Assessment as a Firm.

325(1)

A firm shall be assessed as a firm for the purposes of this Act, if—

• (a) the partnership is evidenced by an instrument; and
• (b) the individual shares of the partners are specified in that instrument.

325(2)

A certified copy of the instrument of partnership referred to in sub-section (1) shall accompany the return of income of the firm of the tax year in respect of which assessment as a firm is first sought.

325(3)

For the purposes of sub-section (2), the copy of the instrument of partnership shall be certified in writing by all the partners (not being minors) or, where the return is made after the dissolution of the firm, by all persons (not being minors), who were partners in the firm immediately before its dissolution and by the legal representative of any such partner who is deceased.

325(4)

Where a firm is assessed as such for any tax year, it shall be assessed in the same capacity for every subsequent year, if there is no change in the constitution of the firm or the shares of the partners as evidenced by the instrument of partnership on the basis of which the assessment as a firm was first sought.

325(5)

Where any such change had taken place in the tax year, the firm shall furnish a certified copy of the revised instrument of partnership along with the return of income for such tax year, and all the provisions of this section shall apply accordingly.

325(6)

Irrespective of anything contained in any other provision of this Act, where, in respect of any tax year, there is on the part of a firm any such failure as is mentioned in section 271,—

• (a) the firm shall be so assessed that no deduction by way of any payment of interest, salary, bonus, commission or remuneration, by whatever name called, made by such firm to any partner of such firm shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”; and
• (b) such payment shall not be chargeable to income-tax under section 26(2)(f).

Explanation

Section Summary:

This section outlines the conditions under which a firm can be assessed as a firm for income tax purposes in India. It specifies the requirements for the partnership instrument, the process for submitting certified copies of the partnership deed, and the implications of changes in the firm's constitution or partners' shares. Additionally, it details the consequences of non-compliance with certain provisions, particularly in relation to deductions for payments made to partners.

Key Changes:

1. Clarification on Assessment as a Firm: The section reiterates that a firm must have a formal partnership instrument specifying individual shares of partners to be assessed as a firm. This is consistent with prior laws but emphasizes the need for proper documentation.
2. Certification Requirements: The requirement for a certified copy of the partnership deed, signed by all partners (excluding minors), is explicitly stated. This ensures transparency and accountability.
3. Continuity of Assessment: Once a firm is assessed as such, it will continue to be assessed in the same capacity unless there is a change in the firm's constitution or partners' shares.
4. Consequences of Non-Compliance: If a firm fails to comply with certain provisions (e.g., under Section 271), deductions for payments like interest, salary, or remuneration to partners will be disallowed, and such payments will not be taxable under Section 26(2)(f).

Practical Implications:

• For Firms: Firms must ensure that their partnership deed is properly documented and certified. Any changes in the firm's structure or partners' shares must be reflected in a revised partnership deed, which must be submitted with the income tax return.
• For Partners: Partners must ensure that the partnership deed accurately reflects their shares and that they certify the document as required. Failure to do so could result in disallowed deductions and additional tax liabilities.
• For Compliance: Tax authorities will rely on the certified partnership deed to assess the firm. Any discrepancies or non-compliance could lead to penalties or reassessment.

Critical Concepts:

• Instrument of Partnership: A formal document (partnership deed) that outlines the terms of the partnership, including the roles, responsibilities, and profit-sharing ratios of the partners.
• Certified Copy: A copy of the partnership deed that has been verified and signed by all partners (excluding minors) or their legal representatives in case of dissolution or death.
• Section 271: Refers to penalties for failure to comply with tax provisions, such as filing returns or maintaining proper documentation.

Compliance Steps:

1. Prepare and Certify the Partnership Deed: Ensure the partnership deed is properly drafted, specifying individual shares of partners, and certified by all partners (excluding minors).
2. Submit with Income Tax Return: Attach a certified copy of the partnership deed when filing the income tax return for the first year the firm seeks assessment as a firm.
3. Update for Changes: If there are changes in the firm's constitution or partners' shares, prepare a revised partnership deed, certify it, and submit it with the income tax return for the relevant tax year.
4. Avoid Non-Compliance: Ensure compliance with all tax provisions to avoid disallowance of deductions and penalties under Section 271.

Examples:

• Scenario 1: A new firm, XYZ Partners, is formed with three partners. They draft a partnership deed specifying each partner's share as 40%, 30%, and 30%. They certify the deed and submit it with their first income tax return. The firm is assessed as a firm for that year and subsequent years unless there is a change in the partnership structure.
• Scenario 2: In the third year, one partner exits, and a new partner joins. XYZ Partners updates the partnership deed to reflect the new shares (e.g., 50%, 25%, and 25%). They certify the revised deed and submit it with their income tax return for that year. The firm continues to be assessed as a firm.
• Scenario 3: If XYZ Partners fails to comply with tax provisions (e.g., under Section 271), deductions for payments like salary or interest to partners will be disallowed, and such payments will not be taxable under Section 26(2)(f). This could increase the firm's taxable income and tax liability.