Synopsis
To consider the applicability of
Service Tax on remuneration paid to partner, the authors have analysed
the definition of ‘Service’ defined in Section 65B (44) of Finance Act
2012 alongwith various provisions of Partnership Law, Income Tax law and
considered the various judicial precedents. The authors have also
referred to the relevant case laws on the subject and concluded that
services provided by partners to the firm and remuneration received
thereof from the firm cannot be subjected to Service Tax.
Preliminary
Partnership
continues to be one of the more prominent forms in which businesses are
carried out in the country. Further, it is a very common practice that,
partners are paid salary (either on a fixed basis monthly/annually or
on a basis which is linked to profits earned by the firm). Further,
under the income tax law, salary paid to partners is allowed as
deduction subject to certain specified limits.
The scope of
service tax has been substantially expanded, post introduction of
Negative List based Taxation of Services with effect from 01-07-2012.
The taxability of salary paid by the firm in the hands of partners under
service tax has been a matter of extensive deliberation since
01-07-2012. An attempt is made hereafter to discuss this issue,
considering the provisions of partnership law & income tax law, in
addition to the provisions of service tax law effective 01-07-2012.
Relevant Statutory Provisions
Extracts from Finance Act, 1994 – as amended (FA 12) effective 01/07/2012.
(A) Section 65 B (44) of FA 12
‘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)
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
iii) 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 2
– For the purpose 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.
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;
(B) Section 65B (37) of FA 12
“Person includes –
(i) an individual, juridical
(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,
(x) every artificial juridical person, not falling within any of the preceding sub – Clauses
(C) Charge of Service tax – Section 66 B of FA 12
There
shall be levied a tax (hereinafter referred to as the service tax) at
the rate of twelve per cent 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.
Relevant extracts from TRU Circular dated 20/6/12 – “Taxation of Services – An Education Guide” issued by CBEC
Guidance Note 2 – What is Service?
‘Service’ has been defined in clause (44) of the new section 65B and means –
• any activity
• for consideration
• carried out by a person for another
• and includes a declared service.
The said definition further provides that ‘service’ does not include –
•
any activity that constitutes only a transfer in title of (i) goods or
(ii) immovable property by way of sale, gift or in any other manner
•
(iii) a transfer, delivery or supply of goods which is deemed to be a
sale of goods within the meaning of Clause (29A) of article 366 of the
Constitution
• a transaction only in (iv) money or (v) actionable claim
• a service provided by an employee to an employer in the course of the employment.
• fees payable to a Court or a Tribunal set up under a law for the time being in force
………….
Activity
What does the word ‘activity’ signify?
‘Activity’
is not defined in the Act. In terms of the common understanding of the
word activity would include an act done, a work done, a deed done, an
operation carried out, execution of an act, provision of a facility etc.
It is a term with very wide connotation.
Activity could be
active or passive and would also include forbearance to act. Agreeing to
an obligation to refrain from an act or to tolerate an act or a
situation has been specifically listed as a declared service u/s. 66E of
the Act.
………………….
Activity for a consideration
The
concept ‘activity for a consideration’ involves an element of
contractual relationship wherein the person doing an activity does so at
the desire of the person for whom the activity is done in exchange for a
consideration. An activity done without such a relationship i.e.
without the express or implied contractual reciprocity of a
consideration would not be an “activity for consideration” even though
such an activity may lead to accrual of gains to the person carrying out
the activity.
Thus, an award received in consideration for
contribution over a life time or even a singular achievement carried out
independently or without reciprocity to the amount to be received will
not comprise an activity for consideration.
There can be many
activities without consideration. An artist performing on a street does
an activity without consideration even though passersby may drop some
coins in his bowl kept after feeling either rejoiced or merely out of
compassion. They are, however, under no obligation to pay any amount for
listening to him nor have they engaged him for his services. On the
other hand, if the same person is called to perform on payment of an
amount of money then the performance becomes an activity for a
consideration
Provision of free tourism information, access to
free channels on TV and a large number of governmental activities for
citizens are some of the examples of activities without consideration.
Similarly,
there could be cases of payments without an activity though they cannot
be put in words as being ‘onsideration without an activity’
Consideration itself presupposes a certain level of reciprocity. Thus
grant of pocket money, a gift or reward (which has not been given in
terms of reciprocity), amount paid as alimony for divorce would be
examples in this category.
However, a reward given for an activity performed explicitly on the understanding that the winner will receive the specified amount in reciprocity for a service to be rendered by the winner would be a consideration for such service. Thus, amount paid in cases where people at large are invited to contribute to open software development (e.g. Linux) and getting an amount if their contribution is finally accepted will be examples of activities for consideration.
By a person for another
What is the significance of the phrase ‘carried out by a person for another’?
The phrase ‘provided by one person to another’ signifies that 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.
Are there any exceptions wherein services provided by a person to oneself are taxable?
Yes. Two exceptions have been carved out to the general rule that only services provided by a person to another are taxable. These exceptions, contained in Explanation 3 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 presently in section 66A (2)]
- an unincorporated association or body of per- sons and members thereof, are also treated as distinct persons. [Also exists presently in part as explanation to section 65].
Implications of these deeming provisions are that inter-se provision of services between such persons, deemed to be separate persons, would be taxable. For example, services provided by a club to its members and services provided by the branch office of a multinational company to the headquarters of the multinational company located outside India would be taxable provided other conditions relating to taxability of service are satisfied.
a)Brief analysis of provisions of the Indian Partnership Act, 1932
Some relevant provisions are as under:
- the ‘partnership’ is the relation between persons who have agreed to share the profits of a business carried on by all or 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’s name.” [section 4].
- a partner is not entitled to receive remuneration for taking part in the conduct of business of the firm subject to a contract between the partners. [section 13(a)]
a partner is the agent of the firm for the purposes of business of the firm. [section 18]
- any act of the partner which is done to carry on, in the usual way, business of the kind carried on by the firm, binds the firm. [section 19]
- every partner is liable, jointly with all the other partners and also severally, for all the acts of the firm done while he is a partner. [section 25]
b) Some judicial considerations
- under partnership law, a partnership firm is not a legal entity, but only consists of the individual partners for the time being. It is not a distinct legal entity apart from the partners constituting it and equally, in law, the firm, as such, has no separate rights of its own in the partnership assets. When one talks of the firm’s property or the firm’s assets, all that is meant is property or assets in which all partners have a joint or common interest. [Malabar Fisheries Co. vs. CIT [1979] 120 ITR 49 (SC); in CIT vs. Dalmia Magnesite Corpn. [1999] 236 ITR 46 (SC).]
- a partnership concern is not a legal entity like a company. It is a group of individual partners [Comptroller & Auditor General vs. Kamlesh Vadilal Mehta [2003] 126 Taxman 619 (SC – 3 Member Bench).]
- 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. A partnership firm cannot enter into partnership with another partnership firm. HUF or individual [Dulichand Laxminarayan vs. CIT (1936) 29 ITR 535 (SC – 3 member Bench); Mahabir Cold Storage vs. CIT [1991] 188 ITR 91 (SC).]
- a partnership is not a legal entity. Partners are the real owners of assets of the partnership firm. Firm is only a compendious name given to partnership for the sake of convenience. Each partner is owner of assets to the extent of his partnership [N. Khadervali Saheb vs. N. Gudu Sahib [2003] 129 Taxman 597 (SC – 3 Member Bench).]
c) Other important & relevant Judicial Views
- The Honorable Supreme Court in the case of Champaran Cane Concern vs. State of Bihar [1964] 2 SCR 921, has pointed out that in a partnership each partner acts as an agent of the other. The position of a partner qua the firm is, thus, not that of a master and a servant or an employer and an 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 gives but that would not involve any change of status and bring him within the definition of an employee.
- The Honorable Supreme Court in the case of CIT vs. R. M. Chidambaram Pillai [1977] 106 ITR 292 has held as under :
“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 ex- pression to designate an entity, not a person. 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. This telling test is that where a firm suffers loss, that 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.”
“…The matter may be looked at another way too. 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 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 receive 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.”
- The Honorable Supreme Court in the case of Regional Director, Employees State Insurance Corpn. vs. Ramanuja Match Industries [1985] 1 SCC 218 while dealing with the question, wheth- er 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.
Brief analysis of provisions under income tax law
Under the Income-tax Act, 1961, some relevant provisions which need to be noted, are as under:
- A partnership firm (registered or unregistered) is taxed as a separate entity. Share of income of the partner in income of the firm is not included in computing total income of the partner (as it has already been taxed in the hands of partnership firm).
- In addition to share of income of the firm, working partners can draw salary commission or remuneration from the partnership firm as per provisions of section 184, read with section 40(b). This is allowed as deduction from income of the firm (subject to certain limits) and is treated as an income of the partner for income-tax purposes.
- According to section 2(23), a firm, partner and partnership have the same meaning as in the Partnership Act, 1932.
- Explanation 2 to section 15 specifically 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 be regarded as ‘salary’.
- Section 28(V) specifically states that any interest, salary, bonus, commission or remuneration, by whatever name called, due to or received by a partner of a firm from such firm shall be treated as income chargeable to tax under the head ‘Profits and Gains of Business or Profession.’
- Provisions of TDS (Section 192) are not applicable to salary paid by the firm to its partners.
Partnership is a “person” by legal fiction for taxation
Though partnership is not a legal person, yet a firm has been defined as a ‘person’ u/s. 2(31) of the Income-tax Act, 1961 and section 65B(37) of FA 12 effective 01-07-2012, by creating a legal fiction. Hence, once a legal fiction is created by law, it has to be taken to its logical end. Accordingly, partnership firm and the partners have to be ‘deemed’ as two different persons and a partner should be deemed to be employee of the partnership firm.
Conclusion
Based on the foregoing, the following proposi- tions emerge :
- there is a specific exclusion in the definition of ‘service’ for services provided by an employee to an employer in course of or in relation to his employment. However, there is no relationship of an employee and an employer between the partners and the partnership firm;
- any agreement for remuneration of a partner for taking part in the conduct of the business is nothing but an additional share of profit remuneration is a different label for profits, in the context of a partner’s remuneration paid by firm to its partners. For services rendered by the partners, to the firm, would have oth- erwise got additional share of profit instead of remuneration.
- the partners act as agents of their firm and render the services to themselves,
- the partnership business belongs to the partners and each of them is an owner thereof, and, hence, the services are rendered by partners to themselves.
Based on the above, it can be reasonably concluded that, since the services are rendered by the partners to themselves and not by one person to another and since services provided by partners to the firm is not covered by the two specific exceptions in Explanation 3 to section 65 B(44) of FA 12, services provided by the partners to the firm would not constitute “any activity carried out by a person for another” in terms of the definition of ‘service’ u/s. 65B(44) of FA 12, Hence, service tax would not be applicable to remuneration received by a partner from the partnership firm. Alterna- tively, by deeming fiction if a partner is treated as a different ‘person’ under tax laws overriding the provisions of the partnership law, then a partner would be deemed to be an employee of the firm. If that be the case, services provided by partners to the Partnership firm would be excluded from the definition of ‘service’ in terms of clause (b) of section 65 B(44) of FA 12. Hence, the question of any liability to service tax, on remuneration received by partners from the partnership firm, would not survive.
