INTRODUCTION

When two or more person agree to start a business, which will be carried on by all or any of
those partners acting for all, with an aim of earning profit out of the activities of the business,
will be called as partnership firm. But the partnership firm is an independent entity like other
individuals. Therefore, the income of the partnership firm is calculated separately. Income of
partners does not have any relation with the income of partnership firm. It means that the tax
liability is calculated separately for on income of partners and partnership firm. The accounts
of partnership firm are maintained like other business firms. All the expenses relating to the
partnership firms are booked within the permission limit of law.

Partnership is the most common form of business organisation in India. Partnership firms are
governed by the provisions of the Indian Partnership Act, 1932. The Act lays down the rules
relating to formation of partnership, the rights and duties of partners and dissolution of
partnership. It defines partnership as a "relationship between persons who have agreed to
share the profits of business carried on by all or any of them acting for all".1

Under the Act, persons who have entered into partnership with one another are individually
called as 'partners' and collectively as 'firm' and the name under which they run their business
is called the 'firm name'.

Partnership firm can’t deny to be taxed under the Income Tax Act. It is an umbrella Act for
all the matters relating to income tax. Central Board of Direct Taxes(CBDT) has been
empowered to form rules2 for better implementation of the provisions of the Act and it forms
part of Revenue Department in the Finance Ministry. It is responsible for the administration
of direct tax laws through the Income Tax Department. The Income Tax Act is subject to
annual amendments introduced through the Finance Act every year, which mentions the
'rates' of income tax and other taxes for the corresponding year.

Under the Income Tax Act, the partnership firm is taxed as a separate entity. It is treated
separate from its’ partners and Income of the firm is considered distinct from the income of

1
Section-4 of Indian Partnership Act,1932
2
The Income Tax Rules, 1962
the Partners. In the Act, there is no distinction recognised as between registered and
unregistered firms. However, the partnership must be evidenced by a partnership deed. The
partnership deed is a blue print of the rights and liabilities of partners as to their capital, profit
sharing ratio, drawings, interest on capital, commission, salary, etc, terms and conditions as
to working, functioning and dissolution of the partnership business.

Nowhere in the Income Tax Act, the term firm has been defined but Sec.2(23) implies the
definition of the term FIRM as given below;
“a. Firm shall have the meaning assigned to it in the Indian Partnership Act, 1932.
b. Partner shall have the meaning assigned to it in the Indian partnership Act, 1932 and shall
include –
I. Any person who, being a minor, has been admitted to the benefits of partnership; and
II. A partner of a limited liability partnership as defined in the Limited Liability Partnership
Act, 2008
c. Partnership shall have the meaning assigned to it in the Indian Partnership Act, 1932, and
shall include a limited liability partnership as defined in the Limited liability Act, 2008.”

Essential Elements of Partnership3:

Three elements that need to be compulsorily present in a partnership are: -

a. There should be at least two or more persons who have entered into an agreement to form a
Partnership Firm.
b. The agreement so entered by the partners should be with respect to carry on some business
and share the profits so arisen.
c. The business for which the partnership deed is entered by the partners should be either
carried on by all or any of the partner who carries on the same on behalf of all.4

3
Dulichand Laxminarayan v. CIT
4
Mohd. Hafeez Khan vs. S.T.A.T. Gwalior, AIR 1978 MP 116 (FB)
 TAXATION OF PARTNERSHIP FIRM

A Partnership firm may be assessed, under the Act, either as a firm or Association of
Persons (AOP). Section 184 lays down conditions which need to be fulfilled to be taxed
as a firm else the persons involved will be taxed as AOP: -

 Evidence of existence of a firm is through a written instrument called partnership

deed.
 The Partnership deed clearly mentions the individual shares of the partners in the
firm.
 A certified copy of partnership deed should be accompanied with the returns of the
firm of the previous year in which the partnership was formed.
 During the previous year, if any change took place in the constitution of the firm or in
the profit-sharing ratio, a certified copy of the revised partnership deed should be
submitted along with the returns of the previous year in question.
 The firm should not fail in attending any notice given by the IT Officer for the
completion of assessment of the respective firm.

It is less beneficial to be assessed as an Association of Persons than a Firm, since AOP

can’t claim, mentioned below, deductions which the partnership firm can claim as
mentioned under Section 40(b) of the Act: -

 Interest payable to any partner, which has been authorised by the partnership deed,
can be deducted from the Income of the firm.
 Any salary, commission, or such remuneration which is paid to an individual working
partner but such an amount of remuneration should be within the limits as prescribed
under the Act.
 ASSESSMENT OF PARTNERS OF A FIRM:

 According to section 10(2A) of the Act, the share of a partner in the income of the
firm is exempted completely while computing his total income. His share, as
mentioned in the deed, in the total income of the firm should be excluded while
computing his income which is to be taxed.
 If the conditions as given under S.184 and S.40(b) of the Act are fulfilled, then any
kind of remuneration paid to any partner by the firm is to be taxed in the hands of
partners. But the same will be taxed in hands of partners to the extent such deductions
are allowed while computing the taxable income of the firm.

The only certain things to be kept in mind are: - 

 Remuneration payable by the firm is not to be taxed under the income earned
through the head ‘Salaries’. Therefore, any standard deductions will not be
allowed which are available.
 Any expenditure made for earning such income can be claimed for deduction
from such. If a partner borrows money for making his capital contribution to
the firm and he is paid interest on his capital contribution then the interest paid
by him on the money so borrowed will be allowed as deduction.
 If any part of remuneration is not allowed as deduction in the hands of the
firm, then the whole or that part of remuneration will not be taxed in the hands
of the partner. In other words, in the hands of partners the entire remuneration
(excluding the amount disallowed under S.40 and S.184 of the Act) is to be
charged with tax.
 COMPUTATION OF TAXABLE INCOME OF THE FIRM:
Following are the steps to be taken for computing the income of the partnership firm:

1. Determine the firm’s income and place them under the different heads: - 

 Income from House Property

 Profits and Gains of Business or Profession
 Capital Gains
 Income from other sources including interest on securities, winnings from
lotteries, races, puzzles, etc. ('Salary' income head is not included) 

Ignore the exemptions as prescribed under the Act for the time being.

2. Remuneration and interest payable to the partners, as prescribed under the written
deed, is deductible if conditions are fulfilled as provided under S. 184 and S. 40(b) of
the Act. Any kind of such remuneration which is payable to the partners is to be
allowed as a deduction from the income of the firm. The remuneration and interest
paid to the partners, which is deducted, will be taxed in the hands of partners.

3. Brought forward losses/ disallowances of interests, remuneration, etc paid by firm

to its partners need to be adjusted into the accounts of the firm for computing the
income of the firm which is to be taxed.

4. The total income obtained, after deducting the losses brought forward and any
disallowed remuneration or interest, is the "Gross Total Income".

5. Prescribed Deductions will made on the reached “Gross total income” and the amount
which is left as balance will be the “Net Income” of the partnership firm.

Income Tax at flat rate of 30% is levied on the Partnership Firm

 “SECTION 184” CONDITIONS ARE AS FOLLOWS:

 Evidence of existence of a firm is through a written instrument called partnership

deed.
 The Partnership deed clearly mentions the individual shares of the partners in the
firm.
 A certified copy of partnership deed should be accompanied with the returns of the
firm of the year in which it was formed.
 If any change took place in the constitution of the firm in the previous year or if there
was any change in the profit-sharing ratio in the previous year, a certified copy of the
revised partnership deed should be submitted with the returns of the year in question
i.e. financial year in question.
 The firm should not fail in attending any notice given by the IT Officer for the
completion of assessment of the respective firm.

Note: It is necessary for the Firm to satisfy all the conditions so mentioned above, else the
payments made by the firm which are allowed as deduction, under the concerned sections of
the Act, will not be allowed.

“SECTION 40(B)” CONDITIONS ARE AS FOLLOWS:

A. Remuneration which is be paid to partners shall be allowed as deduction in the hands of

the firm only if the conditions mentioned below are fulfilled:
(i). It should have been provided under the written the partnership deed i.e. Authorisation for
remuneration must flow from the deed;
(ii). It must be related to a period which falls after the date of the partnership deed is entered
into;
(iii). Complete deductions is not allowed. A limit has been prescribed for allowable
deduction.

The limit is given below:

BOOK PROFIT REMUNERATION ADMISSIBLE
On the first Rs 3,00,000 or in case of a Rs 1,50,000 or 90% of Book Profit
 loss. whichever is more
On the balance 60% of Book Profit
(iv). Only the remuneration paid to a working partner is allowed as deduction under this
section. A partner who is actively involved in carrying out the affairs of the business of the
firm is termed as a Working Partner.

B. Interest to be paid to the partners, on the contribution made by them, shall be allowable as
a deduction from the income of the firm, only if conditions mentioned below are fulfilled:
(i). It should be clearly mentioned under the partnership deed so entered into;
(ii). It must be relating to a period which happens to fall after the date of entering the
partnership deed;
(iii). Simple interest @12% paid to a partner will be allowable as deduction. Any further
payment of interest to the partner beyond 12% will not be allowed to be deducted.

ASSESSMENT OF PARTNERS

 Once the tax is paid by the firm to the concerned authority, no tax will be levied on
the share of income of the partner in the firm.
 Amount of Interest and remuneration which is due to a partner will be liable to be
taxed in his hands, since the interest and remuneration received by him forms part of
‘Profits from Business or Profession’ only up to the prescribed limits as allowed
under section 40(b).
 On the balance amount, which was disallowed to be deducted from the income of
firm, has already been taxed in the handS of the firm. The partner’s share of profit in the
firm’s income does not form part of his income while computing his total income. Partner’s
profit share in the total income of the firm is to be exempted from tax under S.10(2A) of the
Act.
 FIRM’S LOSS AS PER SEC. 75

1. From the assessment year 1993-94, all the Unabsorbed loss including depreciation in
respect of the firm will not be apportioned amongst the partners.

2. The loss so sustained by the firm in any assessment year will be carried forward and set-off
will be allowed for the same in the income of the firm in the coming years.

3. Death or Retirement of any partner, in such cases there is a change in the constitution of
the firm or dissolution of the firm. If there just a change in the constitution of firm then that
portion of share of the partner, so retired or deceased, will not be allowed to be carried
forward.

PRESUMPTIVE TAXATION

1. According to section 44AD of the Act, any resident partnership firm can claim the benefits
as given under the section.

2. The firm’s annual turnover must not have exceeded Rs. 2crores in the previous assessment
year.

3. The firm must not be involved into the business of plying or hiring of goods carriages.

4. The firm who carries out professional service, who earned income from brokerage or
commission, were earlier ineligible to claim the benefits of Presumptive Taxation. But after
the amendment of 2017, they can avail the same and are can adopt the provisions of
presumptive taxation under section 44ADA.

5. The firm can claim deductions as per the section 40(b) for remuneration and interest to be
paid to the partners from the presumptive income tax computed at the prescribed rate.
 DISSOLUTION OF PARTNERSHIP FIRM:

There are two different things, Dissolution of a Partnership and dissolution of a Partnership
firm. In case of Partnership dissolution, the agreement of Partnership is terminated but when
we speak of dissolution of a Partnership firm it means the closing down or the dismissal of
the firm.
 Dissolution of a firm by the order of the court
Dissolution order is passed by the competent court in cases where a Partner becomes of
unsound mind, or he is unable to perform his duties as mentioned under the deed or if he is
found guilty of misconduct etc.
Other reason could be continuity of the firm but with no profits but only losses, in such a case
court can issued an order for dissolution of firm.
 Dissolution of a firm without the order of the court
If all the partners agree to dissolve or the happening of a certain contingency like death of a
partner or in the case if a Partner gives his assent in writing to all the other partners of his
intention to dissolve a firm, then the firm is dissolved without any order to be waited from the
court.
Upon dissolution, the assets are sold, the liabilities are paid off, and the account of the
partners are settled.
Before the introduction of Section 45(4) and (3), the legal position with respect to firm was
that it was not considered as a distinct legal entity having its own existence apart from the
partners and therefore, the firm’s property, as provided under the law, was owned by all the
partners of the firm, even if the firm may be possessing a personality which is distinct from
the partners who constitute it. When the firm gets dissolved due to any reason, the firm has
no separate rights of its, owing to its legal existence, in assets. The consequence flowing after
dissolution of firm is of distribution, division or allotment of assets to the partners
constituting the firm, which is done after discharging the liabilities, and it is nothing more
than a mutual adjustment of rights among the partners.

Finally, Section 45(3) and 45(4) were introduced in to the Act which is a deeming provision
stating that the assets pooled in to the firm by the partners and distribution of assets by the
firm on dissolution or otherwise is a kind of Transfer for tax purposes. Such a provision will
block the routes so taken by the partners to escape tax liability.

“Section 45.  (3) The profits or gains arising from the transfer of a capital asset by a person
to a firm or other association of persons or body of individuals (not being a company or a
co-operative society) in which he is or becomes a partner or member, by way of capital
contribution or otherwise, shall be chargeable to tax as his income of the previous year in
which such transfer takes place and, for the purposes of section 48, the amount recorded in
the books of account of the firm, association or body as the value of the capital asset shall be
deemed to be the full value of the consideration received or accruing as a result of the
transfer of the capital asset.”5

“Section 45. (4) The profits or gains arising from the transfer of a capital asset by way
of distribution of capital assets on the dissolution of a firm  or other association of persons
or body of individuals (not being a company or a co-operative society) or otherwise, shall be
chargeable to tax as the income of the firm, association or body, of the previous year in
which the said transfer takes place and, for the purposes of section 48, the fair market
value  of the asset on the date of such transfer shall be deemed to be the full value of the
consideration received or accruing as a result of the transfer.”6

 In the year of 1987, Sub-section 4 of section 45 was introduced with an object of

imposing tax on the firm when the assets belonging to it are distributed on the
occasion of Dissolution or otherwise. For such purpose of distribution, the Fair
Market Value of the assets, owned by the firm, on the date of dissolution is deemed
to be the full value of consideration accruing on distribution.
 Enactment of s. 45(4), parliament has intended to provide that a firm is required to
pay capital gain tax as if there is a transfer because of the legal fiction, even though
there is no actual transfer under the general law of partnership.7
 If there takes place any transaction involving Distribution of assets on dissolution of a
firm or otherwise, then such a transaction has to be considered as ‘transfer’.

5
CBDT in circular No. 495 dt. 22.09.87
6
CBDT in circular No. 495 dt. 22.09.87
7
CIT vs. A.N. Naik Associates (2004) 265 ITR 346 (Bombay)
 Therefore, transfer of assets to the partner on dissolution is chargeable to tax under s.
45(4)8

 “During the subsistence of a partnership, a partner does not possess an interest in

specie in any particular asset of the partnership. During the subsistence of a
partnership, a partner has a right to obtain a share in profits. On dissolution of a
partnership or upon retirement, a partner is entitled to a valuation of his share in the
net assets of the partnership which remain after meeting the debts and liabilities. An
amount paid to a partner upon retirement, after taking accounts and upon deduction
of liabilities, does not involve an element of transfer within the meaning of section
2(47) of the Act. Therefore, there is no transfer of capital asset by way of a
distribution of the capital assets, on the dissolution of a firm or otherwise.”9
 “The High Court found that Section 45(4) would have application only where there is
distribution and not where business of the firm continued apparently by the surviving
partners with legal heirs. The liability gets crystallized only when the firm’s assets
are transferred either to surviving partners or legal heirs of the deceased
partner.”10
 “If there is no distribution at all and the business is carried on by the successor firm,
there can be no occasion for the liability under section 45(4).”11
 “The position is different when, during the subsistence of a partnership, an asset of
the partnership becomes the asset of only one of the partners thereof; there is, in such
a case, a transfer of that asset by the partnership to the individual partners.”12
 “Section 45(4) deems transfer of assets distributed to a partner on dissolution or
otherwise. There should not only be dissolution, but also distribution to attract the
provision. Where one of the two partners of the firm dies, there is dissolution of the
firm. But where the surviving the partner carries on the business with all the assets
and liabilities as a going concern, there is no distribution within the meaning of the
guidelines given by the Supreme Court.”13
8
CBDT Circular No. 495 dt. 22.09.1987
9
Prashant S.Joshi Vs ITO [2010] 324 ITR 154 (Bom)
10
CIT v. Vijaylaxmi Metal Industries [2002] 256 ITR 540 (Mad)
11
S.B. Bilimoria and Co. v. Asst. CIT [2009] 317 ITR (AT) 203 (Mum), CIT vs. Manglore Ganesh Beedi
Works (2004) 265 ITR 658 (Kar.)
12
B.T. Patil & Sons vs. CGT (2001) 247 ITR 588 (SC)
13
Sakthi Trading Co. v. CIT [2001] 250 ITR 871 (SC)
  “On reconstitution of firm, two new partners admitted and on second reconstitution
all the four old partners retired and the newly introduced partners continued the
business of firm—There was thus transfer of assets of the firm in the sense that the
assets of the firm as had been held by the erstwhile partners is transferred to the
newly added two partners though all along the assets of the firm continued in the
hands of the firm—Therefore, there is transfer of capital assets within the meaning of
s. 2(47), attracting the capital gain transaction in terms of s. 45(4).”14

But in my opinion, there is should not be any applicability of section 45(4). And the
reason being that there is just reconstructing of firm and hence no transfer of assets
and no capital gains are arising. The same was incorporated in a Karnataka Decision.15

 When a partner brings into the firm his asset for partnership firm and through such
contribution in to the capital of the firm, the asset becomes the property of the firm by
the application of S.14 of The Partnership Act. Formal conveyance of the asset is not
required here.

DUE DATES FOR FILING RETURN OF FIRM

a. 30th September, where accounts of the partnership firm are required to be audited under
Income- tax Act or under any other law for the time being in force.

b. 31st July in any other cases.

DUE DATES FOR FILING OF RETURNS OF PARTNERS

a. In case of a working partner of a firm, due date for filing return of firm is 30th September
irrespective of the fact that he is entitled for remuneration or not.

b. 31st July for other partners.

14
[CIT vs. Gurunath Talkies (2010) 328 ITR 59 (Kar.)]
15
CIT vs. Dynamic Enterprises (2014) 223 TAXMAN 331 (Karn)
 TAXATION OF LLPS

Long felt need in India to provide for a business format that would combine the flexibility of
a partnership and the advantages of limited liability of a company finally came into existence
in form of The Limited Liability Partnership Act, 2008 which is in effect to upgrade the
Indian corporate law. LLP is a type of hybrid legal entity with the best features of both,
companies and partnership firms.

Eligibility of the LLP for taxation

The finance Act, 2009 for the first time covered the taxation provisions of the Limited
Liability Partnership in India and has made the relevant changes with regards to the Indian
Partnership Act, 1932. LLP is treated as Partnership firms for the purpose of Income
Tax16 and is taxed as per the rate fixed in the Finance Act.17

LLP can claim all the deductions as discussed previously for a Firm, only if they satisfy the
conditions as mentioned under Section 184 and 40(b) of the Act.

No deduction can be allowed if it does not comply with section 184 of the Income Tax Act,
1961.

Since LLPs are not treated as company for income tax purpose, there is no Minimum
Alternate Tax & Dividend Distribution Tax. Indian LLP will not be liable to wealth tax
but Foreign LLP will be liable.

Also, LLPs cannot avail PRESUMPTIVE TAXATION scheme under sections 44AC or
section 44AD of Income Tax Act, 1961. 18 This is the only difference between a Partnership
Firm and a LLP.

16
Section 2(23) of Income Tax Act, 1961
17
Paragraph C, Part 3 of the 1st Schedule of the Finance Act, 2010
18
The Chartered Accountant Student’s Journal, August 2010 Volume SJ1, Issue 8
Conversion of partnership firm into LLP 

When a partnership firm is converted into an LLP, there will be no tax implications if the
case is such that the rights and obligations in the newly formed LLP do not change. If there is
no transfer of any asset or liability after conversion. 19 If there is any violation of this
provision, provisions of section 45 of Income Tax Act will apply.

Liability of partner towards liability of income tax of LLP

The partners of a LLP are jointly and severally liable for income tax liability of the LLP, but
a partner can escape this liability if he is able to prove the fact that non-recovery cannot be
attributed to any gross neglect, misfeasance or breach of any duty on his part.20

19
Explanatory memorandum to Finance (No. 2) Act, 2009
20
Section 167C of the Income Tax Act, 1961
 CONCLUSION

Partnership firms is easy to form as well as to close without many formalities. It can be
formed with an agreement and registration is also not mandatory for it. As there are two or
more partners, therefore, funds raised can be more. As per the provisions, the risk is shared
by all the partners. The burden of losses doesn’t come on one individual. Partnership firms is
not required to publish its accounts which lead to the secrecy of its operations

One of the biggest demerits of a partnership is that its partners have unlimited liability. This
means that personal assets or property of the partners may be used for paying companies
debts. Partnership comes to an end with the death, insolvency or retirement of any of its
partner. This results in the lack of continuity. However, if the remaining partners want to
continue with the business then they have to form a fresh agreement. Possibility of conflicts
always arises when two or more persons are involved. The difference in opinion or some
issues may lead to disputes between partners. This comes in the way of a successful
partnership. Resources are limited as there is the restriction on the number of partners. As a
resulting partnership, firms face problems in expansion beyond a certain size.

While computing income tax for a partnership firm and LLPs, we should consider the income
from House Property (if any property owned by firm or LLP & received rent from
that), Capital Gains (at the time of dissolution of asset of firm or LLP as case may be)
& Other Sources (like interest on investments held by the firm or LLP) also in addition to
the income earned from Business or Profession.

It’s mandatory for every partnership firm and LLP to file the return of income irrespective
of amount of income or loss. E filing is mandatory for a Partnership Firms and LLP’s with
or without digital signature.

At the time of dissolution, the partnership firm also gives assets to the Partners. In such
cases, provisions of Section 45(4) would be applicable and income tax would be levied in
the hands of the partnership firm on the sale of asset. The fair market value of the asset on
the date of sale of asset would be taken as the sale price and tax levied thereon.
 BIBLIOGRAPHY

BOOKS

 Supplement to Direct Taxes Law & Practice

Author: Vinod K Singhania

 Law of Taxation
By Dr. S R Myneni
 Principle of Taxation Law
Author: Sheetal Kanwal

ARTICLES

 Taxation of Partners' Compensation, Vinita Krishnan

 Partnership Firm Tax Return, Clear-tax
 Income Tax Calculation of Partnership, CA Ritul Patwa

WEBSITES

 http://www.legalserviceindia.com/income%20Tax/partnership_firm.htm
 http://www.letslearnaccounting.com/taxation-of-income-of-partnership-firm
 https://archive.india.gov.in/business/taxation/partnership_computetaxable.php
 http://www.commercevilla.com/partnership-firm.html
 http://www.tnkpsc.com/Image/Taxation_of_Partnership_Firms_1_.pdf
 https://www.legalraasta.com/partnership-firms/