Taxation of Limited liability Partnership under Income Tax Act, 1961

The Concept of Limited liability Partnership was came in the year 2009 when the Limited Liability Act, 2008 was applicable. It is a body corporate which has registered under the LLP Act, 2008. This article is all about the taxation of LLP but before discussion further let me clarify some points:

Taxation of LLP

That means under the income tax act, the taxation of the firm is similar to the taxation of LLP. In simple words, LLP is a partnership firm having limited liabilities. So, after reading this article, you will able to calculate the total income and tax amount of firm and LLP.

Applicability of Tax Rates Under the Income Tax Act,1961

For Firms/LLP. There are no slab rates has been defined. Tax rates applicable for a firm is as follows:

  • Tax Rate: 30% shall be charged on Total Income
  • Surcharge: 12% (Surcharge is levied on Tax amount and not on the total income)

The surcharge shall be levied if the total income exceeds Rs. 1 Crore rupees.

  • Health and Education Cess: 4% in all cases.

Note: The benefit of section 87A shall not be given to the Firm/LLP even if the total income of the firm/LLP is up to Rs. 3,50,000, because the said benefit is available only to the Resident Individual.

Note: If the firms are having an income from capital gain then it will taxable as per the provision of section 112 or 112A, as the case may be, in long term capital gain and section 111A in short term capital gain.

Section 40(b): Conditions for deductibility of payment of interest, salary, Bonus commission (remuneration) by the firm to their partners 

The interest and other payments like salary, interest, bonus, etc. (Say remuneration) made by the firm to their partners shall be allowed as deduction if the following conditions are satisfied as same as applicable also to Firm:

  • If the interest and other remuneration are being given to the working partner. If these are given to Non-working partner then such payment shall be disallowed.
  • The remuneration shall be allowed only when the partnership deed specifies the amount of remuneration or specify the method of quantifying the amount of remuneration.
  • The above specifies payment shall be allowed only after the date of partnership deed i.e., the payments shall not be allowed from the retrospective form.
  • The payment of interest shall not be exceeded from 12% per annum simple interest.

Note: If the firm is charging interest on the amount withdrawn from the current account by the partner as drawings then such interest shall not net off with the interest on capital given by the firm to its partners.

The interest given by the partner to the firm on his drawings shall be chargeable as income from PGBP in the hands of Firm and

The interest given by the firm to the partners on capital shall be allowed as a deduction to the firm under section 40(b).

Note: As we already specified above, the deduction of interest on capital shall be allowed only when such amount has been specified in the partnership deed. This also applies to current account and loan account. In simple words, the following shall be allowed as a deduction only when it specified in the partnership deed:

  • Interest on Fixed Capital
  • Interest on current capital(as on Capital Account it is presumed to be allowed always at a certain %)
  • Interest on Loan Account.

Sec 40(b): -Limit for the deduction of payment of remuneration to partners

The payment of remuneration to the partners shall not exceed the following amount. That means any amount above the following specified amount shall be disallowed in the hands of the firm:

On Condition Allowable deduction Amount
1st Rs.3,00,000 of Book Profits*
Or
In Case of Loss
Rs.1,50,000 Or
90% of the Book Profits*
Whichever is Higher
Balance Amount of Books Profits At 60% of Book Profits

Book Profit: Book profit can be calculated by making the following adjustment in the Net Profit as calculated under the normal provisions of PGBP:

  • Only Income under the head PGBP is to be taken for calculating the book profits.
  • Brought forward losses shall not be deducted. (Section 72).
  • Chapter VI-A deductions shall not be deducted.
  • Remuneration already debited in the profit and loss account shall be added back that means the effect of remuneration to be reversed off.
  • Interest paid to the partners shall be added back to the extent of the amount which is not deductible.

Explanation 1 to section 40(b)

If the individual person is a partner in a representative capacity and he has received the interest in an individual capacity, then such interest shall be disallowed in the hands of the firm/LLP.

For Example, XYZ is a HUF which is a partner in the firm/LLP and Mr. X has received the interest in a representative capacity of XYZ then such interest shall not be allowed in the hand of such firm/LLP.

Explanation 2 to section 40(b)

If the individual joins the firms in his individual capacity and he has received the interest from the firm/LLP on the behalf of other people as representative capacity then also the interest amount shall be disallowed to firm/LLP.

Note: Since, the interest and remuneration with compliance of section 40(b) are exempt in the hands of firm/LLP, the same shall be taxable in the hands of partners of firm/LLP under section 28.

Section 10(2A): Exemption to the partners

Share in the total income of the firm/LLP shall be exempt in the hands of the partners.

It has been clarified by the CBDT that even if the total income of the firm/LLP is Nil then also, the profit in the hands of the partner would not be taxable.

For Example:

Particulars Amount in Lakhs
Net profit before Deduction and tax 100
Deductions under Chapter VI-A -100

Now, let’s say, the profit as per books is also Rs.100 lakhs and distributed it in the partners, say 50 lakhs each.

So, the total income of the firm is Nil, hence no tax on firm/LLP

Share in profit of Rs.50 lakhs is exempt in the hands of partners under section 10(2A), hence no tax on partners.

Like the profit is exempt in the hands of partners and taxable to firm/LLP, similarly in case firm/LLP is having a loss, such loss shall be set off or carried forward by the firm/LLP and not to the partners.

Important Case Study

There is a famous case study of CIT Vs. Great City Manufacturing Company in which the firm has paid the remuneration to the partners as per section 40(b) but The assessing officer has disallowed the expense since such payment is unreasonable and excessive as per section 40A(2).

It was held that, if the payment is made with compliance of section 40(b), then AO cannot disallow the payment or part of the payment on the ground that it was excessive or unreasonable.

LIMITED LIABILITY PARTNERSHIP

Other Notes:

  • If the company is being converted into the LLP then the capital gain shall be exempted on such transfer.
  • LLP cannot opt for presumptive taxation under section 44AD.
  • Where any tax/penalty/interest is due from LLP in respect of income of the previous year, then every person who is a partner in the LLP during the relevant previous year shall be jointly and severely liable for the payment unless he proves that non-recovery was not due to his negligence or misfeasance or breach of duty on his part in relation to the affairs of the limited liability partnership.
  • When the company upon whom MAT provision already applicable and then if afterward if it  is converted into LLP then provision of MAT(Minimum Alternate Tax )will not be applicable to that LLP

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