Legal Guide

Understanding Income tax on partnership firm

by Bhavya Choudhary · 3 min read

income tax on partnership firm

What is a partnership firm?

  • A business owned by one or more individuals where they share the profits and loss. They all are active participants, or one acts on behalf of all of them. 
  • In India, it is governed by the Partnership Act 1932 and is also the oldest type of commerce. The main objective of such firms is to maximize profits. 
  • The income tax on partnership firms is calculated on their total revenue for a financial year. They work mainly on four known features, which are very crucial for it to start and function. The features are an agreement, business, profit sharing, and principal-agency relationship. 
  • It is carried out by an agreement that can be oral or written. They are required to file the partnership firm income tax return following the income tax act 1961. 
  • The Registration of a partnership firm does not affect the income tax on the partnership firm as it comes under the same income tax act 1961. No penalty is fined even if it is unregistered, but such firms are deprived of some benefits and privileges. 
  • People who are in a contract with one another are called “partners,” and their company is named a “firm name.”

Partnerships can be of 4 types, and each one has a different percentage of taxation under law. They are:

  • General partnership
  • Limited partnership
  • Limited liability partnership
  • Limited liability limited partnership

Taxation of partnership firms

  • A partnership firm is not a separate legal entity that is treated differently from the members. They are treated differently from the partners in the implementation of income tax. 
  • They can be registered firms or unregistered firms but is necessary to get Registration of a partnership firm with the income tax department and receive a PAN card no. Income tax on LLP is also treated in the same way as partnership firms.
  • They are taxed as a separate entity. It is advisable to take legal consultancy services before filing a Tax Return form. Income tax on partnership firms is not directly taxed on partners.

What is LLP?

  • It is a limited liability partnership (LLP) that is a type of substitute corporative form of business that allows the partners to enjoy the benefits of the company’s limited liability and partnership flexibility merits. 
  • It does not have a dependency on any changes in the partners involved and can go into contracts or purchase/hold property in its name. Unlike a partnership, LLP has a separate legal existence. The income tax on partnership firms and LLP are the same at a rate of 30%.

Income tax of Partnership Firm

  • An even rate of 30% Income Tax on partnership firm and LLP are imposed on their net profit, and calculation as per Income Tax slab rates is not accounted for as it is only valued for individuals and HUF. 
  • Education cess @ 2% and SHEC (secondary higher education cess) @ 1% is also to be paid.
  • If any case, the income of any partnership firm surpasses the 1 crore mark in a financial year, then the surcharge @ 12.5% is payable. An alternative minimum tax of 18.5% is to be paid as “adjusted total revenue.” 
  • The income tax of a partnership firm is at a flat rate of 30%. (Surcharge is levied on the tax which is payable and not on the total overall income)
  • Any partnership firm whose capital gain is taking place through the sale of an asset, then income tax on partnership firm is taxed under Section 112
  • If the holding period in case of the sale of shares and mutual funds is less than one year, the income tax on the partnership firm will be taxed under Section 111A at a flat rate of 15%. If the holding period is more than 1 year, then it’s exempted from taxation.

What are the allowed deductibles?

There are some permissible deductions from the amount of income that comply with the income tax on partnership firms. These are as follows:

  • The non-working partners get a range of salaries, bonuses, and commissions.
  • The compensation of paying partners as per the agreement even if the payment was cleared before the signing of the agreement.
  • The overall revenue interest can be deducted to pay interest to their partners. But the interest of the partner’s yearly rate of 12% cannot exceed.

Essential things to know about Income Tax on Partnership Firm

  • The partners are personally held accountable for tax debts if the business is not able to clear the income tax on the partnership firm.
  • LLPs are taxed in the same manner as income tax on partnership firms, but there is a Section 44AD that applies specifically to the partnership firm. LLPs cannot enjoy the privileges of this particular section.
  • There is no tax accounted for in the portion of any partner’s business revenue because it is already deducted from income tax on the partnership firm.
  • Income tax on partnership firm is filed under partnership tax return; the due date for audit is different. If, in any case, the audit is not necessary, then the tax return can be filed by 31st July. The income tax on the partnership firm must be audited by 30th September if the same is not audited.

The process of paying Income Tax on a Partnership firm (income tax returns)

  • The income tax on the partnership firm should be filed using Form ITR-5, which is used for the partnership firm and not for the partners themselves. It does not need any supportive documents or declarations as the other cases of ITR-5 forms have been presented. 
  • It is very crucial to keep a trail of transactions taking place in the business so that such can be presented to the Tax Authorities. The income tax on partnership firms is not separate from their partners.
  • The Income Tax Department accepts the online filing of ITR-5, and the documents must be provided when the same is requested while processing the income tax on the partnership firm. 
  • The partners must have a digital signature certificate to authenticate the partnership tax return filings. 
  • The process can be easily handled by taking legal consultancy services through which individuals will be more alert about the terms used and tax accounted for.

Conclusion 

In light of the information given above, the taxation process is a critical matter for any partnership firm. Income tax on partnership firms is charged at an even rate of 30%, including EC and SHEC on firms and LLP with surcharge paid. It is highly advised to take legal consultation before commencing the process for better knowledge and understanding of the law.

Income tax on partnership firms is charged at an even rate of 30%, including EC and SHEC on firms and LLP with surcharge paid. Consult a professional expert to ensure payment of taxes on time.

Bhavya Choudhary

Written by

Bhavya Choudhary

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