under the Income Tax Act.

Salient features of the assessment of a firm are as under: 


1. A firm is treated as a separate tax entity. 


2. While computing the income of the firm under the head “Profits and gains of business or profession”, besides the deductions which are allowed u/ss 30 to 37, special deduction is allowed to the firm on account of remuneration to working partners and interest paid to the partners. However, it is subject to certain limits laid down u/s 40(b). 


3. Share of profit which a partner receives from the firm (after deduction of remuneration and interest allowable) shall be fully exempt in the hands of the partner. However, only that part of the interest and remuneration which was allowed as a deduction to the firm shall be taxable in the hands of the partners in their individual assessment under the head ‘profits and gains of business or profession.’ 


4. The firm will be taxed at a flat rate of 30% plus education cess @ 3% plus for the financial year 201011. 


5. The firm will be assessed as a firm provided conditions mentioned under Section 184 are satisfied. 


In case these conditions are not satisfied in a particular assessment year, the firm will be assessed as affirm, but no deduction by way of payment of interest, salary, bonus, commission or remuneration, by whatever name called, made to the partner, shall be allowed in computing the income chargeable under the head “profits and gains of business or profession” and such interest, salary, bonus, commission or remuneration shall not be chargeable to income tax in the hands of the partner. 

Assessment of firm: From point (5) stated above, it can be concluded that for taxation purposes, a firm can be of two types: Firm assessed as firm (provided conditions mentioned u/s 184 are satisfied).and the firm shall be eligible for deduction on account of interest, salary etc while computing its income under the head business and profession). However, it will be subject to the maximum of the limit specified under Section 40(b) If the prescribed conditions are not satisfied, no deduction shall be allowed to the firm on account of such interest, salary, bonus etc. 

Essential conditions to be satisfied by a firm to be assessed as firm (Section 184) 
1. In the first assessment year: The firm will be assessed as a firm, also known as ‘Firm Assessed as Such’ (FAAS) if the following conditions are satisfied: 
(a) Partnership is evidenced by an instrument i.e. there is a written document giving the terms of partnership. 
(b) The individual share of the partners is specified in that instrument. 
(c) Certified copy of partnership deed must be filed: A certified copy of the said instrument of partners hip shall accompany the return of income in respect of the assessment year for which the assessment as a firm is first sought. Where certified copy is not filed with the return there is no provision for condo nation of delay. However where the return itself is filed late then there is no problem if the certified copy is filed along with such return as the condition that it shall accompany the return of income is satisfied. 

Further Delhi ITAT in the case of Ishar Dass Sahini & Sons v CIT held that where uncertified Photostat copy of the instrument of partnership is submitted along with the return of income and the certified copy is produced at the time of assessment, it will satisfy this condition. 

2. In the subsequent assessment years: If the above three conditions are satisfied the firm will be assessed as such (FAAS) in the first assessment year. Once the firm is assessed as firm for any assessment year, it shall be assessed in the same capacity for every subsequent year if there is no change in the constitution of the firm or the share of the partners. Where any such change had taken place in the previous year, the firm shall furnish a certified copy of the revised instrument of partnership along with the return of income for the assessment year relevant to such previous year. Read the box for some important points to be considered in this regard. 


Box 
1. The copy of the instrument of partnership should be certified by all partners, not being minors.
2. Where a firm had been assessed as a firm and in a later year, the salary and interest to be paid to partners has been changed in the partnership deed but the changed partnership deed is not attached along with the return of income of such assessment year, the firm will be still assessed as a firm but in such a situation, the interest and salary shall be allowed as deduction as per the earlier deed which was attached along with the return of income.


Circumstance where the firm will be assessed as a firm but shall not be eligible for deduction on account of interest, salary, bonus, etc. [Section 184(5)]
 The firm will be assessed as a firm but shall not be eligible for any deduction on account of interest, salary and bonus etc. if there is failure on the part of the firm as is mentioned in Section 144 (relating to Best Judgment Assessment) and where the firm does not comply with the three conditions mentioned under Section 184.

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