Business / Partnership Firm Income Tax Guide

This document covers

1. Registration of the Firm
2. Income Tax Rates
3. Advantages & Disadvantages
4. Compare Business Registrations

1. Registration of Partnership firm

Registration of the firm is optional and is not mandatory. It can be registered at any time after its formation. A registered Partnership firm can avail certain benefits like below

1.1 Ability to file a case against Third Parties:

The partners of the registered Partnership Firm can bring third parties to the court for resolution of disputes arise during the Business or any other matter relating to the Partnership Firm.

1.2 Power to file suit against co-partners:

As none knows when the dispute between the Partners arises, whether for the sharing of profits or any other matter regarding operations of the Partnership Firm. The resolution of any dispute is best resolved by the Court of Law.

1.3 Higher Credibility:

Compared to an unregistered Partnership Firm, a Partnership Firm which has completed Registration of Partnership Firm enjoys higher credibility. Although both registered and unregistered Partnership Firms are legal and valid under the given Act, the Registered Firm is highly preferred by authorities over unregistered one.

1.4 Conversion of Entity:

The conversion of the Partnership Firm into any other entity such as Private Company or LLP i.e. in corporate structure can be easily completed, except in the case of assets registered under the existing firm, which requires valuation and related complexity before moving them to the higher compliance entity such as LLP.

2. Rate of Income tax applicable to Partnership Firm

2.1 Business income:

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 Health and Education Cess 4% on Income-tax ( w.e.f AY 2019-20 education Cess secondary and higher education Cess @ 3% replaced by Health and Education Cess 4% )

2.2 Capital gains income:

Capital gains arising from the sale of any asset by the partnership firm are taxable under section 112, if it is short-term capital gain tax rate as per normal tax slab, if it is long-term capital gain tax rate is 20%, in case of sale of shares and mutual funds the tax rate for short-term gain is 15%, for long-term income would be exempted from the levy of tax under section 10(38).

2.3 Remuneration or interest can be paid to a partner:

1. Interest payable to partners shall be in accordance with the terms of the partnership deed, however, it shall not exceed 12% per annum.
2. Remuneration payable to partners shall be in accordance with the terms of the partnership deed, however, it shall not exceed the following limit:

On first Rs. 3 Lakhs of book profit or in case of loss - Rs. 1,50,000 or 90% of book profit, whichever is more; rest of the balance of the book profit - 60% of book profit.

2.4 Losses of the firm:

Unabsorbed loss including depreciation of the firm will not be apportioned amongst the partners and will be carried forward by the firm only.

3. Advantages & Disadvantages of partnership firm:

3.1 Advantages:

1. Easy formation: Partnership firm is like a contractual agreement between partners to run the business and share profits from the business. Registration of partnership firm is optional, not mandatory and there will be minimum legal requirements.
2. Tax Advantage: Income from a partnership firm is taxable in the hands of the firm not in the hands of shareholders. Remuneration to partners is a claimable expense.
3. More Capital: As more than one person involved in a partnership firm there will be more capital in the hands of the firm. Partners can be sleeping partners as well as working partners. Hence it can add people who can invest without any problem.
4. Reduction of risk: As there is more than one person carrying on a business, in case of losses every partner is liable to share the business loss hence the share of loss will be less compared to a loss in a sole proprietorship.

3.2 Disadvantages:

1. More than one person: There should be at least two people to start a partnership firm.
2. Profit sharing: As more than one person involved profit has to share between people. The share of profit will be low compared to a sole proprietorship.
3. Unlimited Liability: Each partner has unlimited liability in case of losses of the firm. Every partner is individually liable for obligations of the firm.
4. Restrictions on Transfer of shares: No partner shall transfer the share unless otherwise accepted by all the partners.
5. Visibility: as in 2021, businesses who have a larger vision better choose 'Company' as their entity type, as the cost of owning and operating a company is easier these days, there is no special reason to choose 'Firm' as your entity.
6. Expansion: To expand beyond the ability of the partners who are part of a partnership firm, attracting external capital is difficult in the case of a partnership firm. Hence LLP, or a Pvt Limited Company is a better choice where the capital can be attracted from the Banks, VCs much easier than a typical partnership firm.