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Remuneration to Partners: Service Tax Applicable?

-An insight by CA Arvind Singh Chawla

A)    Nature of Payments made to Partners

  • Salary/ Remuneration
  • Interest on Capital
  • Share of Profit

 

Service Tax Provisions

B)   Charging Section

Sec 66B:- There shall be levied a tax (hereinafter referred to as the service tax)

  • At the rate of 12%
  • On the value of all services,
  • Other than those services specified in the negative list,
  • Provided or agreed to be provided
  • In the taxable territory
  • By one person to another
  • ·       And collected in such manner as may be prescribed

 

C)   What is “Service”?

U/s 65B (44) "service" means

  • Any activity
  • Carried out by a person for another
  • For consideration
  • And includes a declared service

but shall not include

(a) An activity which constitutes merely,––

(i) A transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or

(ii) A transaction in money or actionable claim;

(b) A provision of service by an employee to the employer in the course of or in relation to his employment;

(c) fees taken in any Court or tribunal established under any law for the time being in force.

Explanation 1.— ………………………………………..

Explanation 2-For the purpose of this clause transaction in money shall not include any activity in relation to money by way of its use or conversion by cash or by any other mode ,from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged.’

Explanation 3.–– For the purposes of this Chapter,—

(a) an unincorporated association or a body of persons, as the case may be, and a member thereof shall be treated as distinct persons;

(b) an establishment of a person in the taxable territory and any of his other establishment in a non-taxable territory shall be treated as establishments of distinct persons.

Explanation 4.— A person carrying on a business through a branch or agency or representational office in any territory shall be treated as having an establishment in that territory;

 

D)    What is “Activity”?

The term activity is not defined in the Finance Act, however the CBEC education guide dated 20-06-2012 defines it to be “either be active or passive or forbearance of an act”. For eg.amount charged for following will be treated as service:

  • Non-compete agreements
  • Vacating of plot

 

Activity done without express or implied contractual reciprocity of consideration would not be an “activity for consideration”

  • Activity without consideration: Artist performing on street receiving money from passerby [outside the purview as the listeners are “under no obligation” to engage or pay]
  • Consideration without activity: Pocket money, gift, amount paid as alimony.

 

E)    What is “Person”?

U/s 65B (37) "person" includes,––

(i) an individual,

(ii) a Hindu undivided family,

(iii) a company,

(iv) a society,

(v) a limited liability partnership,

(vi) a firm,

(vii) an association of persons or body of individuals, whether incorporated or not,

(viii) Government,

(ix) a local authority, or

(x) every artificial juridical person, not falling within any of the preceding sub-clauses

 

F)    What is activity by a person for another?

Para 2.4 of the CBEC guide supra explains that phrase ‘provided by one person to another’ signifies services provided by a person to self are outside the ambit of taxable service.

Example of such service would include a service provided by one branch of a company to another or to its head office or vice-versa.

However the two exceptions wherein services provided by a person to oneself are deemed as separate persons and hence taxable under Explanation 2 of clause (44) of section 65B, are:

  • An establishment of a person located in taxable territory and another establishment of such person located in non-taxable territory are treated as establishments of distinct persons. [Similar provision exists in section 66A (2)].

Eg. Services provided by branch office of MNC to HQ placed outside India

 

  • An unincorporated association or body of persons and members thereof are also treated as distinct persons. [Similar provision exists in explanation to section 65].

Eg. services provided by a club to its members]

 

G)   Analysis of transactions between Partners and Firm

a.     Induction of Capital in Firm

Para 2.8.4 of the CBEC Education Guide states that “Investment of funds by a person with another for which the return on such investment is returned or repatriated to the investors without retaining any portion of the return on such investment of funds is a transaction only in money. Thus a partner being admitted in a partnership against his share will be a transaction in money.”

b.    Interest on Capital

Negative List entry :

(n) Services by way of –

(i) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount.

 

Provisions of Partnership Act,1932

Section 4 : Definition of Partnership, Partner, firm and firm name

"Partnership" is the a)relation between persons b)who have agreed to share the profits of a business c)carried on by all or d)any of them acting for all.

Persons who have entered into partnership with one another are called individually, "partners" and collectively "a firm", and the name under which their business is carried on is called the "firm-name".

 

Section 9: General Duties of Partners

Partners are bound to carry on the business of the firm to greatest common advantage, to be just and faithful to each other, and to render true accounts and full information of all things affecting the firm to any partner, his heir or legal representative.

 

Section13 : Mutual rights and liabilities

Subject to contract between the partners -

(a) a partner is not entitled to receive remuneration for taking part in the conduct of the business;

(b) the partners are entitled to share equally in the profits earned, and shall contribute equally to the losses sustained by the firm

(c) where a partner is entitled to interest on the capital subscribed by him, such interest shall be payable only out of profits.

(d) ………………………..

(e) the firm shall indemnify a partner in respect of payments made and liabilities incurred by him

(i) ……………………

(ii) in doing such act, in an emergency, for the purpose of protecting the firm from loss, as would be done by a person of ordinary prudence, in his own case, under similar circumstances; and

(f) a partner shall indemnify the firm for any loss caused to it by his willful neglect in the conduct of the business of the firm.

 

Sec 18: Partner to be agent of the firm

Subject to the provisions of this Act, a partner is the agent of the firm for the purposes of the business of the firm.

 

Sec 19: Implied authority of partner as agent of the firm

Subject to the provisions of section 22, the act of a partner which is done to carry on, in the usual way, business of the kind carried on by the firm, binds the firm.

The authority of a partner to bind the firm conferred by this section is called his "implied authority".

 

Sec 25 : Liability of a partner for acts of the firm

Every partner is liable jointly with all the other partners and also severally, for all acts of the firm done while he is a partner.

 

Sec 14: The Property of the Firm

Subject to contract between the partners, the property of the firm includes all property and rights and interest in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or for the firm for the purposes and in the course of the business of the firm, and includes also the goodwill of the business.

Unless the contrary intention appears, property and rights and interest in property acquired with money belonging to the firm are deemed to have been acquired for the firm.

 

Sec 15: Application of the property of firm.

Subject to the contract between the partners, the property of the firm shall be held and used by the partners exclusively for the purposes of the business.

 

View of Judiciary

H)   Firm is not a legal Person

 

Here the first thing that we must grasp is that a firm is not a legal person even though it has some attributes of personality.

Partnership is a certain relation between persons, the product of agreement to share the profits of a business. "Firm" is a collective noun, a compendious expression to designate an entity, not a person.

{CIT vs.R.M. Chidambaram Pillai, [1977] 106 ITR 292 (SC)}

 

A partnership firm is not an independent legal entity, the partners are the real owners of the assets of the partnership firm. Actually the firm name is only a compendious name given to the partnership for sake of convenience. The assets of the partnership belong to and are owned by the partners of the firm.

So long as partnership continues each partner is interested in all the assets of the partnership firm as each partner is owner of the assets to the extent of his share in the partnership

 

{N. Khadervali Saheb (Dead) By Lrs. ... vs N. Gudu Sahib(Dead) And Ors 2003-129-Taxman 597 (SC-3 Member Bench)}

 

I)      Partner is not an Employee

In income-tax law, a firm is a unit of assessment, by special provisions, but is not a full person which leads to the next step that since a contract of employment requires two distinct persons, viz., the employer and the employee, there cannot be a contract of service, in strict law, between a firm and one of its partners.

 So that any agreement for remuneration of a partner for taking part in the conduct of the business must be regarded as portion of the profits being made over as a reward for the human capital brought in. Section 13 of the Partnership Act brings into focus this basis of partnership business.

It is implicit that the share income of the partner takes in his salary. The telling test is that where a firm suffers loss the salaried partner's share in it goes to depress his share of income. Surely, therefore, salary is a different label for profits, in the context of a partner's remuneration.

In law, a partner cannot be employed by his firm, for a man cannot be his own employer. A contract can only be bilateral and the same person cannot be a party on both sides, particularly in a contract of personal employment.

 

A supposition that a partner is employed by the firm would involve that the employee must be looked upon as occupying the position of one of his own employers, which is legally impossible. Consequently, when an arrangement is made by which a partner works and receives sums as wages for services rendered, the agreement should in truth be regarded as a mode of adjusting the amount that must be taken to have been contributed to the partnership's assets by a partner who has made what is really a contribution in kind, instead of contribution in money.

 

…………………salary of a partner is but an alias for the return, by way of profits, for the human capital sweat, skill and toil are, in our socialist republic, productive investment he has brought in for common benefit. The immediate reason for payment of salary was service contract but the causa causans  is partnership.

 

{ CIT vs.R.M. Chidambaram Pillai, [1977] 106 ITR 292 (SC)}

 

Para 3A partnership firm is not a legal entity. In a partnership each partner acts as an agent of the other. The position of a partner qua the firm is thus not that a master and a servant or employer and employee which concept involves an element of subordination but that of equality.

The partnership business belongs to the partners and each one of them is an owner thereof.

In common parlance the status of a partner qua the firm is thus different from employees working under the firm, it may be that a partner is being paid some remuneration for any special attention which he devotes but that would not involve any change of status and bring him within the definition of employee.”

{Regional Director Employees State Insurance Association vs Ramanuja Match Industries 1985 AIR 278, 1985 SCR (2) 119}

 

Service tax Decisions

J)    Judgments relating to club and its members

1.     Hon’ble Calcutta High Court in Saturday Club Ltd vs. AC [2005 (180) ELT 0437 (Cal.)]

Para 17 “……….Income-tax is applicable if there is an income. Sales tax is applicable if there is a sale. Service tax is applicable if there is a service. All three will be applicable in a case of transaction between two parties.

Therefore, principally there should be existence of two sides/entities for having transaction as against consideration. In a members’ club there is no question of two sides. ‘Members’ and ‘club’ both are same entity.

One may be called as principal when the other may be called as agent, therefore, such transaction in between themselves cannot be recorded as income, sale or service as per applicability of the revenue tax of the country. Hence, I do not find it is prudent to say that members’ club is liable to pay service tax in allowing its members to use its space as ‘mandap’.”

 

2.     Ranchi Club Ltd. vs. CCE & ST [2012 (026) STR 0401 (Jhar.)]

Para 18. “However, learned counsel for the petitioner submits that sale and service are different. It is true that sale and service are two different and distinct transaction. The sale entails transfer of property whereas in service, there is no transfer of property. However, the basic feature common in both transaction requires existence of the two parties; in the matter of sale, the seller and buyer, and in the matter of service, service provider and service receiver. Since the issue whether there are two persons or two legal entity in the activities of the members' club has been already considered and decided by the Hon'ble Supreme Court as well as by the Full Bench of this Court in the cases referred above, therefore, this issue is no more res integra and issue is to be answered in favour of the writ petitioner and it can be held that in view of the mutuality and in view of the activities of the club, if club provides any service to its members may be in any form including as mandap keeper, then it is not a service by one to another in the light of the decisions referred above as foundational facts of existence of two legal entities in such transaction is missing. However, so far as services by the club to other than members, learned counsel for the petitioner submitted that they are paying the tax.”

{Followed in Sports Club of Gujarat Ltd. vs. UOI 2013(03)LCX0133 (Guj) decided on 25-3-2013}

 

Provisions under Income Tax

Basic tenets of Sec 40(b)

  • No deduction if remuneration or interest is not authorized by Partnership Deed.
  • Remuneration like salary, remuneration, commission, bonus etc. paid to working partner (actively engaged in working) and not to silent partners.
  • Unless the deed quantifies remuneration or provides for computation, no deduction will be allowed.-CBDT circular no. 739 dt 25/03/1996. Also refer Commissioner of Income Tax Versus M/s. Anil Hardware Store [2010] 323 ITR 368 (HP)

 

  • No deduction allowed for remuneration for the period prior to which it was mentioned in the partnership deed.

 

  • Limit of Remuneration deduction:

o   Upto first 3 lacs of Book Profit incl  loss : 1,50,000/- or 90% of BP w.e.h.

o   Balance 60% of BP

  • Interest > 12% is disallowed even if authorized by deed

 

Other Provisions

  • Share of profit from firm not taxed in hand of partner as it is already taxed.
  • Sec 15 excludes the amount received by partner from the head salary and Sec 28 specifically includes the same under the head business and gains from Business/ Profession.
  • TDS deduction is not applicable to remuneration paid to partners

 

Issue of Service tax: different schools of thought

a)Firm is no legal entity

  • Unlike a body corporate, a firm is not a legal person. It is specifically included in the definition of “person” under IT Act,1961, Finance Act, 1994.
  • As firm is a not a legal person, it (firm) and partners are one and the same, the business of partnership owned by partners only. Hence service by partner to firm is service to oneself and out of the definition of service itself.
  • The explanation 3 to Sec 65B(44) – definition of service- [which provides taxability to oneself ] , does not provide for the services provided by partners, hence service will not be taxable.

 

b)Partner and firm are distinct

  • If firm and partner are treated as different persons, then the relationship can be treated as employer-employee as the partner is working for the firm. However even in such a case it will be outside the purview of definition of service itself.

  • A remotest possibility that as both firm and partner are different persons, partner can be treated as providing service to firm as it is handling its business, and enhancing its value including goodwill. However definitely, same will not stand in light of discussion held above.