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Taxation of Partnership Firms & Limited Liability Partnership (LLP)

  1. Partnership Firm – Definition [Sec. 2(23)]

  • Section 2(23) of the Income-tax Act which defines "Firm", "Partnership" and "Partner" provides that these terms shall have meanings assigned to them under the Indian Partnership Act, 1932.

  • As per amendment made by Finance (No. 2) Act, 2009, a Limited Liability Partnership (LLP) is included in the definition of ‘Firm’, ‘Partnership’ and ‘Partner’.

  • Accordingly the provisions of Taxation applicable to a Partnership Firm constituted under Indian Partnership Act, 1932 will equally be applicable to a firm constituted under LLP Act, 2008.

  1. Rates of Tax A.Y. 2011-12

    Particulars

    Income Tax

    Surcharge

    Education Cess

    Higher Education Cess

    Effective  Rate

    Total Income (Other than Capital Gain)

    30%

    - 

    2%

    1%

    30.9%

    Long Term Capital Gain
    [Sec. 112(1)(d)(ii)]

    20%

    -

    2% 

    1%

    20.6%

    Short Term Capital Gain
    on Securities (where STT is paid) (Sec. 111A)

    15%

    - 

    2%

    1%

    15.45%

  1. AUDIT UNDER SECTION 44AB

Tax Audit u/s 44AB would be applicable if Total Sales, Turnover or Gross Receipts exceed Rs.60 Lakhs with effect from A.Y. 2011-12.

  1. OTHER AUDITS

There is no requirement of audit for a Partnership Firm under Indian Partnership Act, 1932. However, under LLP Act, 2008, every LLP having turnover not less than Rs. 40 lakhs or Capital contribution not less than Rs. 25 Lakhs should get their accounts audited by a Chartered Accountant.

  1. Due dates for filing of Return of Income [Sec. 139(1)]

    Firms whose accounts are required to be audited.

    30th September

    Other Firms

    31st July

With effect from A.Y. 2006-07, it is mandatory for a firm to file return of income irrespective of whether there is taxable income or not. From A.Y. 2007-08, return of income for firms which are subject to Tax Audit u/s. 44AB need to compulsorily filed in electronic form with or without digitally signed.

  1. Conditions for Assessment as a firm

  1. The Partnership should be evidenced by an instrument in writing and individual shares of partners should be specified therein. (Sec. 184)

  2. A certified copy of the instrument (Partnership Deed) should be filed with the return of income of the year in which assessment is first sought. The copy of the Deed be certified by all partners in writing. (Sec. 184)

  3. In the year in which there is a change in constitution of firm or shares of partners, a certified copy of the instrument of change of Partnership is to be filed with the return of income for the relevant previous year. (Sec. 184)

  4. In the event there is failure on part of firm in complying with the conditions of Sec. 184 or has committed failures specified in Sec. 144, no deduction shall be allowed in respect of Interest, Salary, Bonus, Commission or Remuneration, by whatever name called. (Secs. 184, 185). However in view of new income tax returns which are filed annexureless, compliance of the above provisions can be made when first notice is received by the firm. (Refer Circular No. 3/2009/21-5-2009)

  5. Where, at the time of making an assessment of the firm, it is found that a change has occurred in the constitution of the firm, the assessment shall be made on such reconstituted firm.

    For this purpose,

    1. If any of partners cease to be partners or any new partner is admitted and one or more of the persons who were partners of the firm before change continue to be partner after the change, or

    2. Where all partners continue but there is change in shares of some or all of them, such change would constitute change in constitution of the firm (Sec. 187)

  6. Where a firm is succeeded by another firm (not being a change in constitution u/s. 187 as referred in (e) above) separate assessments shall be made on the predecessor and successor firms. (Sec. 188)

  7. If business or profession carried on by the firm is discontinued or where a firm is dissolved, all the proceedings under the Act shall be made as if there is no discontinuance or dissolution.

If such discontinuance or dissolution takes place after any proceedings in respect of an assessment year have commenced, the proceedings may be continued against persons who were partners at the time of dissolution or discontinuation or legal representative of such person who is deceased. (Sec. 189)

  1. Interest to Partners [Sec. 40(b)]

Maximum interest allowable on capital/current accounts of partners is 12% per annum. The payment of interest should be authorised by and in accordance with the instrument of partnership.

  1. Remuneration to Partners [section 40(b)]

  1. Any payment of salary, bonus, commission or remuneration, by whatever name called can be paid only to a "working partner"; i.e., a partner who is actually engaged in conducting the affairs of the business or profession of the firm.

    Such remuneration should be authorised by and in accordance with terms of the instrument of partnership.

  2. Maximum permissible deduction in respect of remuneration payable collectively to all working partners has been made uniform for all Firms/LLPs engaged in business or profession with effect from a. y. 2010-11, which is as follows:—

    Book Profit

    Maximum allowable deduction

    Loss or book profit up to Rs. 3,00,000

    Rs.1, 50,000 or 90% of Book Profit whichever is higher

    On balance book profit

    60% of book profit

The remuneration is to be calculated on book profit of the firm; i.e. net profit as per profit and loss account (in the manner laid down in Chapter IV-D) of the firm before allowing deduction of remuneration to partners.

  1. Allowability of remuneration and interest vis-à-vis presumptive income

Remuneration and interest will be allowed from the presumptive income computed at prescribed rates u/ss. 44AD, 44AE & 44AF.

  1. Losses of the Firm [section 78]

Unabsorbed losses of the firm shall be carried forward and set off as per provisions of sections 70, 71, 71B, 72, 73, 74 and 74A in the hands of the firm.

In case of change in constitution of the firm, the loss proportionate to share of the retired or deceased partner shall not be allowed to be carried forward.

  1. OTHER ISSUES OF TAXATION OF LLPs

  • Alternate Minimum Tax (Sec.115JC to Sec.115JF): With effect from A.Y. 2011-12, LLPs are required to pay Alternate Minimum Tax (AMT) @ 18.5% on their Book Profit which is similar to MAT applicable for companies.

  • Dividend Distribution Tax: LLP would not be liable to dual taxation on distribution of its profits as it is not liable for Dividend Distribution Tax (DDT) under section 115-O of the Income-tax Act.

  • Deemed Dividend [Section 2(22) (e)]: Any loan given by LLP to its partners out of its accumulated Profits/Reserves is not liable to be taxed as Deemed Dividend unlike in the case of closely held companies.

  • Designated Partner: A LLP shall have at least 2 designated partners. The designated partners have been defined in Sec. 7 of the LLP Act, 2008 being an individual who shall be resident in India. The designated partners are necessarily individuals and in case of body corporate individuals being nominees of such bodies corporate.

  • Signing of Income Tax Return: Under section 140 return of income of an LLP is to be signed by a designated partner. However, if for any unavoidable reason designated partner cannot sign or where there is no designated partner, any partner may sign the return.

  • Carry forward and Setoff of losses: Provisions of Sec. 78 relating to carry forward and set off of losses in case of change in constitution of firm or on succession are applicable to LLP also.

  • Benefit of presumptive taxation not available to LLP: It may be noted that the newly amended provisions of section 44AD w.e.f. 1-4-2011 relating to presumptive taxation specifically exclude partnership firms established as limited liability (LLP).

Capital gain issues on conversion of an existing Firm/Company into an LLP

  • Conversion of a Partnership Firm into an LLP:

No specific tax shelter has been incorporated under Income-tax Act for conversion of firm into LLP. However Memorandum explaining the provisions of the Finance (No. 2) Bill 2009 provides that General Partnership and LLP is treated as equivalent (except for recovery purposes) for Income-tax purpose. The Explanatory Memorandum, also stated, that conversion of a General Partnership Firm to an LLP will have no tax implications if

  1. the rights and obligations of partners remain the same after conversion and

  2. there is no transfer of any Asset or Liability after conversion.

If the above conditions are violated, the provision of Capital gains specified in section 45 shall apply. However above clarification is ambiguous and may create various issues.

  • Conversion of a Company into an LLP: Finance Act, 2010 has provided that any transfer of capital assets, intangible assets by a private company or unlisted public company to LLP on its conversion into LLP would not be taxable on fulfilment of following conditions specified in Sec. 47(xiiia).

    •

    1. Conversion is in accordance with provisions of Sec. 56/57 of LLP Act, 2008,

    2. The total sale, turnover or gross receipts in business of the company does not exceeds Rs 60,00,000 in any of the three preceding previous years.

    3. All the assets & liabilities are transferred to LLP,

    4. All the shareholders of the company become partner of the LLP in same proportion as their shareholding in the company,

    5. No consideration other than share in profit and capital contribution in the LLP arises to partners,

    6. The erstwhile shareholders of the company continue to be entitled to receive at least 50 per cent of the profits of the LLP for a period of 5 years from the date of conversion,

    7. No amount is paid, either directly or indirectly, to any partner out of the accumulated profits of the company for a period of 3 years from the date of conversion,

    In case above stipulated conditions are not compiled with, the benefit availed by the company shall deemed to be the profits and gains of the successor LLP chargeable to tax during the year in which requirements are not compiled.

    Appropriate provisions have been incorporated to allow carry forward and set-off of business loss and unabsorbed depreciation of the predecessor company in the hands of successor LLP [Sec. 72A(6)], cost of block of assets, allowance of depreciation in the hands of company & LLP in the year of conversion, etc. it is also clarified that credit of MAT u/s 115JAA is not allowed in the hands of converted LLP [115JAA(7)].

    1. TAXATION OF PARTNERS

    • Interest on capital, remuneration received from firm is taxable in the hands of partner as Profits & Gains of Business and Profession. However in case any amount is disallowed in the hands of firm, such amount would not be taxable in the hands of partners.

    • Share of profit received from firm is exempt from tax (Sec 10(2A))

    • Tax Liability of Firm on partners:

    1. Partner of General Partnership: Every person who was a partner during the relevant previous year or legal representative of such person who is deceased, is jointly and severally liable for tax, penalty or any other sum payable by the firm in respect of the relevant previous year. (Section 188A)

    2. Partner of LLP: Under new Section 167C, each partner of an LLP is jointly and severally liable for tax due from an LLP if it cannot be recovered from the LLP unless he proves that the non recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the LLP.


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