Taxation of Partnership Firms

Partnership is a form of Business venture where at least two or more people come together to carry out a common business activity. This is done with a view to make profits. Every member of such a partnership firm is called a partner. Partners of such firm are offered share of profit of the firm, their individual remuneration and interest on the capital brought by them. In this article, we will explore the taxation aspects of a partnership firm.

Tax rate applicable to Partnership firm:
Net taxable income of the partnership firm is taxed at the rate of flat 30%. If the income of partnership firm exceeds Rs. 1 crore then a surcharge of 12% is applicable on such tax amount. Health and education cess @4% is also levied on such tax amount including surcharge. Carry forward of losses is allowed only to the partnership firm and not to be proportionately associated to partners. Profit of the firm is taxed at its own hands and not to be charged to partners. 

Section 10(2A) of the Income Tax Act, 1961 exempts partner's share in the total profit of the firm in the hands of partners.

Section 40(b) Deduction Limits:
Remuneration and interest on capital payments to partners are allowed as a deduction while computing book profits of a partnership firm. However, these deductions are subject to restrictions under section 40(b). Payment of salary, commission, bonus, or remuneration etc. shall be treated as remuneration paid to the partners. Deduction of such remuneration will not be allowed if the firm is reporting its income under presumptive taxation scheme. If the remuneration exceeds the below mentioned permissible limits then the firm cannot claim it as a deduction and shall be liable to pay tax.

Section 40(b) specifies following limits for deduction of remuneration:

Book Profit	Limits of remuneration
On first 3 Lakhs of Book Profit	Higher of Rs. 1,50,000 or 90% of the Book Profit
On the balance Book Profit	60% of the Book Profit

Book Profit: 

Book profit is the Net profit as per P & L account after making necessary adjustments of Interest, remuneration, brought forward losses, any other deductions if debited to P&L etc. Incomes from all the other heads are deducted from such profit to arrive at the figure of Book Profit.

Deduction in case of Interest on Capital:

The interest paid by the firm to its partners on their capital or loan shall be allowed as a deduction in accordance with section 40(b) of the Act. However, interest @12% p.a. on simple interest basis is allowed as deduction and anything paid in excess shall not be allowed as deduction. Hence, the firm will be liable for tax on such excess payment. 

Deduction of such interest payment will not be allowed if the firm is reporting its income under presumptive taxation scheme.

Such excess amounts of either remuneration or interest on capital or both will be exempt in the hands of the partner receiving such payments under the head 'Profits & Gains of Business or Profession.'

Therefore, some of the other deductions which are allowed to a Partnership firm are –

1. Remunerations or interest paid to the partners of the firm which are not in accordance with the terms of the partnership.
2. Salaries, bonuses, remunerations, commissions paid to the partners who are not ordinarily active as well.
3. If remunerations paid to partners are according to the terms of the partnership deed, but such transactions relate to the period prior to the partnership deed, they are still eligible for deduction.

Returns Applicable for Partnership Firm / LLP:

ITR 4

This return is applicable for an Individual or Hindu Undivided Family (HUF), who is Resident other than not ordinarily resident or a Firm (other than LLP) which is a Resident having Total Income up to ₹ 50 lakh and having income from Business or Profession which is computed on a presumptive basis (u/s 44AD / 44ADA / 44AE) and income from 1. One house Property 2. Other sources 3. Agriculture Income up to Rs.5,000.

ITR 5

This return is applicable to Partnership firms as well as LLPs.

Conclusion:
Partnership firm is a separate legal entity from its partners. Therefore, taxation of such firm is also to be considered separately from their partners. However, while claiming certain deductions a firm has to keep in mind the restrictions imposed upon it under section 40(b). Being a separate entity for taxation, paying taxes on its profits exempts its partners from paying taxes on their share of profit from such firm.