In what could bring a major relief to partnership companies, the Income-Tax department is set to clarify that the income of a firm that has been exempted from tax cannot be taxed for its profit in the hands of its partners.

Earlier, even if the income chargeable to tax for a firm was nil due to certain deductions and exemptions, some assessing officers levied tax on the profit credited to its partners. This led to disputes and some taxpayers challenged this in courts.

“After looking into the issue, the Central Board of Direct Taxes (CBDT) has decided to clarify that such income in the hands of partners will be completely exempt,” said a senior finance ministry official.

The official said the partners that had already paid taxes on such income might be allowed to get refunds or adjustments against their future tax liability (but there are only a few such cases).

The move came after CBDT received representations in connections with interpretation of provisions of Section 10 (2A) of the Income-Tax Act. According to this section, inserted by the Finance Act, 1992, a tax partner is not liable to tax again on his share in the total income of the firm.

“The position is clear but the language of the section in the law created difficulty... The ambiguity will be cleared with this clarification. It will certainly provide a lot of relief to promoter companies and others from the consequences of unintended taxation,” said Deloitte Partner N C Hegde.

The profit of a partnership firm is divided among its partners in sync with their partnership deal. For the purpose of computation of income tax, identities of a partner and the firm are co-terminus. This means assets and liabilities are not different. The profits are credited to a partner’s account and he can plough it back into the business. It is more of a book entry, as no cash is generally drawn out of the company. Therefore, the income of partners was made tax exempt in 1993 to avoid double taxation.

As some assessing officers interpreted the section differently and started levying taxes on partners’ profits, clarifications were sought as to what amount would be exempt in the hands of partners in cases where a firm had claimed exemptions or deductions. The firm is taxed at 30 per cent plus surcharge and applicable tax and the partners’ profit is also taxed at the same rate.

“The income of a company is to be taxed in the in the hands of the company alone. This can, under no circumstances, be taxed in the hands of its partner,” says a CBDT circular that is likely to be made public soon.

However, partners’s interest income from capital in account and the remuneration they receive from the company will continue to be taxable according to the provisions of the I-T Act. (Business Standard)