Partnership Firms (Firms) along with Association of Persons (A0Ps) and Body of Individuals (B0Is) constitute one of the major businesses apart from the corporate sector in India. Firms are governed by India Partnership Act, 1932. The Income Tax Act, 1961 (Act) provides various exemptions and deductions to the Firms. Income Tax Department (ITD) has the responsibility to oversee that the conditions specified in provisions of the Act for availing exemptions/ deductions are fulfilled. The main objective of the present review is to seek an assurance that system and procedures of the ITD are sufficient relating to provisions of the Firms vis-a-vis existence of proper machinery within the ITD to exercise necessary checks/controls in the area of potential misuse of the provisions of the Act.
The returned income of the Firmsl has increased from 36,942 crore in Assessment Year (AY) 09 to 51,482 crore in AY 12. Firms pay income tax at the rate of 30.90 percent2, however, effective tax rate in their case is only 23.80 percent3 as number of tax concessions are given to Firm assessees. This necessitates examination of the veracity of exemptions/ deductions allowed to the partnership Firms vis-à-vis the claims made by the Firms.
We requisitioned 27,944 assessment records relating to Firms, out of which ITD produced and we audited 26,328 records. We have highlighted 1,497 cases involving a tax effect of 328.04 crore relating to systemic, compliance and control issues in assessment.
We have pointed out inconsistencies and lack of clarity in the Act which has resulted in incorrect assessments and short levy of taxes. Besides, we have highlighted lapses in allowance of exemptions/ deductions to the Firms and inadmissible remuneration/interest to their Partners. We have also brought out compliance and internal control issues of ITD indicating deficiencies in quality of assessments and internal control mechanism.
We noticed in 937 cases having a tax effect of 16.95 crore wherein Assessing Officers (AOs) did not cross verify/co-relate the return of income of the Partners with that of the respective assessee Firms. AOs allowed deductions to the Firms for salary and interest without submission/ verification/ certification of the partnership deed. We also noticed that the Partners of the Firms claimed excess exemption under section 10(2A) of the Act and no interest was charged on the withdrawals/debit balances in the Partners’ capital account (paragraphs 2.3 – 2.8)
We further noticed in 227 cases having a tax effect of RS. 65.72 crore wherein ITD had allowed (a) expenditure on remuneration paid for a period prior to the date of the deed, (b) expenditure on remuneration paid to the Partners who were not actively engaged in the affairs of the Firm and (c) expenditure on remuneration which was not authorized or paid in excess of the amount specified in the partnership deed. ITD also allowed deduction for expenditure on payment of interest to the Partners (a) which was more than the rate prescribed/authorised in the partnership deed, (b) where the rate prescribed in the partnership deed was exceeding the limits provided under the Act and (c) which was not authorized in the deed. ITD allowed book profit for the purpose of remuneration without excluding capital gain, interest income and income from other sources with the profits shown in the Profit & Loss Account. We also observed that the Firms were availing more exemptions/deduction by inflating profits through non-payment of remuneration/interest to their Partners and ITD allowed carry forward/set-off of losses pertaining to the retired/deceased Partner to the subsequent year (paragraphs 3.2 – 3.9).
We noticed 287 cases with a tax effect of RS. 244.57 crore, where the provisions of the Act were not followed during the assessments (paragraphs 4.2 – 4.8).
With respect to internal audit, we noticed that the Commissioners of Income Tax did not carry out inspections/ reviews of assessment orders. ITD did not give importance to their internal audit as it was neither conducted nor did it cover the Firms assessment records. ITD did not effectively utilize the information available in the Tax Audit Reports and maintain updated registers required for effective control of various functions.
With the view to streamline the assessment of Firms in India, we have made recommendations relating to systemic issues, inconsistencies in the Act and internal control by the ITD which are placed under ‘Summary of Recommendations’ and at the end of each Chapter.
Summary of Recommendations
With reference to systemic issues relating to Firms and their Partners
With reference to special provisions of exemption/deduction to the Firms
With reference to Assessment of Firms
With reference to Internal Control
Source- Report of the Comptroller and Auditor General of India for the year ended March 2013- Performance Audit on Assessment of Firms – Union Government, Department of Revenue-Direct Taxes- Report No. 7 of 2014