Month: July 2020

Bangalore University B.com Notes

Levy and Collection of duties not covered under GST

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There are certain activities which are items not covered under GST. They are beyond the scope of GST, i.e., GST will not apply on them. These are classified under Schedule III of the GST Act as “Neither goods nor services”.

1.Services by an employee to the employer in relation to his employment

Related parties include employer-employee which raised many concerns whether employment now attracted GST.  This clarification has been brought in to clarify whether GST is not applicable on employment. An employee will still pay income tax on salary earned .

  1. Court/Tribunal Services including District Court, High Court and Supreme Court

Courts will not charge GST to pass judgement.

  1. Duties performed by:

  • The Members of Parliament, State Legislature, Panchayats, Municipalities and other local authorities
  • Any person who holds a post under the provisions of the Constitution
  • Chairperson/Member/Director in a body established by the government or a local body and who is not an employee of the same

  1. Services of a funeral, burial, crematorium or mortuary including transportation of the deceased

There are no taxes on funeral services for any religion.

  1. Sale of land and sale of building

Construction of a new building is subject to GST (being works contract).

  1. Actionable claims (other than lottery, betting and gambling)

Actionable Claims’ means claims which can be enforced only by a legal action or a suit, example a book debt, bill of exchange, promissory note. A book debt (debtor) is not goods because it can be transferred as per Transfer of Property Act but cannot be sold. Bill of exchange, promissory note can be transferred under Negotiable Instruments Act by delivery or endorsement but cannot be sold. 

Actionable claims are neither products nor services. They can be considered as something in lieu of money. So GST will not apply on these.

Lottery, betting, and gambling attract 28% GST.

  1. Supply of goods from a place in the non-taxable territory to another place in the non-taxable territory without such goods entering into India*.
  2. Supply in Customs port before Home consumption*:
    (a) Supply of warehoused goods to any person before clearance for home consumption;
    (b) Supply of goods by the consignee to any other person, by an endorsement of documents of title to the goods, after the goods have been dispatched from the port of origin located outside India but before clearance for home consumption.

  3. Petroleum Product, Alcohol

One of the biggest burdens for home buyers is that they will have to bear both GST and Stamp Duty. This is because Stamp Duty was not subsumed under the GST. As a result, they are paying both the taxes which is a burden.

Since GST does not cover road tax, Vehicle Tax was not subsumed under GST. So, vehicle buyers still need to pay road tax as per the Motor Vehicle Act.

In order to bring alcohol under the purview of GST, a constitutional amendment is needed. Hence, Excise on Liquor was not covered under GST.

The Tax on sale and consumption of Electricity is not covered by GST. So, states still charge VAT and centre charges Central Excise on electricity bills.

Toll Tax, environment tax and all other taxes that are directly paid by the users are still levied by the states as they do not come under GST.

Entertainment tax collected by the Local Bodies is not covered under GST. As a result, users will have to pay extra tax in addition to GST which leads to an increase in the price of things like movie tickets.

All the above taxes are a burden on the users or consumers, hence they want the government to levy a single tax to avoid double taxation.

Bangalore University B.com Notes

Sales Tax / Central Sales Tax Meaning and Definition, Features

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A sales tax is a tax paid to a governing body for the sales of certain goods and services. Usually laws allow the seller to collect funds for the tax from the consumer at the point of purchase. When a tax on goods or services is paid to a governing body directly by a consumer, it is usually called a use tax. Often laws provide for the exemption of certain goods or services from sales and use tax. A value-added tax (VAT) collected on goods and services is like a sales tax.

The indirect tax imposed on selling and purchasing of goods within India is referred to as Sales Tax. It is an additional amount paid over and above the base value of the product being purchased. This tax, usually imposed on the seller by the government, enables the seller to recover the tax from the purchaser. It is usually charged from buyers at the point of purchase or the exchange of some specific goods and is chargeable at a certain percentage of the product value.

Sales Tax is levied by the Central Government as well as State Governments. It is decided by the Central Government basis its tax policies. State Sales Tax laws vary between states.

Central Sales Tax

The following are some of the key features of the Central Sales Tax Act.

  • Lays down principles regarding the time of sale and purchase of goods
  • Enlists goods that have special importance for trade and commerce
  • Lays down regulations regarding charging, collection and distribution of taxes generated from interstate trade
  • Holds the final authority for settling interstate trade disputes

State Government Taxes

State Governments in India have the power to decide on Sales Tax policies as per their unique financial requirements. This explains the reason as to why sales taxes vary from state to state. States classify businesses dealing in the sale of goods under three heads – manufacturers, dealers and sellers. Each of them require certificates to operate legally.

Exemptions from Sales Tax

The following categories are exempted from State Sales Tax and are offered to overcome double taxation, or on humanitarian grounds.

  • Certain specific goods as per the list of goods that have been exempted by the state government
  • Products from sellers with valid state resale certificates
  • Products sold for the purpose of charities or educational institutions like schools

Sales Tax Calculation

Sales Tax rate applicable on a particular product can be calculated through a simple formula:

Total Sales Tax = Cost of item x Sales tax rate

While the formula is a simple one, sellers and manufactures need to consider the following while calculating Sales Tax on their goods:

  • It is calculated as a percentage
  • Be updated on the Sales Tax rate of the state and city that the manufacturer or seller belongs to, as it varies from state to state

Types of Sales Tax

Though countries across geographies have their unique Sales Tax policies, there are certain standard types of sales taxes that are applicable to most countries. They are:

Wholesale Sales Tax: Tax levied on individuals dealing with wholesale distribution of goods is referred to as Wholesale Sales Tax.

Manufacturers’ Sales Tax: Tax charged on manufacturers of some specific goods is known as Manufacturers’ Sales Tax.

Retail Sales Tax: Tax levied on sale of retail goods and directly payable by the final consumer is called Retail Sales Tax.

Use Tax: This is a tax levied on the consumer for goods bought without paying sales tax. This usually holds true when goods are bought from vendors who are not a part of the tax jurisdiction.

Value Added Tax: An additional tax levied by some central governments on all purchases is called the Value Added Tax.

Bangalore University B.com Notes

Tax Administration

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Composition of Central Board of Direct Taxes

The Central Board of Direct Taxes is the administrative authority for levying and collection of sale taxes in India. It is a part of the Department of Revenue that is integral to the Ministry of Finance, and functions as per the Central Board Revenue Act, 1963.

The Central Board of Direct Taxes is composed of members who are assigned responsibilities across different departments like Income Tax, Revenue, Investigation, Legislation and Computerisation, Personnel and Vigilance, and Audit. The governing body is headed by the Chairman.

The Central Board of Direct Taxes is responsible for the following:

  • Formulate policies related to direct taxes.
  • Oversee administration of direct tax laws along with the Income Tax Department.
  • Investigates complaints and disputes related to evasion of taxes.

According to the federal structure of Goods and Services Tax in India, the taxation system has been divided into two parts Central GST (CGST) and State GST (SGST). In this case Centre and States will simultaneously levy Goods and Services Tax across the value chain. The Goods and Services Tax will be levied on every supply of goods and services. Centre would levy and collect Central Goods and Services Tax (CGST), and States would levy and collect the State Goods and Services Tax (SGST) on all transactions within a State.

This topic concentrates on defining the concepts of GSTN. GSTN Act Commencement, Powers of Officer, Tax exemption and Levy, Time value of money and Input tax credit. Let us now start defining the concept of GSTN.

GSTN abbreviated as Goods and Services Tax Network, is a not-for-profit, non-Government Company to provide shared IT infrastructure and services to Central and State Governments, tax payers and other stakeholders. The key objectives of GSTN are to provide a standard and uniform interface to the taxpayers, and shared infrastructure and services to Central and State/UT governments. Goods and Services Tax Network (GSTN) is a Section 8 (under new companies Act, not for profit companies are governed under section 8), non-Government, private limited company. It was incorporated on March 28, 2013.

GST Act Commencement

The Goods and Services Tax Act Commencement covers Section 1 – Short title, extent and commencement

  • This Act may be called the Central / State Goods and Services Tax Act, 2016.
  • It extends to the whole of India / State’s name.
  • It shall come into force on such date as the Central or a State Government may, by notification in the Official Gazette, appoint in this behalf:

Only if different dates may be appointed for different provisions of this Act and any reference in any such provision to the commencement of this Act shall be construed as a reference to the coming into force of that provision.

Bangalore University B.com Notes

Taxable value of Goods and Services not covered under GST

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GST exemptions for goods

There is a list of goods which do not attract GST as recommended by the GST Council. The reasons for granting exemption on goods might include any of the following:

  • In the interest of the public
  • The exemption is as per the GST Council’s recommendation
  • The exemption is granted by the Government through a special order
  • The exemption is allowed on specific goods through an official notification

Moreover, there are two types of GST exemptions on goods. These are as follows:

  • Absolute exemption: Under this type of exemption, the supply of specific types of goods would be exempted from GST without considering the details of the supplier or receiver and whether the good is supplied within or outside the State.
  • Conditional exemption: Under this type of exemption, supply of specific types of goods would be GST exempt subject to certain terms and conditions which have been specified under the GST Act or any amendment or notification.

Here is a list of some of the most common goods which are GST exempt:

Types of goods Examples
Live animals Asses, cows, sheep, goat, poultry, etc.
Meat  Fresh and frozen meat of sheep, cows, goats, pigs, horses, etc.
Fish  Fresh or frozen fish
Natural products Honey, fresh and pasteurized milk, cheese, eggs, etc.
Live trees and plants Bulbs, roots, flowers, foliage, etc.
Vegetables  Tomatoes, potatoes, onions, etc.
Fruits Bananas, grapes, apples, etc.
Dry fruits Cashew nuts, walnuts, etc.
Tea, coffee and spices Coffee beans, tea leaves, turmeric, ginger, etc.
Grains  Wheat, rice, oats, barley, etc.
Products of the milling industry  Flours of different types
Seeds  Flower seeds, oil seeds, cereal husks, etc.
Sugar  Sugar, jaggery, etc.
Water  Mineral water, tender coconut water, etc.
Baked goods Bread, pizza base, puffed rice, etc.
Fossil fuels Electrical energy
Drugs and pharmaceuticals Human blood, contraceptives, etc.
Fertilizers  Goods and organic manure
Beauty products Bindi, kajal, kumkum, etc.
Waste  Sewage sludge, municipal waste, etc.
Ornaments Plastic and glass bangles bangles, etc.
Newsprint  Judicial stamp paper, envelopes, rupee notes, etc.
Printed items Printed books, newspapers, maps, etc.
Fabrics  Raw silk, silkworm cocoon, khadi, etc.
Hand tools Spade, hammer, etc.
Pottery  Earthen pots, clay lamps, etc.

GST Exemption on services

Just like specific goods, specific services are also GST exempt. There are three types of supply of services which would qualify for GST exemption. These include the following:

  • Supplies which have a 0% tax rate
  • Supplies which do not attract CGST or IGST due to the provisions stated in a notification which amends either Section 11 of CGST Act or Section 6 of IGST Act
  • Supplies which are defined under Section 2(78) of the GST Act which are not taxable.

Since these types of supplies are GST exempt, any Input Tax Credit which is applicable on these supplies would not be available to utilise or set off the GST liability.

Moreover, even under supply of services, there can be two types of GST exemptions which are as follows –

  • Absolute exemption wherein the service would be exempted from GST without any conditions
  • Conditional exemption or partial exemption wherein exemption is granted based on a condition. This condition states that if the service is supplied intra-State or if the service is supplied by a registered person to an unregistered one, GST would be exempted if the total value of such supplies received by a registered person is not more than INR 5000/day.

Here is a list of some of the services which enjoy GST exemption:

Types of services  Examples 
Agricultural services Cultivation, supplying farm labour, harvesting, warehouse related activities, renting or leading agricultural machinery, services provided by a commission agent or the Agricultural Produce Marketing Committee or Board for buying or selling agriculture produce, etc.
Government services Postal service, transportation of people or goods, services by a foreign diplomat in India, services offered by the Reserve Bank of India, services offered to diplomats, etc.
Transportation services  Transportation of goods by road, rail, water, etc., payment of toll, transportation of passengers by air, transportation of goods where the cost of transport is less than INR 1500, etc.
Judicial services Services offered by arbitral tribunal, partnership firm of advocates, senior advocates to an individual or business entity whose aggregate turnover is up to INR 40 lakhs
Educational services Transportation of faculty or students, mid-day meal scheme, examination services, services offered by IIMs, etc.
Medical services  Services offered by ambulance, charities, veterinary doctors, medical professionals, etc. 
Organizational services  Services offered by exhibition organisers for international business exhibitions, tour operators for foreign tourists, etc.
Other services  Services offered by GSTN to the Central or State Government or Union Territories, admission fee payable to theatres, circuses, sports events, etc. which charge a fee up to INR 250

Though GST is applicable for all businesses and on the supply of goods and services, the above-mentioned exemptions are available. These exemptions reduce the GST burden and help in the socio-economic development of the country.

Management Notes

Assessment of Firms (Section 184)

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The assessment of firms under Section 184 of the Income Tax Act, 1961, is a cornerstone of partnership taxation in India. It defines the conditions under which a partnership firm can be recognized for tax purposes, setting the stage for its tax liabilities and entitlements. Compliance with Section 184 is crucial for firms seeking to avail themselves of the tax benefits specific to their status, including deductions for interest and remuneration paid to partners and the taxation rate applicable to firms. Given the complexities and stringent requirements, firms must approach compliance with meticulous attention to detail, ensuring that all conditions are met and that the necessary documentation is in place. This not only facilitates smoother assessment and taxation processes but also optimizes the firm’s tax position. In navigating the intricacies of Section 184, firms often benefit from professional advice, ensuring that they remain compliant while making the most of the tax benefits available under the Income Tax Act.

Understanding Section 184: Conditions for Assessment as a Firm

Section 184 lays down the conditions under which a partnership firm is recognized for the purpose of assessment and taxation. The fulfillment of these conditions is essential for a firm to be assessed as a ‘firm’ under the Income Tax Act, which in turn affects its tax liabilities and entitlements to deductions.

Conditions to Be Fulfilled by A Firm To Be Assessed As Such (PFAS):

  1. Partnership Deed:

The firm should be constituted under a partnership deed. This deed should be in writing, clearly outlining the various terms and conditions agreed upon by the partners.

  1. Individual Names:

The partnership deed must specify the individual names of all the partners.

  1. Business Details:

The deed should clearly mention the business that the firm is engaged in.

  1. Profit-Sharing Ratio:

The partnership deed must clearly state the profit (or loss) sharing ratio among the partners.

  1. Registration:

Though not mandatory for the purpose of formation, for a firm to be assessed under the Income Tax Act, it is advisable that the partnership deed is registered with the Registrar of Firms. This helps in certain legal and procedural matters.

  1. Permanent Account Number (PAN):

The firm must have its own Permanent Account Number (PAN) and should apply for it if not already done.

  1. Fulfilling Other Conditions:

Any change in the constitution of the firm or in the profit-sharing ratio during the previous year should be duly attested by all the partners (including new partners, if any) and should be in accordance with the partnership deed. If there’s no such deed or if the deed does not specify these details, such changes should be evidenced by any instrument in writing, attested by all the partners.

  1. Timely Submission:

The firm should submit the partnership deed, and any changes thereto, along with the return of income for the assessment year relevant to the financial year for which it is first assessable.

Implications of Assessment as a Firm

Being assessed as a firm under the Income Tax Act has significant tax implications:

  • Taxation Rate:

Firms are taxed at a rate specified under the Act, which is distinct from the rates applicable to individuals or companies.

  • Deduction for Interest and Salary Paid to Partners:

 Subject to conditions and limits specified under Section 40(b), firms can claim deductions for interest on partners’ capital and remuneration paid to partners for services rendered.

  • Share of Profit in Partners’ Hands:

The share of profit received by the partners from the firm is exempt from tax in their hands to avoid double taxation, as the income is already taxed at the firm level.

Compliance and Documentation:

  • Permanent Account Number (PAN):

Every taxpayer, whether an individual, firm, or company, must have a PAN. It serves as a unique identifier for tax-related transactions and communications with the Income Tax Department.

  • Tax Deducted at Source (TDS):

Persons responsible for making payments like salaries, rent, interest, etc., are required to deduct TDS at specified rates. Proper documentation and filing of TDS returns are necessary to comply with TDS provisions.

  • Advance Tax:

Taxpayers, including individuals, firms, and companies, are required to estimate their income and pay taxes in advance in installments known as advance tax. Compliance involves accurate estimation, timely payment, and documentation of advance tax payments.

  • Income Tax Returns (ITR):

Every taxpayer is required to file an income tax return annually, declaring their income, deductions, and taxes paid. Proper documentation of income sources, investments, and expenses is necessary for accurate reporting in the ITR.

  • Tax Audit:

Certain taxpayers, including businesses and professionals, are required to undergo a tax audit under the provisions of the Income Tax Act. Compliance involves maintaining books of accounts, financial statements, and other relevant documents as per audit requirements.

  • Goods and Services Tax (GST):

Businesses registered under GST need to comply with GST provisions, including filing periodic returns, maintaining records of sales and purchases, and adhering to invoicing requirements.

  • Transfer Pricing Documentation:

Multinational companies engaged in international transactions with associated enterprises are required to maintain transfer pricing documentation to demonstrate that transactions are conducted at arm’s length prices.

  • Tax Exemptions and Deductions:

Taxpayers claiming exemptions or deductions under various provisions of the Income Tax Act must maintain proper documentation to substantiate eligibility and compliance with conditions specified for claiming such benefits.

  • Income and Expense Documentation:

Proper documentation of income sources, receipts, invoices, bills, bank statements, and other financial records is crucial for substantiating income, expenses, and deductions claimed in the tax return.

  • Compliance with Notices and Communication:

Taxpayers must comply with notices, summons, and communications received from the Income Tax Department within the stipulated time frame. Proper documentation of responses and supporting documents is essential.

  • Record Retention:

Taxpayers should retain relevant documents, records, and correspondence for a specified period as prescribed under the Income Tax Act to meet audit and verification requirements.

Challenges:

Complex Regulations

  • Complexity:

The Act is voluminous and complex, with numerous sections, sub-sections, and clauses. This complexity can be daunting for the average taxpayer.

  • Frequent Amendments:

Tax laws are subject to frequent changes through annual Finance Acts, making it difficult for taxpayers to stay updated.

Compliance Burden

  • Compliance Costs:

Small and medium enterprises (SMEs) and individual taxpayers may find compliance costs high due to the need for professional assistance.

  • Time-Consuming:

Keeping up with filing returns, maintaining records, and adhering to deadlines can be time-consuming.

Digitalization and Technology Use

  • Technology Challenges:

While digitalization (e.g., e-filing of tax returns, digital assessments) has simplified many processes, it also poses challenges for those not tech-savvy.

  • Data Privacy Concerns:

With the increasing use of technology, data privacy and security become significant concerns.

Litigations and Disputes

  • High Volume of Litigations:

The complexity of tax laws leads to numerous disputes and litigations, causing a backlog in courts and tribunals.

  • Resolution Time:

Dispute resolution mechanisms can be time-consuming, impacting businesses and individuals.

Transfer Pricing

  • Complex Regulations:

Transfer pricing regulations are complex and pose challenges in compliance, especially for multinational companies.

  • Documentation Burden:

Maintaining extensive documentation and substantiating transfer prices can be cumbersome.

International Taxation

  • Double Taxation:

Taxpayers working or doing business in multiple countries face challenges due to double taxation, despite Double Taxation Avoidance Agreements (DTAAs).

  • BEPS Initiatives:

Adhering to Base Erosion and Profit Shifting (BEPS) initiatives and reporting requirements adds to the compliance burden.

Tax Planning and Avoidance

  • Thin Line Between Planning and Avoidance:

Taxpayers often struggle to distinguish between legitimate tax planning and aggressive tax avoidance, risking scrutiny.

  • GAAR Provisions:

General Anti-Avoidance Rules (GAAR) aim to curb aggressive tax planning, but they also create uncertainty in their application.

Cryptocurrency Taxation

  • Unclear Regulations:

The taxation of cryptocurrencies and digital assets lacks clarity, creating uncertainty for investors and traders.

  • Valuation Challenges:

Determining the value of transactions and applicable taxes can be complex due to the volatility of digital assets.

Considerations for Taxpayers and Practitioners

  • Stay Informed:

Keeping abreast of the latest tax laws, amendments, and judicial precedents is crucial.

  • Seek Professional Help:

Given the complexities, seeking advice from tax professionals is advisable for compliance and strategic planning.

  • Adopt Technology:

Leveraging technology for compliance, documentation, and transaction tracking can ease the burden.

Case Law and Interpretations

Various case laws and rulings have provided interpretations of Section 184, clarifying aspects such as the implications of minor changes in the partnership deed, the effect of non-compliance with registration requirements, and the treatment of remuneration to partners. These interpretations help firms navigate the complexities of compliance and assessment under the Act.

Broader Context: The Role of Section 184 in Firm Assessment

Section 184 plays a crucial role in the broader context of the assessment of firms under the Income Tax Act. It sets the foundation for recognizing a partnership firm as a distinct assessable entity, establishing the criteria for its eligibility for certain tax benefits and laying down the compliance framework for firms to be taxed under the specific provisions applicable to them.

Management Notes

Computation of firm’s Business Income

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Computation of a firm’s business income is a meticulous process that demands a thorough understanding of the Income Tax Act’s provisions and a strategic approach to tax planning. It involves starting from the gross receipts, adjusting for COGS, allowable expenses, disallowances, depreciation, and considering any set-off or carry forward of losses. Accuracy in record-keeping, compliance with legal requirements, and strategic tax planning are pivotal to ensuring that the firm accurately reports its income and optimizes its tax liabilities. Given the intricacies involved, firms are advised to seek professional guidance to navigate the complexities of tax computation and ensure adherence to all regulatory mandates.

Understanding Business Income

Business income refers to the profit or gain that arises from the conduct of any trade, commerce, manufacturing, or any activity undertaken with the aim of making a profit. For a firm, it encompasses the earnings from its operational activities after subtracting allowable expenses.

Step-by-Step Computation of Firm’s Business Income

  1. Gross Receipts or Sales

The starting point for computing business income is the gross receipts or sales from the business during the financial year. This includes all revenue generated from the sale of goods or rendering of services before any deductions.

  1. Deducting Cost of Goods Sold (COGS)

From the gross receipts, the cost of goods sold is deducted to arrive at the gross profit. COGS includes the cost of materials, direct labor, and other direct expenses related to the production or purchase of goods sold by the firm.

  1. Adjustment of Expenses

The gross profit is then adjusted for allowable business expenses incurred during the year. The Income Tax Act specifies various expenses that are deductible, including but not limited to:

  • Rent, rates, taxes, repairs, and insurance for premises
  • Salaries, wages, and bonuses to employees
  • Interest on borrowed capital
  • Depreciation on assets used for business purposes
  • Bad debts written off
  • Other expenses directly related to the business

However, it is crucial to note that expenses must be wholly and exclusively incurred for the business and not of a capital, personal, or illegal nature.

  1. Disallowances and Additions

Certain expenses and losses are disallowed under the Act and must be added back to the net profit to compute the taxable income. These include:

  • Personal expenses of the partners
  • Interest, salary, commission, or remuneration to partners above the limits specified under Section 40(b)
  • Penalties and fines for violation of law
  • Expenses related to exempt income

  1. Depreciation

Depreciation on fixed assets used for the purpose of the business is an important deduction. The Income Tax Act provides rates of depreciation for different classes of assets. Firms must calculate depreciation as per the prescribed rates and methods and deduct it from the gross profit.

  1. Deductions under Sections 80C to 80U

Firms are eligible for certain deductions from their gross total income under sections 80C to 80U of the Income Tax Act for investments, contributions to specified funds, insurance premiums, etc. However, these deductions are more applicable to individuals and HUFs, and firms have limited scope in this area.

  1. Set-Off and Carry Forward of Losses

Business losses can be set off against other heads of income in the same year or carried forward to future years, subject to conditions and limitations provided in the Act. Understanding these provisions is crucial for optimizing the tax liability.

  1. Calculation of Taxable Income

After making all adjustments, additions, and allowable deductions, the net amount arrived at is the firm’s taxable income from business/profession for the financial year.

Key Considerations

  • Accurate Record-Keeping:

Maintaining precise and detailed records of all transactions, expenses, and incomes is fundamental for the computation of business income.

  • Understanding Tax Provisions:

Familiarity with the Income Tax Act’s provisions regarding allowable deductions, disallowances, depreciation, and specific exemptions is critical.

  • Compliance with Legal Requirements:

Firms must ensure compliance with all statutory requirements, including timely filing of returns, payment of advance tax, and adherence to tax audit provisions, if applicable.

Strategic Insights

  • Tax Planning:

Effective tax planning involves strategizing to avail of all permissible deductions and benefits under the law, thus minimizing the tax liability without infringing on legal provisions.

  • Consultation with Tax Professionals:

Given the complexity of tax laws and frequent amendments, consulting with tax professionals or chartered accountants can provide valuable insights and help in optimizing tax outcomes.

Method of accounting Firm’s Business Income:

Accrual Basis of Accounting:

  • Revenue Recognition: Income is recorded when it is earned, regardless of when the cash is received.
  • Expense Recognition: Expenses are recorded when they are incurred, not necessarily when they are paid.
  • Inventory: Valued at cost or market value, whichever is lower, and is considered in computing the business income.
  • Depreciation: Calculated as per the rates and methods prescribed under the Income Tax Act. The Written Down Value (WDV) method is commonly used.
  • Tax Deductions and Allowances: Certain expenses that are directly related to the business operations and revenue generation are deductible from the gross income.

Cash Basis of Accounting:

  • Revenue Recognition: Income is recognized only when the cash is actually received.
  • Expense Recognition: Expenses are recognized only when the cash is paid out.

Key Points for Accounting in Firms:

  • Mandatory Audit:

Firms with a turnover exceeding a specified limit (subject to change, so it is advisable to refer to the latest provisions) in a financial year are required to get their accounts audited by a Chartered Accountant.

  • Tax Filing:

Firms are required to file their income tax returns annually, detailing their income, expenses, and tax liability.

  • Presumptive Taxation Scheme:

Small firms (engaged in certain businesses) with gross receipts below a specified limit can opt for a presumptive taxation scheme under sections 44AD and 44ADA of the Income Tax Act, which allows for a simpler way of computing taxable income based on a prescribed percentage of the turnover.

Management Notes

Meaning of Partnership, Firm and Partners

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The Income Tax Act, 1961, in India, the terms “partnership,” “firm,” and “partners” hold specific meanings and implications for tax purposes. Understanding these definitions and the legal framework surrounding them is crucial for compliance and tax planning for entities operating as partnerships.

Definition of Partnership

Under Section 4 of the Indian Partnership Act, 1932, a partnership is defined as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” This definition underscores the essence of a partnership as a voluntary association of two or more persons who agree to carry on a business and share its profits or losses. The Partnership Act does not limit the maximum number of partners; however, the Companies Act, 2013, imposes a limit of 50 partners for a partnership firm to prevent it from becoming an association or company.

Characteristics of a Partnership:

  • Agreement-Based:

The formation of a partnership is based on a contract, either oral or written (Partnership Deed), among the partners.

  • Profit and Loss Sharing:

Partners agree to share the profits and bear the losses of the business in a predetermined ratio.

  • Mutual Agency:

Every partner acts as both an agent and principal. Each partner is an agent of the firm and other partners, binding the entity in the course of the business.

  • Unlimited Liability:

Partners have unlimited liability, meaning their personal assets can be used to settle the firm’s debts if necessary.

Definition of Firm

In the context of the Income Tax Act, the term “firm” specifically refers to a partnership entity that is engaged in a business or profession. The Act recognizes a firm as a separate taxable entity distinct from its partners. The term is synonymous with a partnership firm and carries the same legal implications as outlined under the Partnership Act, with additional requirements for taxation purposes.

Characteristics of a Firm:

  • Separate Legal Entity for Tax Purposes:

Although not a separate legal entity like a corporation, for tax purposes, a firm is treated distinctly from its partners.

  • Taxation:

A firm is taxable at a rate specified for firms under the Income Tax Act. It enjoys certain benefits and deductions specific to its status.

  • Partnership Deed:

The existence of a partnership deed is crucial for the recognition of a firm for tax purposes. It outlines the rights, duties, profit-sharing ratio among partners, and other terms governing the partnership.

Definition of Partners

Partners are individuals who have entered into a partnership with one another. They contribute capital, share profits and losses, and participate in the firm’s management, unless otherwise agreed. Partners are the driving force behind the partnership, making decisions and undertaking actions for the firm’s benefit.

Taxation of Partnership Firms and Partners

The Income Tax Act lays down specific provisions for the taxation of partnership firms and their partners:

  • Taxation of Firms:

A firm is taxed on its income at the rates applicable to firms. It is required to file an annual income tax return. A partnership firm is also eligible for certain deductions and benefits under the Act.

  • Remuneration and Interest to Partners:

The Act allows firms to deduct interest on capital and remuneration (salary, commission) paid to partners, provided these payments are authorized by the partnership deed and within the limits prescribed under the Act.

  • Taxation of Partners:

Individual partners are taxed on their share of the firm’s profits. The share of profit from a firm is exempt in the hands of the partners to avoid double taxation, as the income is already taxed at the firm level. However, interest and remuneration received by partners from the firm are taxable as income from other sources or profits and gains from business or profession, depending on the nature of the receipt.

Basis of Comparison

 Partnership Firm Partners
Definition Agreement Business Entity Individuals
Legal Status Not Separate Separate Individuals
Formation Agreement Registration Joining Agreement
Liability Unlimited Unlimited Unlimited
Management Shared By Partners Personal Involvement
Profit Sharing Agreed Ratio As per Agreement Direct Share
Loss Bearing Shared By Firm Individual Share
Decision Making Collective Partners’ Consent Individual Opinion
Continuity Uncertain Depends on Agreement Affects Continuity
Ownership Shared By Partners Personal Stake

Number of Members

 2-20 (Typically) Not Applicable At least 2
Dissolution Easier Legal Process Affects Partnership
Legal Formalities Fewer More Minimal
Capital Contribution Voluntary As per Agreement Personal Contribution

Books of Accounts

 Maintained Mandatory

Partner’s Responsibility


Compliance and Documentation

Compliance with tax laws for a partnership firm involves the proper documentation of the partnership deed, accurate bookkeeping, timely filing of income tax returns, and adherence to the provisions related to remuneration and interest payments to partners. The partnership deed, in particular, plays a pivotal role in determining the tax obligations and entitlements of both the firm and its partners.

Bangalore University B.com Notes

New Scheme of Taxation of Firms

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Rate of Income tax applicable to Partnership Firm / LLP

Flat rate of 30% on the total income after deduction of interest and remuneration to partners/Designated Partners at the specified rates + Surcharge of 12% if Total Income exceeds 1 Crore and will be further increased by education cess secondary and higher education cess @ 3% on Income-tax (wef A.Y. 2019-20 health and education cess @ 4% shall be levied in lieu of education cess secondary and higher education cess @ 3% )

Income Tax Slabs for Partnership Firm / LLP

F.Y. 2017-18 F.Y. 2018-19
Tax Rate 30% 30%
Surcharge If income is greater than Rs.1,00,00,00 12% of income tax amount. Subject to marginal relief. If income is greater than Rs.1,00,00,00 12% of income tax amount. Subject to marginal relief.
Education Cess 2% extra – charged on the amount of income tax + surcharge being paid.

 

 N.A.
Secondary and Higher Education Cess  1% extra – charged on the amount of income tax + surcharge being paid.

 

 N.A.
Health and Education cess N.A. 4% extra – charged on the amount of income tax + surcharge being paid.

Remuneration to Partners/Designated Partners

  • Payment of Remuneration to a non-working partner will not be allowed as a deduction
  • A ‘working partner’ is an individual who is actively engaged in conducting the affairs of the business or profession of the firm.
  • Quantum of allowance is to be determined with reference to ‘book profit’ which is defined to mean an amount computed in accordance with the provisions of sections 28 to 44D of the Income-tax Act, as increased by the amount of remuneration to partners if deducted in determining book profit.

As per section 40(b)(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder will be disallowed:

Slab of Remuneration to Partners/Designated Partners

Particulars Salary Allowed
a. On the first 3,00,000 of book profits or in case of a loss Rs. 1,50,000 or at the rate of 90% of the book profit (whichever is higher)

 
b. On the balance of book profits at the rate of 60%

 

Explanation 3 to section 40(b) defines “book-profit” as to mean the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D 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.

Conditions for allowance of remuneration and interest to partners

  1. Remuneration should be to a working partner.
  2. Payment of remuneration and interest should be authorised by and should be in accordance with the terms of the partnership deed and should relate to any period falling after the date of such partnership deed.
  3. No deduction u/s. 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration: Circular No. 739 dt. 25-3-1996.
  4. Conditions for assessment as a firm
  • The partnership should be evidenced by an instrument in writing specifying individual shares of the partners.
  • A certified copy of the instrument signed by all the partners (not being minors) shall accompany the return of the firm for the first assessment as a ‘firm’.
Management Notes

Remuneration Received by partners (Sec 40b)

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The Treatment of remuneration received by partners is a critical aspect of tax planning and compliance for partnerships and Limited Liability Partnerships (LLPs) under the Indian Income Tax Act, 1961. Section 40(b) of the Act plays a pivotal role in defining the deductibility of such remuneration for the purpose of calculating the taxable income of the partnership firm.

The treatment of remuneration received by partners under Section 40(b) of the Income Tax Act, 1961, is a complex but crucial element of tax planning for partnerships and LLPs. It requires a careful balance between optimizing tax liability and adhering to stringent legal requirements. Strategic planning, meticulous documentation, and adherence to prescribed limits and conditions are fundamental to ensuring that remuneration paid to partners is recognized as a deductible expense by the firm, thereby minimizing the overall tax burden. Given the intricacies involved and the potential for significant financial implications, seeking professional advice and conducting regular reviews of remuneration policies in light of evolving tax laws and judicial rulings is highly recommended for firms.

Understanding Remuneration to Partners

Remuneration to partners may include salaries, bonuses, commissions, or any other form of compensation for services rendered to the firm. While such remuneration is an expense from the firm’s perspective and reduces its taxable income, it is concurrently taxable as income in the hands of the receiving partner under the head “Profits and gains of business or profession.”

Legal Framework Under Section 40(b)

Section 40(b) of the Income Tax Act specifies conditions under which remuneration paid to partners can be claimed as a deductible expense by the firm:

  1. Authorization in Partnership Deed:

The payment of remuneration to partners must be authorized by the partnership deed. The deed should clearly stipulate the amount of remuneration or the formula for its calculation.

  1. Quantum of Remuneration:

The Act prescribes limits on the amount of remuneration that can be deducted as an expense by the firm. The allowable deduction is subject to a ceiling based on the firm’s book profits:

  • On the first INR 3,00,000 of book profits or in case of a loss – 90% of book profits or INR 1,50,000, whichever is more.
  • On the balance of the book profits – 60%.
  1. Payment for Services Rendered:

The remuneration must be paid for services rendered by the partner to the firm. It should be directly related to the operations of the firm and not for personal services.

  1. Timing and Payment Method:

The remuneration must be paid within the stipulated time frame and in accordance with the terms specified in the partnership deed. Payments should ideally be made through traceable banking channels to establish a clear record.

Compliance and Documentation

For the remuneration to be recognized as a deductible expense, firms must ensure:

  • Adequate documentation, including maintaining an updated partnership deed that specifies the terms of remuneration.
  • Compliance with the prescribed limits and conditions under Section 40(b).
  • Disclosure of remuneration payments in the firm’s tax returns and financial statements, and proper accounting in the books of the firm.

Strategic Considerations for Structuring Remuneration

  1. Tax Efficiency:

Structuring remuneration within the limits of Section 40(b) can optimize the overall tax liability of the firm and its partners. Consideration should be given to the tax brackets of individual partners and the firm’s profitability.

  1. Compliance:

Ensuring that remuneration agreements are fully compliant with the legal requirements minimizes the risk of disallowances during tax assessments.

  1. Flexibility in Partnership Deed:

The partnership deed should be drafted to allow flexibility in determining remuneration, within the bounds of the law, to adapt to changing business needs and tax laws.

Implications of Non-Compliance

Non-compliance with the conditions laid out in Section 40(b) can lead to the disallowance of remuneration expenses, resulting in a higher taxable income for the firm and potentially higher tax liabilities. Furthermore, discrepancies or inconsistencies in the documentation or payment of remuneration can attract scrutiny from tax authorities, leading to assessments, penalties, or litigation.

Case Studies and Judicial Precedents

Several judicial precedents highlight the importance of adherence to the stipulations of Section 40(b). Courts have consistently ruled that for remuneration to be allowed as a deductible expense, strict compliance with the conditions mentioned in the section is mandatory. Cases where firms failed to properly document the terms of remuneration or exceeded the allowable limits have resulted in disallowances upon review by tax authorities.

Challenges and Best Practices

  • Determining Appropriate Remuneration:

Determining the quantum of remuneration that balances tax efficiency and compliance with legal norms can be challenging. Firms must undertake careful planning and analysis to arrive at an optimal figure.

  • Documentation and Record-Keeping:

Maintaining robust documentation, including a comprehensive partnership deed that meets legal standards, is essential for compliance and audit readiness.

  • Staying Updated:

Tax laws and interpretations can evolve, affecting the treatment of partner remuneration. Regularly reviewing and updating the partnership deed and remuneration strategy in light of current laws and judicial precedents is advisable.

Management Notes

Treatment of Interest, Commission

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Treatment of Interest and Commission in the taxation context requires careful consideration of the provisions of the Income Tax Act, 1961, particularly those related to allowable deductions for firms. Compliance with the conditions set forth in the Act, proper documentation, and strategic tax planning are pivotal in optimizing the tax implications of these transactions. Firms must navigate the complexities of tax regulations judiciously, ensuring that interest and commission payments are structured in a manner that is both tax-efficient and compliant with the law. Given the intricacies involved, professional advice from tax experts and careful planning are indispensable in managing the tax treatment of interest and commission effectively.

Understanding Interest and Commission

Interest refers to the cost paid for borrowing funds. It is an expense for the borrower and income for the lender. In business contexts, interest can be paid on loans, advances, or credit facilities.

Commission represents a service charge or a fee paid for services rendered or for executing specific transactions. It is commonly incurred in sales-driven businesses where salespersons receive a commission as part of their remuneration.

Tax Treatment of Interest and Commission: General Overview

  1. As Income:

Interest and commission received by a firm from its operations, investments, or services are considered income and are taxable under the head “Income from Other Sources” or “Profits and Gains from Business or Profession,” depending on the context of the receipt.

  1. As Expense:

When a firm pays interest or commission, these are generally allowable as business expenses, provided they are incurred wholly and exclusively for the purpose of the business and are not of a capital nature.

Specific Provisions Affecting Firms and Partners

Interest to Partners

Under Section 40(b) of the Income Tax Act, 1961, interest paid to partners is allowed as a deduction to the firm, subject to certain conditions:

  • The interest must be authorized by the partnership deed.
  • The rate of interest does not exceed 12% per annum or such rate prescribed under the Act.
  • The interest is paid on the capital contributed by the partner and not on loans or advances for personal purposes.

Commission to Partners

Similarly, commission paid to partners is deductible subject to the partnership deed authorizing such payment and the payment being in accordance with the terms of the deed. The commission must be for services rendered to the firm, and the amount must be reasonable and justifiable as per the business needs.

Compliance and Documentation

For both interest and commission payments to be recognized as deductible expenses, firms must ensure:

  • Proper documentation, including the partnership deed specifying the terms of such payments.
  • The payments are made via banking channels, ensuring traceability and compliance with tax laws.
  • Adequate disclosure of these transactions in the firm’s tax returns and financial statements.

Implications for Tax Planning

  1. Optimizing Deductions:

By structuring payments of interest and commission within the permissible limits, firms can optimize their taxable income, thereby reducing their overall tax liability.

  1. Strategic Allocation:

Firms might strategically allocate interest and commission to partners in higher tax brackets, thus ensuring a more tax-efficient distribution of income.

  1. Meeting Compliance to Avoid Disallowance:

Ensuring that all conditions under Section 40(b) are met is crucial for the deduction of interest and commission payments to be allowed. Non-compliance can lead to disallowances, increasing the firm’s tax liability.

Case Studies and Judicial Precedents

Numerous judicial rulings and case studies highlight the importance of adherence to the conditions under Section 40(b). For example, cases where firms failed to prove the business necessity of high commission payments to partners resulted in partial disallowances. Similarly, interest payments without proper documentation or exceeding the prescribed limits have been disallowed, underscoring the need for meticulous compliance and documentation.

Challenges in Treatment

  • Determining Reasonableness:

One of the primary challenges in deducting interest and commission expenses is establishing their reasonableness and direct relation to business purposes. This often requires a detailed analysis and justification.

  • Changing Tax Laws:

With frequent amendments to tax laws and rates, staying updated and ensuring compliance with the current provisions is essential for firms.

  • Documentation and Compliance:

Maintaining exhaustive records and ensuring that all transactions are adequately documented and comply with tax regulations can be burdensome for firms but is critical for audit and verification purposes.

Strategic Considerations

  • Holistic Planning:

Interest and commission payments should be part of a firm’s overall tax planning strategy, considering other deductions, allowances, and the firm’s and partners’ overall tax scenarios.

  • Legal and Financial Advice:

Consulting with legal and financial advisors can provide valuable insights into structuring transactions in a tax-efficient manner while ensuring compliance with the law.

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