Guidelines for Tax Assessment of Firms

The Central Board of Direct Taxes has issued Circular No. 12, 2019 – Assessment of Firms, on 19th June 2019, wherein the Board, in order to improve the quality of assessment being framed, has laid down certain issues to be taken into consideration by the Assessing Officer while assessing firms under Income Tax Act ,1961 (‘Act’). The Circular is also applicable to limited scrutiny cases if the assessee is a registered firm.

  • Cross verification of Tax Returns and Examination of Partnership Deed

AO should cross verify the Income Tax Return of Partner(s) with the Tax Return filed by the Firm for the amounts such as interest paid to the partners, remuneration payable to the working partner etc.

Further, AO should examine the Partnership Deed of the Firm so that instances of payment of remuneration to any non-working partner or remuneration payment for period prior to the date of partnership deed but claimed as deductible are identified.

  •  Interest on Capital payable to Partner

AO should strictly refer to the terms of the Partnership Deed while computing the Interest on Capital payable to Partner as per Section 40(b)(iv) of the Act. The interest payable should strictly be as stated in the Partnership Deed and should not exceed 12% simple interest per annum.

  • Remuneration payable to Partner 

AO should ensure that claim under section 40(b)(v) of the Act is allowed only after a thorough verification of the partnership deed so that payment of remuneration to a working partner should be authorized and be in accordance with the terms of the partnership deed, not exceeding the maximum amounts prescribed therein. 

Also the remuneration should not exceed a particular aggregate amount which is based upon the figure of ‘book profit’. The Explanation 3 to section 40(b) of the Act contains definition of ‘book profit’ for purposes of section 40(b)(v) and it is further clarified that all incomes which do not fall under the head ‘profit or gain of business or profession’, should be excluded while computing ‘book profit’.

  • Application of provisions of Chapter XVI

AO are advised to apply the provisions of Chapter XVI of the Act and it is further brought to attention that as per Section 185, in case of non-compliance of the provisions of section 184 of the Act, expenses (eg. remuneration, interest etc.) payable to the partners may be denied by the Firm.

  • Preventing inflation of profits under section 80IA

If any firm try to inflate the profits eligible for deduction under section 80IA of the Act by not claiming expenditure towards remuneration, salary, interest etc. which are payable to the partners , AO has power under section 80IA (10)  to re-compute profit of the eligible business after excluding the profits of the related activity/business which produced the excessive profit.

  • Verifying claims of carry forward and set off of losses

AO should verify such claim of carry forward and set off of losses of a firm under Section 78 of the Act and disallow it in case of change in constitution of the firm or on succession.

  • Tax Audit Report

In order to take possible action against Tax Auditor for furnishing incomplete information in the Tax-Audit Report and effective utilization of information in the Tax Audit Report by the Assessing Officers Instruction No.09/2008 dated 31.07.2008 of CSDT should be followed by the AO.

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