PARTNER'S REMUNERATION WHETHER TAXABLE UNDER SERVICE TAX

[Dr. Sanjiv Agarwal]

New Meaning of Service

In the negative list approach of service tax, all services, other than services specified in the negative list, provided or agreed to be provided in the taxable territory by a person to another would be taxed under section 66B. Service' has been defined in clause (44) of the new section 65B and means and includes -

• any activity
• for consideration
• carried out by a person for another
• and includes a declared service.

But does not include

• transfer in title of goods or immovable property
• transaction in money or actionable claim
• provisions of service by employee to employer
• deemed sale of goods
  • duties performed by MP/MLA/Members of Municipal Corporation, Panchayats or Local authorities person holding constitutional posts.

Two Persons Must

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.

As service is an activity involving two persons- one as service provider and other as service receiver, explanation 2 to the definition clarifies that any unincorporated association or body or persons and its members, both will be treated as distinct persons. Thus, if a person who is member of body of persons or association which is not incorporated or registered, provides service to such body or association, it will be considered as a service. This will not apply in case of registered associations such as firm, company, limited liability partnership etc.

Exclusion of Partners

As per section 4 of the Indian Partnership Act, 1932, 'partnership' 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. Agreement share of profit and mutual agency are core aspects of a partnership firm.

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. It cannot, therefore, be said that upon dissolution the firm's rights in the partnership assets are extinguished. Consequences of the distribution, division or allotment of assets to partners which flow from dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between partners. It does not amount to transfer of assets involved on dissolution.-Malabar Fisheries Co. v. CIT 1979 (9) TMI 1 - SUPREME Court [reiterated in CIT v. Dalmia Magnesite Corporation 1997 (3) TMI 13 - SUPREME Court .

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 v. N. Gudu Sahib 2003 (2) TMI 63 - SUPREME Court.

Partner is not an employee of the firm. In CIT v. R M Chidambaram Pillai 1976 (11) TMI 2 - SUPREME Court, 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. In Income-tax law, a firm is a unit of assessment, by special provisions, but is not a full person. Salary paid to partner is only profit known by a different name. In strict law, there cannot be a contract of service between a firm and one of its partners, since contract of employment requires two distinct persons, viz., employer and employee. A man cannot be his own employer.

In Regional Director, Employees State Insurance Corporation v. Ramanuja Match Industries 1984 (11) TMI 316 - SUPREME COURT , it was held that a partner is not an 'employee' of the company. - [Also see Prakash D. Shah v. UOI 2003 (9) TMI 708 - BOMBAY HIGH COURT .

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."

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.

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. Also, in this judgment the following observations of Lord Justice Mathew in Ellis v. Joseph Ellis & Co. [1905] 1 KB 324 (CA) were referred to with approval:

Salary to partner is only share of profit. In RM. Chidambaram Pillai (supra), it was held that a firm is not a 'legal person', though it has some attributes of a personality. In Income-tax law, a firm is a unit of assessment, by special provisions, but is not a full person. Salary paid to partner is only profit known by a different name. Thus, salary to partner is may be considered as only share of profit under a different name. It is only a transaction in money and, hence, not covered under 'service tax' provisions, as mere transaction in money is not 'service' as per section 65B(44)(a)(ii)of the Act.

The remuneration paid to partners is nothing but it is basically a part of profit which is given only for extra human efforts. Remuneration is given to working partners only and not to dormant partners because they provide their services to the business and in return they receive extra profit in form of remuneration. Thus, it cannot be said that the remuneration given to partners, is salary. It may be considered a case of different form of distribution of profit. It is also a transaction in money and, hence may not be covered under the definition of services, because the definition of service u/s 65B (44) clearly excludes the transaction in money from the scope of service.