How to book income for partners- different business model

Hi Ms. Nupur,

If the partners wants to share income on project base istead of % sharing, they can.

It is their wish whether they want to share the income derived in the form of profit or remuneration or both.

Simply on the basis of the point, partners are sharing income from projects project-wise instead of %-wise does not sense the entire income is profit. They are eligible for remuneration too ...

I agree. But profit can be shared between the partners only at the end of the year as per income tax act. And any salary that has to be paid to partners must be quantified in the deed. In this particular case, How do I treat this sharing of income? This is not salary as it is not fixed for every month. This cannot be called profits since, partners want to withdraw the amount earned by them on their respective project as and when they need money. Should this be called and treated as drawings then?

Section 40(b) is about allowance of Remuneration/interst to Partner of Partnership Firm which is based on "Book Profit" of the Firm. In your given scenerio, the profit sharing clause is based on work/project, does'nt matter, the receipt will be counted as of Firm. As you mentioned, deed must be clear of providing remuneration clause to be specific and not ambigious. If the remuneration clause is also event based, it will counted as contingent and no remuneration will be allowed.

 

Further, I doubted such partnership to be regarded as partnership within the meaning of Partnership Firm as the sharing is based on individual work and not collective work. So in crux, nothing will be allowed as remuneration and receipt should be taxed in individual hands after allowance of respective expenses.

Hi Arvind,

 

Thanks for replying. I hold exactly same views. In my opinion this is not a partnership firm. There is no pooling of funds, no collective work. Its just that there is a common bank account for receipts. Every individual partner should file his own tax return showing his own share of income and expenses nad then get taxed based on slab rates.

I would still appreciate to hear contrary views on this. 

Bt they even cannot file individual return showing their respective share. Since they are undertaking projects all together n then doing project individually, so this is a kind of partnership only. Here nothing has changed just project has been decided that which partner will undertook which project. N wht abt Project D ?

It surely can't b treated as remuneration as its not mentioned in deed. So completely agree upon this point. 

I agree with arvind sharma as well that it really doesn't look like partnership as they are receiving profits  on entirely basis for their projects done. ( there must b clause regarding the project undertaken will be sole or collective resposibility of partners..... if this substantial factor is missing, it may be treated as individual efforts and treated otherwise) 

 

but if its not the case, means liablity is severly and joint, it would b treated as drawing during the year and profits would be distributed in the respective manner for their shares done.

 

correct me, if I'm wrong or misunderstanding something....

My view is that salary portion can be project based, but residual profit should be shared on documented % as specified in deed. The overall salary cannot exceed the limits of the income tax act as per profits at the firm level for claiming tax deduction. It is not necessary that in order to constitute as salary under it act, the salary amount should be specified. It is enough if the methodology for arriving at partners' salary is specified in the deed.

I think that it can be termed as partnership, as long as it fulfils the following conditions. If we fail to prove it then it might be called Body of individuals

(Partly agreeing with Renu Singh)

[Please tell if disapprove]

 

As per section 4

"Partnership" is the relation between persons who have agreed to share the profits of
a business carried on by all or any of them acting for all.

 

The profits from all the projects are indeed the profit of the firm which shall be distributed as per their agreed terms which here is their receipt/profit from the projects

 

 

S. 10

Subject to the provisions of this Act, a partner is the agent of the firm for the
purposes of the business of the firm. 

 

Section19
IMPLIED AUTHORITY OF PARTNER AS AGENT OF THE FIRM.
(1) Subject to the provisions of section 22, the act of a partner which is done to
carry on, in the usual way, business of the kind carried on by the firm, binds the
firm.
The authority of a partner to bind the firm conferred by this section is called his
"implied authority". 

 

Section25
LIABILITY OF A PARTNER FOR ACTS OF THE FIRM.
Every partner is liable jointly with all the other partners and also severally, for all
acts of the firm done while he is a partner 

 

Further in my opinion this method which has been provided (allocation of projects profit) can be said to be satisfying the condition of laying out the method of allocation of remuneration as specified by the circular. 

[Raja Praturi Sir has stated the same, concuring with you sir]

 

Hi,

Ankit, they definitely can file there return as individuals. The individual in whose name the bank account has been opened, can show all the receipts as income and then show the work being done by partners on some projects as work outsourced. This will be done based on contractual agreements among them. These payments can be claimed as business expenses then, something like a salary to employees. 

If they are to treat this as a partnership, then what should be written in the deed regarding this unusual method of distributing income/ remuneration even if it is project based. Also, if the partner asks me today that based on limits specified in section 40(b) how much share should he pay as remuneration so as to avoid dissalowance, then in that case what should be done. 

Should not these be treated as drawings instead of remuneration even if it means that their capital accounts will turn negative ?

Please guide .....

Is it a firm?

Section4 of partnership Act 1932

Partnership and Partner:

"Partnership" is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into partnership with one another are called individually, "partners" and collectively "a firm".

Section6 of partnership Act 1932

Mode Of Determination Of Existence Of Partnership:-

In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together. It should be decided by the partners of the partnership as defined in section 4 of the Act and such a partnership should be arises from the contract and not from the status as per section 5 of the Act.  

 

So from the definition of partnership it is very clear that they ‘have agreed to share profits from the business carried on by all or any of them acting for all’. There is no need of common deploying or injection of fund or capital by all the partners like AOP as judged by Honourable supreme court in the case of ‘Sudhir Nagpal And Others vs The Income Tax Officer’. As per section 5 of the Act partnership should arise from a contract. As per section 6 partners have to decide are they partners or not. Since the stated case is a partnership as they are sharing profits of the business carried on by them self’s, they have contract, partnership deed and they stated in that they are partners (assuming from the situation).So it is a partnership firm.

Applicability of section 40(b) of Income Tax Act 1961

As per section 40(b) of the Act

i) Remuneration should be authorised by and in accordance with partnership deed. A Circular has been issued by CBDT having no.739 dt. 25.03.1996 stating that amount of remuneration shall be disallowed if the deed doesn’t specify the amount of remuneration OR it doesn’t lay down the manner of fixation of remuneration. One of the above stated clause must be in the deed to avail the deduction as per sec 40(b). Case law CIT v/s Anil Hardware Store (2010) 323 ITR 368 (HP).

ii) Remuneration should be paid to a working partner, defined in explanation 4 of the section. As you specified here in the situation remuneration is paid only to the working partners.so this condition is satisfied in the partnership.

iii) Remuneration should be within the limits as stated in the section (not texting here as it is well known to everyone).If the remuneration paid to the partners is in excess then the excess will be disallowed.

Conclusion of applicability of section 40(b)

Only the working partners alone gets the remuneration and the clause is stated in the partnership deed, section 40(b) is applicable here. If the remuneration paid is in excess of the limits as stated in the Act then the excess only will come under the ambit of disallowance.

Under what head?

The partner will get taxed the whole amount of remuneration under ‘Profits and Gains of Business or Profession’ as per clause (v) of section 28 of the Act and it will not be treated as salary as per section 15 of the Act.

 

Should all this sharing of income from projects be simply treated as sharing of profits or remuneration?
 

As per point (i) of clause (b) of section 40 of the Act “Any payment of salary, bonus, commission or remuneration by whatever name called (hereinafter referred to as remuneration)

So in our case is there a sharing of profit by whatever name called it can be treated as remuneration. So the sharing of profit is a payment of remuneration to the partners and section 40(b) will get apply.

The above referred are my guidance and supportings to your first Query. Expecting this helps you to turn the key of solution to the problem.
 

Agreed with the above reply.

As written by you " there are 3 partners and they undertake IT projects from overseas clients ", So they are working together its just the work that has been divided between them n u also write that they have common bank account for receipts.

They are sharing profit also as mentioned by u in project D. So why cann't we call it a partnership firm ?

One more thing, Sec 40(b) is a sec which tells u abt the disallowances if and only if u provide remuneration bt that sec doen't say that u have to necessarily provide remuneration. So if u r nt providing any remuneration then question on application of that sec doesn't arise.

what u say ?