Can Partners' Remuneration, Commission and Interest be subjected to the provisions of section 44AB of The Income Tax Act, 1961.

Under the general law of partnership, a firm has no separate legal existence but identified as a collective association and represented by its partners. However the Income Tax Act, both under the present Act and the old Act, considers the firm as separate taxable entity, independent of the partners. Till assessment Year 1993-94, Income-tax Act (the Act) double taxed the income of a partnership, the firm on its income and the partners separately on their respective share income and remuneration. In the hands of the partners the share income took the character of the nature of income as recognized in the hands of the firm.

However, from Assessment Year 1993-94, the taxation of partnership firms underwent a sea of change removing the double taxation, taxing the firm separately and exempting the share income in the hands of the partners. However, the remuneration paid to partners is subject to conditions and monetary limits. The remuneration and interest paid to the partners is claimed as a deduction in the firm and taxed in the hands of the partners. Section 28 was simultaneously amended to treat the remuneration and interest as business income and compute the same under Chapter IVD of the Act. Having treated the same as business income, the department is slowly raising an issue whether audit provisions apply to partners whose remuneration and interest exceed the limit specified under section 44AB.

In case of Usha Narayanan, [TS-6853-ITAT-2013(KOLKATA)-O], the Hon ITAT Kolkata was dealing with a case of levy of penalty under section 271B on a partner of a professional firm. She had received salary, commission and share of income from M/s Lovelock & Lewes, as its partner. Usha Narayanan had not complied with the provisions of section 44AB and penalty was levied under section 271B. This penalty was confirmed by the Hon ITAT ex-parte since the appellant did not appear. An issue of 271B penalty, on similar set of facts, came up before the Kolkata High Court in case of Sagar Dutta, ITA 150 of 2009. The penalty was set aside by the high court, on the ground that proper permission was not obtained by the Income-tax Officer before levying the penalty. Can it be concluded that a partner receiving remuneration, interest and share income, as a partner of a firm be subjected compulsory audit under section 44AB?

The paper writer has tried to analyse this moot issue in this article.

Section 44AB of the Act:

Section 44AB of the ACT reads as under:

"Audit of accounts of certain persons carrying on business or profession.

Section 44AB. Every Person - carrying on business shall, if his total sales, ….”

The provision applies to all such persons carrying on business or profession. This is the primary condition to be satisfied before invoking the provisions of section 44AB. If a person is not carrying on the business or profession, then he cannot be subjected to the said provisions merely on the ground that his income has to be computed under chapter IVD - "Profits and gains of Business or Profession"

Does Partner carry on the Business or Profession?

As a partner, under the general partnership law, one can be considered as carrying on the business or profession, though collectively with the other partners. Under the Income-tax law, the firm being a separate taxable entity, it is the firm carrying on the activity of business or profession. Partner can under no stretch of imagination be considered as carrying on the business or profession.

The ratio of the Supreme Court in the case of R.M. Chidambaram Pillai [TS-5057-SC-1976-O] can be of help. In this case the Apex Court was deciding about the nature of the receipts from the firm in the hands of the partners. This was the decision rendered in the context of double taxation scheme. In the present regime the rational does not hold good. In this context it is relevant to consider the observations of the Hon. Mumbai ITAT in the case of Pahilajrai Jaikishin [TS-5320-ITAT-2016(Mumbai)-O] stating:

“While the scheme of taxation of Partnership firm has undergone substantial change by Finance Act, 1992 where by now firm is taxed as a separate entity and allowance is made for deduction from income of the firm of payment of salary, bonus, commission or remuneration and of interest paid to Partners as per provisions of Section 30 to 37 of the Act read with Section 40 of the Act. The salary, bonus, commission or remuneration so allowed as deduction while computing income of the firm shall be added to the income of the Partners albeit under section 28(v) of the Act, read with Section 2(24)(ve) of the Act while as per the law as applicable prior to Finance Act, 1992, the said salary, bonus, commission or remuneration payable to Partner and interest paid to Partner was added to the income of the firm being profit of the firm and tax was computed in the hands of the firm and Hon'ble Supreme Court in Munjal Sales Corporation 168 taxmann 43 holding that the expenses on account of salary, commission, bonus or remuneration and interest to Partner has to be firstly satisfy the requirements of Section 30 to 38 of the Act and then Section 40 is merely a corollary to Section 30 to 38 of the Act limiting the deduction as per Section 40 of the Act. Thus, decision in R M Chidambaram Pillai in [TS-5057-SC-1976-O] cannot be applied under the new changed law post- Finance Act, 1992 whereby the Partnership firm is taxed as a separate entity.”

The remuneration is received by the partner for acting as working partner of the firm and interest as a compensation for the capital he has introduced in the firm. Neither his role as 'working partner' nor 'capital introduced' can be held as an activity in the nature of business or profession.

Is being a Partner amount to Business or Profession?

For the purposes of the act, both 'Business' and 'Profession have been defined under sections 2(13) and 2(36) of the Act.

2(13) "business" includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture;

2(36) "Profession" includes vocation.

Being a Partner is not in the nature of trade, commerce or manufacture, nor any adventure or concern in the nature of trade, commerce or manufacture. It is neither a Profession nor Vocation. In Section 44AB, wordings used at appropriate places are "person carrying on Business...." and "Person carrying on Profession...". Thus being a partner is neither a 'business' nor a 'profession'.

Can the Classification of Remuneration and Interest received by a partner as Business Income make a difference to the above understanding?

Section 28 reads as under:

“Profits and gains of business or profession.

28. The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",—

(i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year;

………………….”

Under the current scenario, from Assessment Year 1993-94, the legislature had to classify the remuneration and interest under one of the five heads of income. The income couldn't have been classified as Salary, House Property or Capital Gains. This leaves the option of business income or income from other sources. Legislature in its wisdom classified the income under the head Income from Business or Profession as Section 28(v). This fiction can never be termed as an income from a business activity. Being a partner in a firm, that too as a working partner or capital contributed can never be considered as an activity of business or profession.

Conclusion

When a partner does not carry any business activity, the remuneration or interest can never be considered for the purpose of invoking the provisions of 44AB of the Act.