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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:
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"service" means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include—
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(a)
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an activity which constitutes merely,—
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(i)
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a transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or
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(ii)
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such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of article 366 of the Constitution; or
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(iii)
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a transaction in money or actionable claim;
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(b)
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a provision of service by an employee to the employer in the course of or in relation to his employment;
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(c)
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fees taken in any Court or tribunal established under any law for the time being in force.
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Explanation 1.— For the removal of doubts, it is hereby declared that nothing contained in this clause shall apply to,—
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(A)
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the functions performed by the Members of Parliament, Members of State Legislative, Members of Panchayats, Members of Municipalities and Members of other local authorities who receive any consideration in performing the functions of that office as such member; or
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(B)
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the duties performed by any person who holds any post in pursuance of the provisions of the Constitution in that capacity; or
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(C)
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the duties performed by any person as a Chairperson or a Member or a Director in a body established by the Central Government or State Governments or local authority and who is not deemed as an employee before the commencement of this section.
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Explanation 2.— For the purposes of this clause, transaction in money shall not include any activity relating to the use of money or its 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.
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Explanation 3.— For the purposes of this Chapter,—
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(a)
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an unincorporated association or a body of persons, as the case may be, and a member thereof shall be treated as distinct persons;
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(b)
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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.
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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”
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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:
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(i)
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an individual,
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(ii)
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a Hindu undivided family,
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(iii)
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a company,
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(iv)
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a society,
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(v)
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a limited liability partnership,
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(vi)
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a firm,
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(vii)
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an association of persons or body of individuals, whether incorporated or not,
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(viii)
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Government,
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(ix)
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a local authority, or
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(x)
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every artificial juridical person, not falling within any of the preceding sub-clauses
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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.
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