The CBDT has issued Circular No. 12/2019 dated 19th June 2019 in which it has systematically set out the important issues to be kept under condieration by AOs while making assessment of firms. The recommendations are based on the report of the C&AG. The CBDT has desired that these issues should be considered in order to improve the quality of assessments being framed in these cases and also to reduce the scope for committing errors
Circular No. 12/2019
Government of India
Ministry of Finance
Department of Revenue
Central Br Board of Direct Taxes
North Block, New Delhi, the 19th of June, 2019
Subject: ‘Assessment of Firms’-some of the important issues to be kept under
consideration by the Assessing Officers while framing assessment-reg.-
C&AG had carried out a Performance Audit regarding ‘Assessment ofFirms/under the Incometax
Act, 1961 ( Act’) and in its Report NO.7 of 2014, has made certain suggestions so that in future ,
assessments in these cases are handled in a more effect ive manner by the Assessing Officers (AOs).
Various recommendations made by the C&AG in its Report have been duly considered by the Board.
In order to improve the quality of assessments being framed in these cases and also to reduce the
scope for committing errors, the Board desires that Assessing Officers should duly take into
consideration the following issues while making assessments in case of firms:
( i) Expenses in the hands of the firm such as interest on capital paid to the partners,
remuneration payable to the working partners etc. are taxable in the hands of respective partners.
Therefore, while framing assessment in case of firms, a cross-verification of such amounts with
income-tax return of firm’s partner will be desirable and any discrepancy between the tax return of a
firm and its partners should be dealt with as per provisions of the Act.
Further, AOs should invariably
call for a copy of the partnership deed during the course of assessment proceedings and examine it
carefully 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 and
cognizance of these are duly taken in assessment.
(ii) Section 40(b)(iv) stipulates followinq three conditions for allowability of interest to the
partners of a firm:
a) the payment should be in accordance with the terms of the partnership deed; and
b) it should relate to any period falling after the date of such partnership deed; and
c) it should not exceed the amount calculated at the rate of twelve percent simple interest per
Instances have been noticed where the interest in the partnership deed was stated to be
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below twelve percent, yet, the same was allowed at the rate of twelve percent by the AO. Such
mistakes should be avoided. Further, in case the rate prescribed in the partnership deed is in excess
of twelve percent, the excess should be disallowed in assessment.
The AO is also required to
ascertain whether payment of interest is duly authorized by the partnership deed or not. Further,
while calculating interest payable to the partners for purposes of section 40(b)(iv) of the Act, AOs are
taking different yardsticks for calculating interest viz. opening balance of capital, closing balance of
capital, fixed capital or current capital etc. In this regard, section 40(b)(iv) of the Act prescribes that
payment of interest to partners should be authorized by and be in accordance with the partnership
Therefore, while framing assessment, AOs should refer to the terms of the partnership deed
for purpose of computation of interest on capital payable to a partner.
(iii) Clause (ii) and (v) of section 40(b) of the Act lays down that payment of remuneration to a
working partner should be authorized by the partnership deed, be in accordance with the terms of
the partnership deed, should relate to a period after the partnership deed and should also not exceed
the maximum amounts prescribed therein.
However, it has been noticed that in some assessments,
AOs had allowed expenditure on remuneration to the working partners though the same was either
not authorized by the partnership deed or was in excess of the amount specified therein. In order to
prevent recurrence of mistakes and allowing the expenditure strictly as per provisions of the Act, the
AOs should ensure that claim under section 40(b)(v) of the Act is allowed only after a thorough
verification of the partnership deed.
Further, while computing remuneration which is allowable to a
working partner under section 40(b)(v) of the Act, the term ‘in accordance with the terms of the
partnership deed’in clauses (ii) and (v) of section 40(b) of the Act implies that remuneration should
not be undetermined or undecided. Hence, in all situations, partnership deed should form the basis
for determination of remuneration payable to the working partners.
Furthermore, in situations where
the remuneration either so specified in the partnership deed or computed as per the method
indicated therein falls short of the amount allowable under section 40(b)(v) of the Act, it would be
restricted to the figure computed on the basis of the partnership deed.
(iv) While computing remuneration payable to the working partners under section 40(b)(v) of the
Act, 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 the purposes of determination of remuneration of the partners and provides that ‘book profit’
shall mean the net profit, as shown in the profit & loss account for the relevant previous year,
computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the
remuneration paid or payable to all the partners of the firm if such amount has been deducted while
calculating the net profit.
Therefore, while computing ‘book profit’ for purposes of section 40(b)(v) of
the Act, all incomes such as capital gain, interest, rental income, income from other sources etc.
which do not fall under the head ‘profit or gain of business or profession’, should be excluded.
(v) AOs are advised to apply the provisions of Chapter XVI of the Act in assessment of firms
whenever required. It should be taken into consideration that under section 185 of the Act, any noncompliance
by the firm or its partners with provisions of section 184 of the Act may result in denial of
expenses such as remuneration, interest etc. payable to the partners which are otherwi se allowable
under the provisions of the Act.
( vi) It has also come to notice that some firms 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.
In such situations, Assessing Officers may examine these transactions in
light of provisions of sub-section (10) of section 80IA of the Act which empower Assessing Officer to
re-compute profit of the eligible business after excluding the profits of the related activity/ business
which produced the excessive profit.
(vii) While framing assessments in case of firms claiming carry forward and set off of losses,
Assessing Officers are requested to verify such claims taking into consideration provisions of section
78 of the Act which disallow such a carry forward and set off in case of change in constitution of the
firm or on succession.
(viii) Regarding the issue concerning possible action against the 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, it is reiterated that directions given earlier viz. Instruction No.
09/2008 dated 31.07.2008 of CSOT should be followed scrupulously by the field authorities.
2. It is hereby clarified that this circular would also be applicable to limited scrutiny cases if the
assessee is a registered firm.
3. This Circular may be brought to the notice of all concerned.
4. Hindi version to follow.