Effects of Section 40 (B) of Indian I.T.Act

Today, I am here on my Blog with a special Post which perhaps may not concern to most of my Readers who are not involved in business. Actually, this Article was written for my community members of Accounting and Taxation on PeerPower, an Exclusive web site of Times Group for Professionals only; but, being the same to be extensive to the limit of number of certain words, I thought to publish it here. Our family businesses fall under various categories of firms such as Proprietary, Partnership, Private Company as well as Professional. We are not purely dependent on our Tax Consultants and therefore we take keen interest in Taxation and its planning limited to our own concerns for fair discussion with them prior to finalize the documents of taxation.   

To make my Article precise, I’ll discuss only the provision of   Remuneration to Partner/s under Section 40 (B). Up to Ass. Year 1992-93, the Partnership Firms (Both Business and Professional) were levied Firm Tax; and over and above, the Partners also had to pay Individual Personal Tax on share of profit earned from the firm. Thereafter, as per provision of Financial Act 1992, the Partnership firms have to pay tax on total income at the flat rate of 35% and later on from Ass. Year 2006-07at the rate of 30% with applicable Surcharge as well as Education Cess. The Partners have to mention their share of profit as Non-Taxable Firm Profit in their Income and Expense A/c and such income is tax exempted u/s 10 (2-A).

As per above Financial Act of 1992, some notable provisions were made in Clause 40 (B) and accordingly the working partner/s are allowed to have Firm Management Remuneration. Following Table indicates what amount the working partner can have based on Book Profit of the firm. Remuneration to partners can be paid only to working partner/s authorized by the partnership deed. It should not pertain to period prior to partnership deed and must not exceed the limits prescribed.

In case of a firm carrying on a profession : –
On the first INR 1,00,000 of the book profit or in the case of loss	INR 50,000 or @ 90% of the book profit whichever is more
On the next INR 1,00,000 of the book profits	@ 60%
On the balance book profits	@ 40%
In case of other firms : –
On the first INR 75,000 of the book profit or in the case of loss	INR 50,000 or @ 90% of the book profit whichever is more
On the next INR 75,000 of the book profits	@ 60%
On the balance book profits	@ 40%

My valued Readers will agree with me on the point that the above table needs to be revised for both types of the firms with change of figures of INR 1,00,000 and INR 75,000/- in line with present inflation ratio and also Tax Exempted initial income limit gradually increasing  in individual cases. It is a surprising matter that above figures have been kept invariable for the last more than 15 years.

In my view, the initial two stages of above table should be revised either by increasing limits by amount or with the mention of certain percentages instead of steady figures. In brief to say that the limits may be read as “On the first 20% or 30% of the book profit” and so on as the Government may think fit. 

It is true that the tool of Income Tax, one of the Direct Taxes, is a very important source for collection of revenue in a very huge amount for a Government. All taxes, direct or indirect, are back-bones of any nation’s economical progress. The tax policy of any Government is aimed to social justice, proper distribution of wealth and mobilization of savings. At the same time, it is equally true that there should not be any injustice among the equivalent class of tax payers. Take an example of Partnership firms and Private companies. There are many advantages in a Private company compared to Partnership firms in provision of admissible expenses and mainly the Remuneration Expense.

My learned Readers can understand the basic concept of this Article. Human nature is always complicated to be understood. It is the fact that any tax payer will obviously try to minimize the tax liability. This tendency can be classified in three categories: (1) Tax evasion (2) Tax avoidance; and (3) Tax Planning. Tax evasion is the serious crime to the nation as the person does not pay a single coin as tax to the Government. Tax avoidance is also similar to tax evasion where the tax payer conceals some incomes and pays a very little amount of tax compared to actual one.

But, the last category of Tax planning is not a crime as it is being done living within the boundaries of the law. Tax planning is an innocent activity where the tax payer enjoys maximum benefits of incentives, rebates and other similar allowances to reduce tax burden. These benefits are achieved through legal means. It is different from evasion and avoidance of tax

I would like to say in general that remuneration to the Partners of a Partnership firm is restricted as per above table of calculation. Private companies have no any such restriction for allowing Director Remuneration/Salary. Thus tax liability of a Partnership firm goes to much higher side compared to Private Companies. Partnership firms may opt to convert to Private Limited companies to enjoy some benefits.   

While summing up, I have pleasure to let my Readers know that the Indian Parliament has recently passed the Limited Liability Partnership (LLP) Bill 2008. The LLP is the combination of Partnership firm and Private company. In this new form, the Partners have limited liability like Private companies. In Private Company, the share-holders other than directors have no right to participate in management of business; but, the Partners of the LLP have the right to manage the business directly.  

Hopefully this Article be benefited and commented,

With regards,

– Valibhai Musa

Notes : –

(1) It is hereby advised to discuss the points narrated here with your Tax Consultants prior to opting for any alternate form of the firm.

(2) Soon after my this Article, the Limits have been amended by Finance Act 2009 (Budget Session of Indian Parliament) applicable to both Professional and Non-  Professional Partnership Firms as follows:

-In case of Loss or on First Rs. 3,00,000 of Profit Rs. 1,50,000 or 90% of Book     Profit, whichever is higher.

-On balance of Profit 60% of Book Profit.