Income Tax - Computation of Taxable Income and Tax Liability of Firms

Computation of

Taxable Income and Tax Liability of Firms

Important aspects in regard to computation of taxable income of firms

1.  Partners’ share in the income of a firm is not chargeable to tax in the hands of the partners.

2.  Remuneration (i.e. salary, bonus, commission, etc.) paid/payable to the partners is allowed as a deduction to the firm. The deduction, however, is subject to the permissible limit u/s 40(b). The amount which is allowed as deduction to the firm is taxable in the hands of the partners.

3.  Interest paid to any partner is allowed as deduction to the firm subject to the maximum rate of 12% per annum. The amount of interest, allowed as deduction in the hands of the firm, is taxable in the hands of the partner.

4.  The income of the firm is taxed at a flat rate of 30% (+ Health and Education Cess @ 4%). Effective rate is 31.20% (if total income of a firm is not more than Rs 1 crore) or 34.944% (if total income of a firm is more than Rs 1 crore). [The amount of income-tax shall be increased by a surcharge at the rate of 12% of such tax, where total income exceeds Rs 1 crore.]

Conditions a firm should satisfy for claiming deduction of remuneration/interest to partners

Conditions u/s 184

1.  The firm must be evidenced by a partnership deed.

2.  Individual share of partners in profits of the partnership must be specified in the partnership deed.

3.  A certified copy of the partnership deed (certified in writing by all the partners other than the minor partners) should be submitted along with the first return of income of the firm.

4.  A certified copy of the revised partnership deed should be submitted along with the return of income of the relevant assessment year whenever there is a change in the constitution of the firm or in the profit sharing ratio among the partners during the previous year.

5.  There should not be any failure as is mentioned in section 144.

Conditions u/s 40(b)

1.  Remuneration should be paid only to a working partner.

2.  Remuneration should not exceed the permissible limit as provided u/s 40(b).

3.  Rate of interest should not exceed 12 per cent (simple interest) per annum.

4.  Payment of remuneration and interest must be authorised by the partnership deed.

5.  Payment of remuneration and interest must not pertain to the period prior to the partnership deed.

Computation of book profit

Particulars	Rs	Rs
Net Profit as per Profit and Loss Account		×××
ADD: Inadmissible Expenses debited to Profit and Loss Account:
Remuneration to partners (if debited to the profit and loss account)	×××
Interest to partners u/s 40(b) (amount in excess of 12%, which is not allowable as deduction)	×××
All other items as considered under this category when computing income from business or profession u/s 28 to 44D	×××
ADD: Incomes not credited to Profit and Loss Account but chargeable to Income Tax:
All the items as considered under this category when computing income from business or profession u/s 28 to 44D	×××	×××
		×××
LESS: Incomes credited to Profit and Loss Account but not chargeable to Income Tax:
All the items as considered under this category when computing income from business or profession	×××	×××
		×××
LESS: Admissible Expenses not debited to Profit and Loss Account:
All the items as considered under this category when computing income from business or profession u/s 28 to 44D	×××	×××
BOOK PROFIT [before setting off brought forward unabsorbed depreciation and brought forward business loss]                        (A)		×××
LESS: Brought forward unabsorbed depreciation [Lower of  1. Brought forward unabsorbed depreciation, and 2. (A) – Brought forward business loss]		×××
BOOK PROFIT		×××

 

Computation of maximum amount deductible −

In respect of remuneration to partners (taking all the partners together) u/s 40(b)

 

Ø         If book profit is negative −	Rs 1,50,000
Ø         If book profit is positive −
On first Rs 3 lakhs of the book profit	Rs 1,50,000 or 90% of book profit, whichever is more
On the balance of the book profit	60% of the balance book profit

 

  Computation of taxable income of firm

Particulars	Rs	Rs
Book Profit (before setting off brought forward unabsorbed depreciation)		×××
LESS: Remuneration to partners [actual remuneration paid   subject to maximum amount deductible u/s 40(b)]		×××
Income from business		×××
ADD: Income from house property		×××
ADD: Income from other sources		×××
ADD: Short term capital gain		×××
ADD: Long term capital gain		×××
Total		×××
LESS: Adjustment on account of set-off and brought forward of losses		×××
Gross Total Income		×××
LESS: Deductions u/s 80G, 80GGA, 80GGC, 80IA, 80IAB, 80IB, 80IC, 80ID, 80IE and 80JJA		×××
Total Income		×××

 

Important Note:

If conditions of section 184 and/or 40(b) are not satisfied, remuneration and interest paid by the firm to its partners are not deductible in computing the taxable income of the firm.

 

Computation of tax liability of firm

On the net taxable income computed above, the tax liability will be computed as follows:

Particulars	Rs
Income tax on short term capital gain u/s 111A (@ 15%)	×××
Income tax on long term capital gain u/s 112 (@ 20%)	×××
Income tax on winnings from lottery, races, etc. (@ 30%)	×××
Income tax on remaining balance of the net taxable income (@ 30%)	×××
Income Tax	×××
ADD: Surcharge @ 12% of Income Tax [If Total Income > Rs 1 Crore]
Income Tax and Surcharge
ADD: Health and education cess [@ 4% of Income Tax and Surcharge]	×××
Tax liability	×××

 

Computation of taxable income of partners of a firm

Share of profit

Section 10(2A) provides that a partner’s share in the total income of the firm shall be exempt from tax in the hands of the partner.

 

Interest and Remuneration

If conditions of section 184 and section 40(b) are satisfied, interest and remuneration paid/payable by the firm to the partners is taxable in the hands of the partners to the extent these are allowed as deduction in the hands of the firm.

 

Treatment in the hands of partner

Share of profit to partners: Partners’ share in the total income of the firm is exempt in the hands of partner [Sec. 10(2A)]. Income of a firm shall be taxed in hands of firm only and the same can under no circumstances be taxed in hands of its partners. The entire profit credited to the partner’s account in the firm would be exempt from tax in hands of such partners, even if the income chargeable to tax becomes Nil in the hands of the firm on account of any exemption or deduction as per provisions of the Income-tax Act.

 

Interest and remuneration to partner: Interest and remuneration to partner shall be taxable in the hands of partner, to the extent it is exempted in the hands of firm.

 

Important Notes:

1.  Interest and remuneration paid/payable by the firm to the partners is not taxable in the hands of the partners under the head “Salaries”. These incomes are taxable in the hands of the partners as “business income”.

2.  Any expenditure incurred by the partners in order to earn interest and remuneration can be claimed as a deduction from such income u/s 30 to 37.

 

Carry forward and set off of loss of firm on change in constitution of the firm

[Section 78]

Section 78 of the Income Tax Act, 1961 provides that where a change has occurred in the previous year in the constitution of a firm, nothing shall entitle the firm to set off or to have carried forward and set off so much of the loss proportionate to the share of a retired or deceased partner as exceeds his share of profits, if any, in the firm in respect of the previous year. In other words, where a change occurs in the constitution of firm, on account of retirement or death of a partner, the proportionate loss of the retired or deceased partner shall not be carried forward. It does not, however, cover the case of change in profit-sharing ratio or the case of admission of a partner.

 

Section 78 is not applicable in the case of unabsorbed depreciation and unabsorbed capital expenditure on scientific research. These unadjusted allowances (without deducting share of outgoing partner) can be carried forward by the reconstituted firm.

 

Tax liability of a limited liability partnership (LLP)

In the case of a limited liability partnership (LLP), tax liability computed above cannot be less than “alternate minimum tax”.

 

Alternate minimum tax for limited liability partnership (LLP) [Sec 115JC to 115JF]

A limited liability partnership (LLP) is subject to alternate minimum tax which is determined as follows:

 

Step – 1

Find out the regular income-tax liability of LLP ignoring the provisions of Sections 115JC to 115JF.

Step – 2

Find out the adjusted total income of LLP as per Section 115JC. Adjusted total income is the total income before giving effect to Chapter XII-BA as increased by –

(a)   Amount claimed as deduction by LLP, if any, under any section (other than section 80P) included in Chapter VI-A under the heading "C.—Deductions in respect of certain incomes";

(b)      Amount claimed as deduction by LLP, if any, u/s 10AA; and

(c)  Amount claimed as deduction by LLP, if any, u/s 35AD as reduced by the amount of depreciation allowable in accordance with the provisions of section 32.

Step – 3

Find out 19.24% (i.e. 18.5% + Health and Education Cess 4%) of adjusted total income computed under Step – 2. [Note: where the person who is liable to pay the regular income-tax for a previous year, is a unit located in an International Financial Services Centre as per the provisions of the Special Economic Zones Act, 2005, and derives its income solely in convertible foreign exchange, the basic rate of alternate minimum tax shall be 9% instead of 18.5%.]

Step – 4

If amount computed under Step – 1 is equal to or more than amount determined under Step – 3, the provisions of alternate minimum tax are not applicable. If, however, amount computed under Step – 3 is more than the regular tax liability determined under Step – 1, then

(a) Adjusted total income as per Step – 2 shall be deemed as net taxable income of LLP, and

(b) 19.24% of adjusted total income computed under Step – 3 shall be deemed as tax liability of LLP.

 

Illustration 1

Uttam Kumar and Dilip Kumar, partners of National Film Distributors, furnishes the following details –

Profit and loss account for the year ended 31-3-2020

Particulars	Rs	Particulars	Rs
Bonus paid to employees	50,000	Gross Profit	10,00,000
Interest on loan taken from bank	45,000	Interest on drawings:
Other Expenses	40,000	Uttam Kumar	2,000
Salary to partners		Dilip Kumar	3,000
Uttam Kumar	2,44,000
Dilip Kumar	4,88,000
Interest on capital @ 15%
Uttam Kumar	4,500
Dilip Kumar	6,000
Depreciation	40,000
Net profit	87,500
	10,05,000		10,05,000

 

Additional information

1.    Depreciation for the year allowed u/s 32 is Rs 30,000.

2.  During the last year, firm has incurred loss of Rs 8, 50,000 (which includes unabsorbed depreciation of Rs 50,000).

3.    Interest on loan taken from bank is yet to be paid.

 

Compute total income of firm for the assessment year 2020- 2021.

 

Solution 1

Computation of book profit

Particulars	Rs	Rs
Net Profit as per Profit and Loss Account		87,500
ADD: Inadmissible Expenses debited to Profit and Loss Account:
Remuneration to partners	7,32,000
Interest to partners u/s 40(b) (amount in excess of 12%, which is not allowable as deduction) [Rs 10,500 – {(10,500 ÷ 15) × 12}]	2,100
Interest on bank loan disallowed u/s 43B	45,000
Depreciation (taken separately)	40,000	8,19,100
		9,06,600
ADD: Incomes not credited to Profit and Loss Account but chargeable to Income Tax:		Nil
		9,06,600
LESS: Incomes credited to Profit and Loss Account but not chargeable to Income Tax:		Nil
		9,06,600
LESS: Admissible Expenses not debited to Profit and Loss Account:
Depreciation u/s 32		30,000
BOOK PROFIT [before setting off brought forward unabsorbed depreciation and brought forward business loss]                                                  (A)		8,76,600
LESS: Brought forward unabsorbed depreciation [Lower of 1. Brought forward unabsorbed depreciation              50,000 2. (A) – Brought forward business loss]     [8,76,600 - 8,00,000]                                                76,600		50,000
BOOK PROFIT		8,26,600

 

 

  Computation of maximum amount deductible in respect of remuneration to partners

  [(taking all the partners together) u/s 40(b)]

On first Rs 3 lakh of the book profit	90% [Rs 3,00,000 × 90%]	Rs 2,70,000
On the balance of the book profit	60% [Rs 5,26,600 × 60%]	Rs 3,15,960
Total		Rs 5,85,960

 

  Computation of taxable income of the firm for the assessment year 2020- 21

Particulars	Rs	Rs
Book Profit (before setting off brought forward unabsorbed depreciation)		8,76,600
LESS: Remuneration to partners [actual remuneration paid subject to maximum amount deductible u/s 40(b)]		5,85,960
Income from business		2,90,640
LESS: Brought forward business loss (maximum amount that can be set off)		2,90,640
Net Taxable Income / Total Income		Nil

 Note: Remaining brought forward business loss

           Rs 8, 00,000 – Rs 2, 90,640 = Rs 5, 09,360  and

           unabsorbed depreciation Rs 50,000 shall be carried forward.

 

Illustration 2

Anil and Mukesh, partners of Computer Software Developers, furnishes the following details –

Profit and loss account for the year ended 31-3-2020

Particulars	Rs	Particulars	Rs
Bonus paid to employees	50,000	Gross Profit	10,00,000
Interest on loan taken from bank	45,000	Interest on drawings:
Other Expenses	40,000	Anil	2,000
Salary to partners		Mukesh	3,000
Anil	2,44,000
Mukesh	4,88,000
Interest on capital @ 15%
Anil	4,500
Mukesh	6,000
Depreciation	40,000
Net profit	87,500
	10,05,000		10,05,000

 

Additional information

4.    Depreciation for the year allowed u/s 32 is Rs 30,000.

5.  During the last year, firm has incurred loss of Rs 9, 00,000 (which includes unabsorbed depreciation of Rs 1, 00,000).

6.    Interest on loan taken from bank is yet to be paid.

 

Compute total income of firm for the assessment year 2020- 2021.

 

Solution 2

Computation of book profit

Particulars	Rs	Rs
Net Profit as per Profit and Loss Account		87,500
ADD: Inadmissible Expenses debited to Profit and Loss Account:
Remuneration to partners (if debited to the profit and loss account)	7,32,000
Interest to partners u/s 40(b) (amount in excess of 12%, which is not allowable as deduction) [Rs 10,500 – {(10,500 ÷ 15) × 12}]	2,100
Interest on bank loan disallowed u/s 43B	45,000
Depreciation (taken separately)	40,000	8,19,100
		9,06,600
ADD: Incomes not credited to Profit and Loss Account but chargeable to Income Tax:		Nil
		9,06,600
LESS: Incomes credited to Profit and Loss Account but not chargeable to Income Tax:		Nil
		9,06,600
LESS: Admissible Expenses not debited to Profit and Loss Account:
Depreciation u/s 32		30,000
BOOK PROFT [before setting off brought unabsorbed depreciation and brought forward business loss]                                                              (A)		8,76,600
LESS: Brought forward unabsorbed depreciation [Lower of − 1. Brought forward unabsorbed depreciation            1,00,000 2. (A) – Brought forward business loss]     [8,76,600 – 8,00,000]                                                76,600		76,600
BOOK PROFIT		8,00,000

 

  Computation of maximum amount deductible in respect of remuneration to partners

  [(taking all the partners together) u/s 40(b)]

On first Rs 3 lakh of the book profit	90% [Rs 3,00,000 × 90%]	Rs 2,70,000
On the balance of the book profit	60% [Rs 5,00,000 × 60%]	Rs 3,00,000
Total		Rs 5,70,000

 

  Computation of taxable income of the firm for the assessment year 2020- 21

Particulars	Rs	Rs
Book Profit (before setting off brought forward unabsorbed depreciation)		8,76,600
LESS: Remuneration to partners [actual remuneration paid   subject to maximum amount deductible u/s 40(b)]		5,70,000
Income from business		3,06,600
LESS: Brought forward business loss (maximum amount that                can be set off)		3,06,600
Net Taxable Income / Total Income		Nil

Note:  Remaining brought forward business loss

           Rs 8, 00,000 – Rs 3, 06,600 = Rs 4, 93,400 and

           unabsorbed depreciation Rs 1, 00,000 shall be carried forward.