Taxation of the Partnership Firm: Planning & Precaution

Partnership firm is one of the most common and easy modes of starting the business jointly with other persons. However, Partnership firms are liable for taxation at the flat rate of 30% and the benefit of slab wise taxation is not available to the partnership firm. There are various cases whereby proper planning & precaution could result in tax optimization. Let us have a look at some of the common planning aspects which can be implemented by few firms vis a vis its partners:

1. Proprietary Firm Vs. Partnership Firm: From the taxation perspective, the proprietary firm is a better option as compared to the partnership firm. If the firm is intended to be formed with the family members alone then one may explore the option of running the business in a proprietary firm rather than going with the partnership firm. Even the existing partnership firm with only family members may explore the option of converting it into a proprietary firm for tax optimization. However, the income of the firm vis a vis individual income of the partners vis a vis overall impact of the surcharge may be compared before taking a call on this. In case of Individual & HUF, Surcharge is applicable @10% if income is in the range of Rs. 50 Lakhs to Rs. 1 Crore, @ 15% for income in the range of Rs. 1 Crore to Rs. 2 Crores @25% for income in the range of Rs. 2 Crores to Rs. 5 Crores, @37% if income exceeds Rs. 5 crores. Surcharge in the case of a firm is @ 12% only if the income exceeds Rs. 1 crore.

2. Interest to Partners:

a) The partnership is allowed deduction @ 12% on the capital of the partners.

b) There are cases wherein the partners have borrowed the amount at a higher rate and have given it to the firm. In such a case, the firm can pay interest @ 12% only to the partner even though the partner may be required to pay the higher interest. Availing the loan directly in the name of the firm is a better option in such a case instead of routing it through the partners account.

c) The partnership deed may be amended so as to restrict the interest rate to lower rate or nil rate in case of there is a loss in the partnership firm. In case there is a loss in the firm, interest to partners further enhances the loss & the partners may be liable for payment of taxes on the interest income received from the loss making firm.

d) If the partners are in a high tax bracket and are liable for a high rate of surcharge on their income, they may amend the partnership deed so as to provide that no interest shall be payable to the partners.

3. Salary & Remuneration to the partners: a) There is a ceiling of maximum amount that can be given as Salary or Remuneration to the partner. The remuneration can be given only to the working partners. If the firm has high income then the number of working partners can be added so as to divide the amount of remuneration amongst more partners.b) Remuneration up to Rs. 1.50 Lakh can be paid even if there is a loss in the partnership firm. The partnership deed may be suitably amended so as to provide that no remuneration shall be payable in case of loss.c) If the partners are in a high tax bracket and are liable for a high rate of surcharge on their income, they may amend the partnership deed so as to provide that no remuneration shall be payable to the partners.

4. Amending the Partnership Deed: Partnership deed can be revised or amended easily. The taxpayers may even amend the partnership deed every year with the tax planning aspects in mind for that year ahead.

5. Withdrawals of Assets from the firm or Dissolution of the Firm: a) Any withdrawals of the assets like land, building, etc from the firm by the partner will attract the capital gain tax in the hands of the firm. b) In case of dissolution or reconstitution of the firm, the firm may be liable for capital gain tax. Even the excess amount received by the partner on retirement or reconstitution may be taxable in the hands of the firm in view of the amendment by the Finance Act-2021. c) The firm will be dissolved on the death of any of its partners unless there is a specific provision in the partnership deed that the firm would not be dissolved on the death of partner – CIT Vs. Ayyanarappan & Co (1999) 236 ITR 410 (SC). In case the firm is having any immoveable property, it is always advisable to have a clause in the partnership deed that the firm shall not dissolve on the death of the partner but it shall be continued with the legal heir of the deceased partner. In absence of this clause, the firm may be liable for capital gain tax on the death of the partners of the firm.

6. Benefit of carry forward of the Loss in case of retirement of the firm

The partnership firm is also eligible for the benefit of the carry forward of the loss. However, the benefit is subject to the condition that the partners at the time of incurrence of the loss are continuing the firm. If any of the partners retires then the proportionate loss of the retiring partner is not allowed to be carried forward. In short, retirement of the partner may be postponed till the loss is fully set off by the firm.

7. Presumptive Scheme of Taxation: The presumptive scheme of taxation which provides for taxation of income @ 8% or 6% is applicable even to the partnership firm. In short, if the turnover of the firm is not exceeding Rs. 2 Cr then a minimum 8% or 6% amount has to be offered for taxation. If the firm doesn’t wish to offer 8% or 6% as income then an audit is mandatory. This 8% or 6% rate is after interest and remuneration to the partner. As a tax planning measure, the firm opting for presumptive scheme of taxation may amend the partnership deed so as to provide that the firm shall not pay any interest and remuneration to the partners.

8. Exemption from Capital Gain by investment in Bonds [Section 54EC]: The partnership firm cannot save tax by investing the capital gain amount for purchase or construction of the house property. However, the option to save by investing the amount in Specified Bonds issued by REC, PFC or IRFC is available even to the partnership firm.

Is an Indian Resident required for a Foreign Company Incorporation

Every company in India is established under the Companies Act, 2013 (‘Act’). An Indian company can be incorporated with a foreign director in India under the Act. The Board of Directors (‘Board’) manages the company.

The Board of a company can comprise Indian residents and foreign nationals. However, an Indian company must have at least one director who is an Indian citizen. The Board cannot contain only foreign directors. A foreign national can be appointed as an executive or an independent director in an Indian company.

Director Under Companies Act, 2013

The Companies Act, 2013 defines a director as a person appointed to the company’s Board. The directors manage the company affairs and are the heads of a company. The directors of a company are jointly known as the Board of Directors.

The Board of a company is also responsible for protecting the interests of the shareholders of the company. Under the Act, a person can be appointed as one of the following types of director in a company:

• Managing director

• Whole-time director

• Independent director

• Small shareholders director

• Additional director

• Alternative director

• Nominee director

The Act does not forbid foreign nationals from being appointed as directors. Hence they can be appointed as any one of the directors as mentioned above in Indian companies.

Criteria to Become a Foreign Director in an Indian Company

The criteria that needs to be fulfilled by a foreign national to be a director in an Indian company is as follows:

Director Identification Number (DIN)

Every person proposed to be a director in an Indian company needs to obtain a Director Identification Number (DIN) at the time of incorporation of the company. A foreign national must obtain a DIN before the appointment as a director in an Indian company. The foreign national can get a DIN by filing form DIR-3 with the Ministry of Corporate Affairs (MCA) or must apply for a DIN in the SPICe+ form (Company incorporation form).

The foreign national must give a declaration while applying for DIN that he/she is not disqualified from becoming a director under the Act. The foreign national cannot act as a director upon his/her appointment unless consent is given to act as a director in form DIR-2. The foreign national should file his/her written consent with the Registrar of Companies within 30 days of his/her appointment.

The documents required for obtaining DIN are

• Photograph

• Address proof such as driving license, bank statement or any utility bill (not older than two months)

• Passport

The copies of the above documents must be notarised by a Public Notary and be apostilled by the competent authority in their country of residence.

Digital Signature Certificate (DSC)

The foreign nationals appointed as directors in an Indian company need to have a Class 3 Digital Signature Certificate (DSC). The DSC is required for filing online forms on the Ministry of Corporate Affairs (MCA) portal. The foreign nationals must affix their DSC on the DIR-3 form or SPICe+ form for obtaining the DIN.

The documents required for obtaining DSC are

• Photograph

• Address proof such as driving license, bank statement or any utility bill (not older than two months)

• Passport

The copies of the above documents must be notarised by a Public Notary and be apostilled by the competent authority in their country of residence.

Managing Director or Whole-Time Director requirement

Foreign nationals intending to become managing directors or whole-time directors in Indian companies must fulfil the criteria of being a resident of India, i.e. who is staying in India continuously, not less than 12 months, immediately before the date of appointment as director.

They should not be less than twenty-one years and not more than seventy years. They should not be insolvent or convicted of an offence and sentenced to imprisonment for a period of more than six months.

Independent Director Requirement

Foreign nationals can be appointed as independent directors when they possess the skill, experience, knowledge and qualification in one or more fields of finance, law, marketing, sales, administration and research related to the company’s business.

Compliances Under FEMA For a Foreign Director

A foreign national appointed as a director in an Indian company is eligible for receiving remuneration, commission and sitting fees like Indian directors. Thus, they must follow the provisions of the Foreign Exchange Management Act (‘FEMA’), 1999.

Foreign nationals intending to be a director in an Indian company should hold a valid employment visa. They can maintain and hold a foreign currency account with a bank located outside India. They can remit or receive the whole salary paid to them for their services as directors in an Indian company.

When Indian companies appoint foreign directors, the Indian companies should make an application for remittance of their remuneration to the authorised dealers with an undertaking certificate and statement regarding payment of Income Tax.

Taxability of Income of a Foreign Director

The income earned by a foreign national as a director of an Indian company is taxable under the Income Tax Act, 1961. The required TDS will be deducted from their commission or remuneration as per the provisions of the Income Tax Act.

Under the Income Tax Act, a foreign national who is a director in an Indian company must obtain a PAN card mandatorily if he/she is having a financial transaction of Rs.2,50,000 or more in a financial year.

Though there is no bar on the appointment of foreign directors in an Indian company, they must follow the provisions under the Companies Act, 2013, Income Tax Act, 1961 and FEMA, 1999.

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Re-Assessment proceedings initiated beyond the Limitation Period are not sustainable: Calcutta HC

The Calcutta High Court held that the reassessment proceedings initiated beyond the limitation period are not sustainable.

The petitioner, SS Commotrade Private Limited challenged the order dated 30th July 2022 under Section 148A(d) of the Income Tax Act, 1961 relating to the assessment year 2014-15 and, all subsequent proceedings based on the impugned notice dated 29th June 2021 under Section 148 of the Income Tax Act, 1961.

The petition wason the ground of jurisdiction of the assessing officer in the issuance of the impugned notice under Section 148 of the Act being barred by limitation under Section 149(1)(b) of the Income Tax Act, 1961.

The assessing officer has tried to justify the initiation of the re-assessment proceeding by relying on an instruction being No.01/2022 dated 11th May 2022 issued by CBDT. Admittedly, the issuance of notice and initiation of re-assessment proceeding was beyond six years and, prima facie, it was barred by limitation both under the old Act as well as under the newly amended provision relating to Section 147 of the Act.

It was viewed that the matter deserves adjudication by calling affidavits from the respondents and the petitioner has been able to make out a prima facie case for an interim order by raising the issue of jurisdiction of the assessing officer concerned in initiating the impugned re-assessment proceeding.

Justice Md. Nizamuddin held that “let the respondents file an affidavit in opposition within four weeks; the petitioner to file a reply thereto, if any, within one week thereafter.

The matter shall appear for a final hearing in the monthly list of November 2022. In the meantime, there will be no further proceeding based on the impugned order dated 30th July 2022 being Annexure P-6 to the writ petition till the disposal of the writ petition.”