ASSESSMENT OF “FIRMS” 

ASSESSMENT OF “FIRMS” 
4.1.   MEANING :
The term ‘Partnership’ . ‘Partner’ , and ‘ Firm’ as defined U/s 2(23) of Income Tax Act, have
the same meaning as assigned to them in the Indian Partnership Act, 1932.
 
Sec. 4 of the Indian Partnership Act has defined the word “Partnership” as “ the relation
between persons who have agreed to shares the profits of a business carried on by all or any
of them acting for all “.
 
From this definition, the following points emerge :

1. That partnership is an association of two or more persons.

2. There must be a agreement entered into by all persons.
3. The agreement is to carry on some business or profession.
4. The business to be carried on by all or by any one of them acting on behalf of
all and for the benefit of all.
5. The agreement is to share the profits and losses of business or profession.

 
The term “Firm” means the entity which comes into existence as a result of partnership
agreement.
 
Partnership Firm have been given a separate status under Income Tax Act , 1961. On its
normal income , a partnership firm is liable to pay tax at a flat rate of 30%. However, on
certain special incomes, it has to pay tax at special rates.
 
4.2.    Necessity to have separate PAN :
A partnership firm is required to have its own separate ‘Permanent Account Number’ (PAN)
which will be different from the permanent account number of the partner(s) ( if any) . the
PAN of firm bears its name and is used for filing return of income of the firm. It is important
to note that the individual income of partner(s) shall not be liable with the income of firm.
 
The share of income received by partner from the firm is exempt in the hands of partners and
hence is not included in their individual income. Under Income Tax, a partnership firm can
be of following Two Types. :
 
4.2.1. A Firm which fulfills conditions prescribed us/ 184 i.e.
 

1. It has submitted its partnership deed

2. Such deed must show the respective share of each partner.
3. It is duly signed by all partners except a minor partner.
4. If is submitted along with its return for the assessment year 1993-94. In case
of firms coming into existence after 1-4-1993 it is to be submitted along with
their first return.
5. In case there is any change in the profit sharing ratio a revived deed must be
submitted.
ASSESSMENT OF “FIRMS” 
6. The firm should not have been assessed to tax u/s 144 i.e. best judgment
assessment.

 
4.2.2. A Firm, which does not fulfill the conditions prescribed u/s 184.
 
As given above or it is firm which fulfills conditions given u/s 184 but has been assessed to
tax u/s 144.
 
Instrument of Partnership
It is the written partnership agreement entered into by partners. It has to be signed and
certified by all the existing partners ( except minor). In case firm has been dissolved before
filing of returns of income, it should be signed by all those persons who were partners in the
firm immediately before its  dissolution and in case partner has died the instrument must be
signed by his legal representative immediately  before its dissolutions as in case partner has
died the instrument must be signed by his legal representative.
 
When Instrument of Partnership is to be submitted ?
Sec. 184(2) of the Act. Provides that a certified copy of the instrument of partnership referred
to in sub-section (1) shall accompany the return of income of the firm of the previous year
relevant to the assessment year commencing on or after the 1st day of April, 1993 in respect
of which assessment as a firm is first sought.
 
Change in Constitution
When a firm is assessed as firm for any assessment years is shall be assessed in same
capacity for every subsequent year unless there is change in the constitution of firm or in the
share of partners as evidence by the instrument of partnership submitted along with return for
first assessment .[ Sec, 184(3)]
 
In case any change has taken place during the previous year the firm shall furnish a
certificate copy for the previous year in which such change takes place. In such case the firm
will continue to be assessed as firm. [Sec.184(4)]
 
4.3.    Treatment if Conditions prescribed u/s 184 are not fulfilled [ Sec.
185] :
 
Where a firm does not comply with the provisions of section 184 for any assessment year,
the firm shall be so assessed that no deduction by way of any payment of interest, salary,
bonus, commission or remuneration, by whatever name called, made by such firm to any
partner of such firm 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 under clause (v) of section 28.]
 
4.4.    Meaning of Change in Constitution [ Sec. 187]
 
In following two circumstances a change can occur in the constitution of firm :
          (a)  if one or more of the partners cease to be partners or one or more new partners are
admitted, in such circumstances that one or more of the persons who were partners
of the firm before the change continue as partner or partners after the change ; or
ASSESSMENT OF “FIRMS” 
          (b)  where all the partners continue with a change in their respective shares or in the
shares of some of them
 
4.5.    Joint and several liability of partners for tax payable by firm
[Sec.188A]
Every person who was, during the previous year, a partner of a firm, and the legal
representative of any such person who is deceased, shall be jointly and severally liable along
with the firm for the amount of tax, penalty or other sum payable by the firm for the
assessment year to which such previous year is relevant, and all the provisions of this Act, so
far as may be, shall apply to the assessment of such tax or imposition or levy of such penalty
or other sum.
 
4.6.    Firm dissolved or business discontinued
 
(1)    Where any business or profession carried on by a firm has been discontinued or where a
firm is dissolved, the Assessing Officer shall make an assessment of the total income of
the firm as if no such discontinuance or dissolution had taken place, and all the
provisions of this Act, including  the provisions relating to the levy of a penalty or any
other sum chargeable  under any provision of this Act, shall apply, so far as may be, to
such assessment.
(2)  Every person who was at the time of such discontinuance or dissolution a partner of the
firm, and the legal representative of any such person who is deceased, shall be jointly and
severally liable for the amount of tax, penalty or other sum payable, and all the provisions
of this Act shall apply to any such assessment or imposition of penalty or other sum.
 
4.7.    Carry forward and set off of losses in case of change in constitution
of firm or on succession 
[ Sec. 78]
 
(1)        First ascertain the share of outgoing partner in the profit / loss of the firm in the year
of change in the  constitution of firm.
(2)        Compute the share of loss of outgoing partner in the brought forward losses.
(3)        The difference between the two ( in the case of profit in the year of change) or the
aggregate of the two ( if there is loss in the year of change in the constitution of firm)
cannot be allowed to be set off and carry forward.
 
4.8.    How to find out Income of Firm
 
First find out the taxable income of firm under the following steps :
 
Step-1. Find out income under the different heads of income ( viz. “Income from House
Property”, “Profit & Gains of Business or Profession”, “Capital Gains” , “  and  “
Income from Other Sources” ) excluding incomes exempt u/s 10 to 13A. The
payment of Remuneration and interest to partners is deductible if conditions of Sec.
184 and Sec.40(b) are satisfied.
 
Step-2. Make adjustment on account of brought forward losses / disallowances . The total
ASSESSMENT OF “FIRMS” 
income under the aforesaid heads is gross total income.
 
Step-3. From the “Gross Total Income” make the deductions U/s 80G to 80JJA and the
balancing amount is net income of the firm.
 
Other Points …
The following other points one should kept in mind  :-

1. Where at the time assessment, it is found that a change has occurred in the
constitution of a firm, only one assessment shall be made in respect of the
entire previous year in which change in the constitution has occurred.
2. Where a firm carrying on a business / profession is succeeded by another
firm and the case is not covered by the aforesaid provision, separate
assessment shall be made on the predecessor firm and the successor firm.
3. Every person who was, during the previous year , a partner of a firm, and the
legal representative of any such person who is deceased , shall be jointly and
severally liable along with the firm for the amount of tax, penalty of other
sum payable by the firm for the assessment years.
4. If conditions of Sec. 184 and / or 40(b) are not satisfied, then salary and
interest paid by a firm to partners are not deductible.

 
4.9.    How to find out Tax Liability of Firm
 
On the income computed above , tax is payable for the assessment year 2009-2010 is
calculated as follows  :
 
1.         Find out Income Tax : -
 
  Tax Rate
Short Term Capital Gain u/s 111A 15%
Long Term Capital Gain (Sec.112) 20%
Winning from Lottery, Races etc. 30%
Income (not being income which is subject to special tax rate) 30%
 
2.         Add :    Surcharges @ 10% of (1) [ to be added only when net income of the firm
exceeds Rs.1 crore]
 
3.         Find out (1) + (2)
 
4.         Add : Education Cess @ 2% of (3)
 
5.         Add : Secondary and Higher Education Cess @ 1% of (3)
 
6.         Tax Liability is (3) + (4) + (5)