Introduction

The issue is covered in this article is whether the remuneration received by the partners from the partnership firms is subject to service tax.

As per section 4 of the Indian Partnership Act, 1932 ‘partnerships’ is the relationship between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all.

Partnership Law is not a legal entity in the eyes of law. Under the Partnership Act the firm and the members of the firm are not distinct legal entity. The Hon’ble Supreme Court in case of Sham Sundar v. State of Haryana held that “partnership is not a legal entity but a mere Association of Persons to carry on the business and is only a collective name for carrying on business of partnership”. The Hon’ble Supreme Court in case of Comptroller & Auditor General v. Kamlesh Vadilal Mehta held that “a partnership concern is not a legal entity like a company. It is a group of individual partners”.

The Apex court in case of Dulichand Laxminarayan lay down that the law has extended only a limited personality to a partnership firm. A firm is not an entity or a 'person' but is an association of individuals, and a firm's name is only a collective name of those individuals who constitute the firm. In other words, a firm's name is merely an expression, only a compendious mode of designating persons who have agreed to carry on business in partnership.

Situation under Income Tax Act

A firm partner and partnership are not different and have the same sense as in the partnership Act, 1932 according to section 2(23) of the Income Tax Act, 1961. Under the Income Tax Act 1961, by creating a deeming fiction partnership firm is treated as a different person than its members for the purpose of assessment only. Explanation 2 to section 15 of the Income-tax Act, 1961 states that any salary, bonus, commission or remuneration, by whatever name called, due to or received by a partner of a firm from the firm shall not regarded as 'salary'. Further, section 28(v) of the Income Tax Act, 1961 states that such incomes received from firm shall be treated as income chargeable to tax under the head "Profits and Gains of business or profession."

The Hon'ble Supreme Court in the case of Regional Director, Employees State Insurance Corpn. v. Ramanuja Match Industries (1985] 1 SCC 218 while dealing with the question, whether there could be a relationship of master and servant between a firm on the one hand and its partners on the other, indicated that under the law of partnership there can be no such relationship as it would lead to the anomalous position of the same person being both, the master and the servant.

In RM Chidambaram Pillai (supra), it was held that a contract of employment requires two distinct firms, viz., employer and employee. A firm is not a 'legal person', though it has some attributes of a personality under Income Tax. Hence there can be no employer employee relationship as one cannot be an employer of one ownself but the salary paid to partner is only profit share known by a different name.

Taxability under Service Tax

Under the negative list regime w.e.f. 01 July, 2012 service has been defined as follows:

Accordingly as per Explanation 3 of section 65B(44) of the Finance Act, 1994, an incorporated association of person is to be treated different from its member by creating a deeming fiction.

However as section 65B(37) a person is defined as:

On plain reading of definition it can be constructed that a partnership firm and an association of person are both different person under the service tax law. Hence it can be safely interpreted that explanation 3 to section 65B(44) of the Finance Act, 1994 is not applicable to a partnership firm. Hence remuneration to partners of a partnership firm cannot be brought under the ambit of service tax laws.

Though partnership firm is not 'legal person', yet under the Partnership Act it has been defined as a 'person' different from the individual partners. This has been done by creating a legal fiction, notwithstanding provisions of the Partnership Act by including a 'firm' in the definition of a 'person' under section 65B(17)(vi) of the Finance Act, 1994. Once a legal fiction is created by law, it has to be taken to its logical end. Hence, partnership firm and the partner have to be 'deemed' as two different persons and then a partner will be employee of the partnership firm. In that case no service tax liability will arise as the same is exempted from the definition of service under section 65B(44) clause b.