[A1] Computation of firm’s business income :
Adjustment of Net Profit as per Profit & Loss Account of the firm:
(a) While calculating firms business profit the provisions as given u/s 28 to 44 are applicable.
(b) Section 40(b) lays down following rules regarding payment of salary, commission, or remuneration to working partners and interest on capital to all partners. These rules are
(i) Any payment of salary, commission or remuneration paid to a partner who is not a working partner, is disallowed.
(ii) Any remuneration paid to a working partner, who is not authorised by or which is not in accordance with terms of partnership deed (instrument of partnership) is disallowed.
(iii) Any interest paid to partners according to terms of partnership deed is allowed provided rate of interest does not exceed 12%. Excess is disallowed.
(iv) Any interest paid to partner, who is not authorised by or is not in accordance with partnership deed is disallowed.
(v) In case interest or remuneration is paid to a partner and is authorised by partnership deed but relates to the period prior to the date of such deed and it was also not authorised by any earlier deed, it shall be disallowed.
In case any payment for remuneration is made to one or more working partners during the previous year, it is allowed up to limits given below. Excess is disallowed.
[A2] Limits on payment of remuneration to partners [Section 40(b)]
1. In case of professional firms (as defined u/s 44 AA) Amt. allowed
(a) On the first Rs. 1,00,000 of the book profit 90% of book profit
(b) On the next Rs. 1,00,000 of the book profits 60% of book profit
(c) On the balance of the book profits 40% of book profit
2. In case of any other firms :
(a) On the first Rs. 75,000 of the book profits 90% of book profit
(b) On the next Rs. 75,000 of the book profits ` 60% of book profit
(c) On the balance of the hook profits 40% of book profit
The above limits can he expressed in following manner :
(a) In case a firm (Whether professional or non professional) has loss or it has profit but total remuneration paid to working partners as per instrument of partnership does not exceed Rs. 50,000. Actual remuneration or Rs. 50,000 whichever is less is allowed.
(b) In case total remuneration is more than Rs. 50,000 and firm is carrying on profession it is allowed up to
(i) Actual remuneration to all working partners as per instrument of partnership.
(ii) An amount equal to [90% of first Rs. 1,00,000 + 60% of next Rs. 1,00,000 + 40% of Balance Book Profits] whichever is less.
(c) In case firm is non-professional firm and total remuneration paid is more than Rs. 50,000, it is allowed up to
(i) Actual remuneration to all working partners as per deed.
(ii) An amount equal to [90% of first Rs. 75,000 + 60% of next Rs. 75,000 + 40% of balance book profits] whichever is less.
Certain Explanations :
1. In case an individual is partner in a representative capacity for the benefit of another person, such partner is called partner in representative capacity and the other person is called person so represented.
2. Any interest paid to partner in representative capacity shall be subject to aforesaid limits but any interest paid to him in his individual capacity (as creditor) shall not be subject to above- mentioned limits.
3. Any interest paid to an individual (who is neither partner in representative capacity nor in personal capacity) and he on behalf of or for the benefit of any other person receives such interest, it shall not be subject to the aforesaid limits.
4. The term Book Profit means the net profit as shown in the Profit & Loss Account for the relevant previous year computed according to provisions given u/s 28 to 44 of the Act and after adding back the full amount of remuneration given to partners (as referred to in limits above).
5. The term working partner means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner.
[A3] Computation of Total Income of a FIRM
1. Income is computed headwise. Firm cannot have salary income.
2. It cannot have self-occupied house. Income from let out house property is computed in same manner as already studied under the head ‘house property’.
3. Profits and gains—same as per above.
4. Income under the head capital gains is computed in same manner but with no exemption u/s 54, 54B and 54F.
5. Income from other sources is computed in same manner.
6. Carry forward and set off of losses is done in the same manner.
7. Deductions out of Gross total income : A firm can claim following deductions
u/s 80 G for donations
u/s 80 GGA for contribution to certain funds
u/s 80 GGC for donation to political parties
u/s 80 IA for infrastructure projects
u/s 80 lAB for setting up Special Economic Zones
u/s 80 lB for new industrial undertaking
u/s 80 IC for setting up industry in backward states
u/s 80 JJA for use of bio waste, and
Firm is not allowed any other deduction.
[A4] Computation of firm’s Tax
(a) It pays tax at flat rate of 30% with no exemption limit.
(b) On long term capital gain—rate of tax is 20%.
(c) On short term capital gain on securities covered under STT—rate of tax is 15%
(d) On winnings from lotteries, crossword puzzle, races, card games, gambling and betting— rate of tax is 30%.
(e) Surcharge is added @ 10% of tax (as calculated above) provided total income of the firm exceeds Rs. I crore. So no surcharge if total income does not exceed Rs. 1 crore.
(f) It is further increased by education cess @ 2% of tax and surcharge plus Secondary and Higher education cess @ 1% of tax and surcharge, if any.
[A5] Treatment of Share of Income from firm
It is fully exempted from tax u/s l0(2A) and as such is not added in individual income of partners.
[A6] Treatment of remuneration and interest received from firm
Following amounts shall be added in the individual income of partners under the head Profits and gains
(a) Interest paid by firm to partners shall not he added in individual income of partners if it has been disallowed to firm as it was paid without its being mentioned in deed. Interest paid by firm to partners shall be fully added in individual income of partners if it has been fully allowed to firm and it was paid as it was mentioned in deed and rate of interest was up to 12%. Interest paid by firm to partners shall be added in individual income of partners up to 12% p.a. if it has been allowed to firm @ 12% p.a. if mentioned in deed.
This means that if partnership deed allows interest to partners @ 12% or less, then it is allowed to be debited to P & L A/c of the firm and while calculating individual income of the partners it is added in the individual income of partners. So by debiting this amount of interest to P & L A/c, the profit of the firm is reduced whereas the same amount of interest is added in the individual income of partners and thus partners would pay tax on such interest.
In case partnership deed allows interest which is more than 12%, then only 12% is allowed and excess will be added back in the profit of the firm if already debited to the P&L A/c. This simply means that only 12% is allowed to be debited to P&L A/c of the firm and only the same amount is treated as individual income of partners.
(b) Remuneration paid to partners and allowed to firm shall be added in individual income of partners in following manner
(i) If it is fully allowed it shall be fully added in partner’s individual income.
(ii) If it was allowed up to restricted amount as per above, amount to be added shall be
Actual Remuneration of a partner
Restricted remuneration X = ___________________________
Total Remuneration of all partners