Wednesday, July 23, 2014

Whether PARTNER REMUNERATION received by a Partner from his firm liable to Service Tax or not

In the Union Budget 2012, a new concept of service tax has been introduced. As per proposal, all the Services are liable to service tax except Negative list. Services provided by Partners to its Firm are not covered by Negative List. So question arises whether services provided by partners to its firm will be treated as taxable services or Not? 

Legal Provisions:
The term ‘Service’ has been defined in clause 44 of the New Section 65 B. As per section
‘Service’ means
  • Any activity
  • For consideration
  • Carried out by a person for another. 
Test check on Partner remuneration:
  • Services provided by partner to its firm are activity.
  • It is always for a consideration.
  • Now we have to check third condition “carried out by a person for another”.
As per the Indian Partnership Act, 1932, 'firm' is a collective name given to the 'partners'. Therefore, even under the partnership law, firm and its partners are not separate persons. The partners are getting remuneration of work performed by them in their own firm. So we can say that activities of partners are not a nature of service as per section 65B.

But two exception of this Condition are also proposed in the budget and before reaching on any conclusion someone have to check that also:- 


The Explanation 3(a) to section 65B(44) provides that:-
  • An establishment of a person located in a taxable territory and another establishment  of such person located in Non taxable territory are treated as establishment of distinct person (separate person)
  • An unincorporated association or body of person and members thereof are also shall be   treated as distinct person.
In Definition of "person", it includes 'a firm' and 'an association of persons or body of individuals, whether incorporated or not'. Therefore, 'firm' and 'association of persons or body of individuals' are different persons under the service tax law. It follows, therefore, that Explanation 3(a) to section 65B(44) applies only to unincorporated association or a body of persons and not to 'a firm' and partners thereof.

Thus, even if the activities carried out by a partner for the benefit of the firm are services provided to the firm, then also, these are 'SELF-SERVICES', as firm and partners are not regarded as 'distinct person' under Explanation 3(a) to section 65B(44).

Partnership firm and partner is not a distinct person and even not covered by exception of the definition ‘service provided to another person’.

 Now, we can solve questions

Capital contributed by new partner can be regarded as a 'consideration' or not?

 The capital contributed by the new partner in the firm is not a 'consideration' because 'consideration' flows from the 'service receiver' to the 'service provider' and belongs to the service provider. The capital contribution of the new partner continues to belong to him and is returned to him whenever he retires. The capital contribution never belongs to the 'firm'. Thus, capital contribution cannot be regarded as a "consideration" for any service.

Sharing of profits, Partners Remuneration, Interest on Capital received by Partner from Partnership Firm is liable to service tax or not?

The question of charge of service tax arises when there is service provided by one person to another. The partners act according to the objectives of the partnership and work together to achieve common good. The remuneration, interest on capital, etc., are methods of sharing of profits earned by the firm and are not for provision of any service by the partner to the firm.

Hence, it is not liable to service tax.

In my opinion:-

a) If Dept. considers partnership Firm and Partners as separate Person
  • Then, there would be an employer-employee Relationship and hence it would be    exempt.   
b) If Dept. considers partnership Firm and Partners as same Person.
  • Then, there would be NO employer-employee Relationship, but it again exempt from the test of 3rd condition ‘carried out by a person for another’ and hence it would be exempt.   
As per Income-Tax Act, 1961
Under the Income Tax Act, the Partnership firm is taxed as a separate entity, distinct from the partners.  So partnership firm is taxes under the income tax slab for partnership firm and partners are taxes under the income tax slab for individuals.

However, the partnership must be evidenced by a partnership deed. The partnership deed is a blue print of the rights and liabilities of partners as to their capital, profit sharing ratio, drawings, interest on capital, commission, salary, etc, terms and conditions as to working, functioning and dissolution of the partnership business.

Provisions under Income Tax Act, 1961
  • The share of profit in the Income of the Firm is fully exempt from income tax as it is already taxed according to the income tax slab for partnership firms.
  • Where a firm pays Interest to any Partner, the firm can claim deduction of such Interest at a maximum rate of 12% p.a. according to the partnership deed. Interest Paid in excess of the above will be disallowed in hands of the firm. (sec 40(b)(iv))
  • In computing the total income of the firm, any salary, commission, remuneration and bonus to a partner shall be deductible subject to certain restriction.


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