Objectives & Agenda : To understand the assessment of partnership firms. To know the conditions to be satisfied to be assessed as a firm. To understand how partnership firms are assessed in various situations. To gain knowledge with regards to the deductions allowed to partnership firms during assessment.To know how to calculate book profit.

1. Assessment of Partnership Firms
CA. Jugal Gala

2. Credits and Acknowledgments
Anand N Krishna

3. Legends used in the Presentation
AO Assessing Officer
AY Assessment Year
HUF Hindu Undivided Family
LLP Limited Liability Partnership
PY Previous Year

4. Presentation Schema
Partnership Firm
Assessment of
Firm
Conditions for
Assessment
Manner of
Assessment
Contraventions
of Conditions
Change in
Constitution of
Firm
Succession of Firm
Dissolution of
Firm
Deduction of
Interest and
Remuneration to
Partners
Computation of
Book Profit
Transfer of Assets
from Partner to
Firm
Transfer of Assets
from Firm to
Partner
Illustrations Caveats and Issues
Judicial
Precedents

5. Partnership Firm – Sec 2(23)
As per Section 2(23) of the Income Tax Act 1961, "firm" 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
Partnership Act, 2008
Section 4 of
Indian
Partnership Act,
1932
Partnership is the relationship between persons who have agreed to
share the profits of a business carried on by all or any of them.
Limited Liability Partnership means a partnership formed and
registered under this Act
Section 2(n) of
Limited Liability
Partnership Act,
2008

6. Assessment of Firm
The firm is taxed as a separate entity irrespective of whether the firm is registered or not.
The definition of firm includes a Limited Liability Partnership and therefore the assessment of
LLP is treated same as that of a firm.
There are certain conditions which are required to be satisfied by a partnership firm to be
assessed as a firm

7. Conditions for Assessment – Sec 184
Along with the first return of income, the firm shall
File certified copy of the Partnership deed and
Individual shares of profits of the partners are
known

8. Manner of Assessment
In case of reconstitution of the firm at the time of assessment, then the assessment shall be done only
on the reconstituted firm
Once a firm is assessed as a
firm for any AY,
it shall be assessed in the
same capacity for every
subsequent AYs
if there is no change in the
constitution of the firm or
share of the partners
When there is a failure on account of Section 144 on the part of firm, no deduction of interest, salary,
bonus, commission or remuneration shall be allowed in the hands of the firm

9. Contravention of Conditions – Sec 185
In case of contravention of the provisions of Section 184,
any payment of interest, salary, bonus, commission or remuneration
to the partners shall be fully disallowed
If disallowed, such interest, salary, bonus, commission or remuneration
won’t be taxable in the hands of partner

10. Change in Constitution of Firm – Sec 187
Change in
constitution of the
firm means
Retirement of
an existing
partner
Admission of a
new partner
Change in the
profit sharing
ratio of the
partners
At the time of scrutiny assessment under Section 143 or best judgement assessment under Section 144,
when it is found that there is change in the constitution of a firm, the assessment shall be made on the
firm as constituted
Where the firm is dissolved on the death of any of its partners, it shall not tantamount to change in
constitution

11. Succession of Firm – Sec 188
Where a firm carrying on a business or profession is succeeded by another firm,
and the case is not one covered by section 187,
separate assessments shall be made on the predecessor firm and the successor
firm

12. Joint and Several Liability for Tax Payable – Sec
188A
During the PY, every
partner, and the legal
representative of any
such partner 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
and all the provisions
of this Act shall apply
to the assessment of
such tax or imposition
or levy of such penalty
or other sum
However, in case of Limited Liability Partnership, the liability for a partner shall be restricted to its capital
contribution

13. Dissolution of Firm – Sec 189
Where a firm is dissolved or
business discontinued,
the firm shall be assessed by the
AO
on its total income as if no such
dissolution or discontinuance
had taken place
Partners at the time of dissolution or discontinuance, or the legal representative of deceased partner, shall be
jointly and severally liable for the amount of tax, penalty and any other sum payable under the Act
Where discontinuance or dissolution takes place after any proceedings have commenced, the proceedings
may be continued for the persons referred above from the stage at which they stood at the time of such
dissolution or discontinuance
If the AO or the Commissioner (Appeals) in the course of any proceeding, in respect of any such firm, is
satisfied that the firm was guilty of any of the acts specified in Chapter XXI (failure to furnish returns, failure to
maintain books of accounts), he may impose or direct the imposition of a penalty
However, the above provisions does not affect the extent of liability of the legal representatives specified in
section 159(6) i.e. liability shall be limited to the extent of estate capable of meeting the liability

14. Deduction of Interest to Partners – Sec 40(b)
Conditions to be satisfied
to claim interest to
partners as deduction
Interest should be
authorised by the
partnership deed
Interest must be allowed
only from the date of
partnership deed
Rate of interest does not
exceed 12% simple interest
per annum
However the above provision is not applicable if interest is paid to a person, acting otherwise
than in a representative capacity, not being a partner (like Karta of HUF)

15. Illustration 1
M/s. A HUF is a partner in a firm, represented by Mr. A. Mr. A is not a partner in that firm in his
personal capacity. Mr. A in his personal interest gave a loan of Rs.1,00,000 and the M/s. A HUF
gave a loan amounting to Rs.4,00,000.
The firm pays interest on the above loans as follows:
A - Rs.15,000 HUF - Rs.50,000
Interest paid to Mr. A (otherwise
than as partner in a representative
capacity)
Interest paid to HUF (in
representative capacity)
The amount paid to Mr. A as
interest in his personal capacity will
not attract provisions of Section
40(b) and so Rs.15,000 will be
allowed as deduction to the firm
Provisions of Section 40(b) will be
applicable in case of Rs.50,000 and
only Rs.48,000 (400000*12%) will
be allowed as deduction to the
firm
Explanation – 2 to Section 40(b) Explanation – 1 to Section 40(b)

16. Deduction of Remuneration to Partners – Sec
40(b)
Conditions to be
satisfied to claim
remuneration to
partners as deduction
Remuneration must be
paid only to a *working
partner
Authorised by the
partnership deed
Allowed only from the
date of partnership
deed
Remuneration must be
within the permissible
limit
*Explanation 4 - Working partner means
an individual who is a partner of a firm
such an individual is actively engaged in
conducting the affairs of the
business/profession of the firm
CBDT Circular No. 739, dated 25-3-1996 states
that the partnership deed must specify either
the quantum of remuneration to partners or lay
down manner of quantifying such remuneration

17. Permissible Limit
The maximum amount of deduction for remuneration to all the partners during the previous year should
not exceed the limits given below
Book Profit Amount deductible u/s 40(b)
Book Loss Rs.1,50,000
Book Profit:
On first Rs.3,00,000 of Book Profit Rs.1,50,000 or 90% of Book Profit,
whichever is higher
On the remaining Book Profit 60% of Book Profit
Explanation – 3
to sec. 40(b)
Book profit means the net profit, as shown in the P&L account for the relevant PY,
computed in the manner laid down in Chapter IV-D (computation for profits & gains of
business) as increased by the aggregate amount of the remuneration paid or payable to
all the partners of the firm if such amount has been deducted while computing the net
profit

18. Computation of Book Profit for Remuneration
Particulars Amount
Profit as per Profit & Loss a/c XXX
Add: Remuneration to partners if debited to Profit and
loss a/c
XXX
Add: Brought forward business loss, deduction under
section 80C to 80U if debited to profit and loss a/c
XXX
Less: Income under house property, capital gain, other
sources if credited to profit and loss a/c
(XXX)
BOOK PROFIT XXX

19. Transfer of Assets from Partner to Firm – Sec 45(3)
The profits or gains arising from the transfer of a capital asset by a person to a firm
in which he is or becomes a partner, by way of capital contribution or otherwise,
shall be chargeable to tax as his income and the amount recorded in the books
of account of the firm 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
However, no capital gains shall arise on transfer of a personal asset which does not fall within the purview of
definition of capital asset

20. Transfer of Assets from Firm to Partner – Sec 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 otherwise,
shall be chargeable to tax
as the income of the firm
and 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

21. Illustration 2
ABC & Associates is a partnership firm with a net profit of Rs.5,00,000 for the year ended 31.03.2019. The
salaries paid to partners B and C, being working partners, was Rs. 2,00,000 each. The firm paid interest on
capital at the rate of 15% which amounts to Rs.1,50,000. The interest earned by the firm on bank deposits is
Rs.50,000 (credited to P&L A/c). The firm transferred its land to A, one of the partners, on 31.03.2019 at Rs.
20,00,000 for which the market value as on 31.03.2019 was Rs.25,00,000. The land was acquired by the firm
on 01.04.2001 for Rs. 8,00,000. The sale consideration was not credited to P&L A/c. Compute capital gains,
book profit and maximum remuneration allowable
Particulars Amount (in Rs)
Sale consideration as per Section 45(4) 25,00,000
Less: Indexed cost of acquisition (8,00,000*280/100) 22,40,000
Long Term Capital Gain 2,60,000
Computation of Long Term Capital Gain in the hands of firm

22. Contd..
Particulars Amount (in Rs)
Profit as per Profit & Loss a/c 5,00,000
Add: Salary paid to partners if debited to Profit and loss a/c 4,00,000
Add: Interest paid in excess of 12% {(1,50,000/15%)*(15%-12%)} 30,000
Less: Interest on Deposits credited to profit and loss a/c (50,000)
Book Profit 8,80,000
Computation of Book Profit

23. Contd..
Book Profit –
Rs.8,80,000
On first Rs.3,00,000 of
book profit
Rs.1,50,000 or
Rs.2,70,000
(3,00,000*90%)
whichever is higher
Rs.2,70,000
On remaining book
profit of Rs. 5,80,000
Rs.3,48,000
(5,80,000*60%)
Rs.3,48,000
Maximum amount deductible in respect of total remuneration to partners
Rs.2,70,000 Rs.3,48,000 Rs.6,18,000
Maximum
Deduction

24. Caveats and Issues
The share of the partner in the income of the firm is not to be included in computing the total income of the
said partner – Section 10(2A)
Can the income of a partner be taxed on presumptive basis under section 44AD?
Any asset used for personal purposes by a partner (say a motor car) is not a capital asset (movable personal
effects are not capital assets under Section 2(14)) in the hands of a partner even though it may be a capital
asset for the firm

25. Judicial Precedents
M/s Durga Dass Devki Nandan vs Income-tax Officer, Palampur [2011] 12 taxmann.com 156 (Himachal
Pradesh)
The assessee, a firm, provided in the partnership deed that its partners would be “working partners within the
meaning of section 40(b)” and “be paid a monthly salary as per the income-tax provisions”
Section 40(b)(v) does not lay down any condition that the partnership deed should fix the remuneration or the
method of quantifying remuneration
CBDT circular No. 739 requires that either the amount of remuneration payable to each individual should be fixed in
the agreement or the partnership agreement deed should lay down the manner of quantifying such remuneration
The CBDT cannot issue a circular which goes against the provisions of the Act. The CBDT can only clarify issues but
cannot insert terms and conditions which are not part of the main statute
So a partnership deed which states that the remuneration would not exceed the maximum remuneration provided
in the Act is valid and deduction is admissible

26. Contd..
Chalasani Venkateswara Rao v ITO [2012] 25 taxmann.com 378 (AP.)
Where assessee, being a partner of a firm, on dissolution of firm, received a lump sum amount
from another partner in full and final settlement towards his share and all assets and liabilities
of firm were vested in said other partner, there was no transfer by assessee to other partner.
Moreover, in case of dissolution of a firm only the firm is taxable on capital gains under Section
45(4) and not the partner
Commissioner of Income-tax v Dynamic Enterprises [2013] 40 taxmann.com 318 (Kar)
It was held that where retiring partner took cash towards value of his share in partnership firm
and there was no distribution of capital assets among partners, there was no transfer of capital
asset and, therefore, no profits or gains chargeable to tax under Section 45(4) arose in hands of
firm

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