budget: Tax on partnership firms: Budget change to put real estate, infrastructure consultancy firms in a fix
Many companies would form a partnership firm and buy assets such as land parcels through the partnership vehicle.
After these assets appreciated, they would bring in a new partner and old partners would exit or retire from the partnership after taking back their ‘appreciated capital’.
Most real estate developers and infrastructure firms have used this trick to buy land or buildings, say tax experts.
The government in the Budget said that such manoeuvring would now attract 20% tax beginning April last year.
All the deals that were carried on in such a manner will now have to pay tax even if the deals are concluded before the Budget announcement.
“Many investors and even real estate companies were forming a partnership firm and buying land parcels, when they wished to sell it, they would just bring in a new partner and the old partners would exit with a higher capital. Such manoeuvres would now attract 23% tax and this can also impact partnership models,” said Girish Vanvari, founder of tax advisory firm Transaction Square.
Tax experts say some of the companies in entirely different businesses such as retail or even manufacturing were using such structures as well to lower tax cost.
“The government has tried to curb the tax evasion practices adopted in the past where certain asset heavy entities passed on / transferred the said assets or money to the retiring partners / members with no or negligible tax incidence both in the hands of the entity and the partner / member by adopting the means of an inflated Cost of acquisition through revaluations etc. However, the proposed amendments would result in some open points and also its interplay with other specific provisions such as a case of conversion of capital asset into stock in trade and then its distribution, need to be thrououghly examined before arriving at any conclusion,” said Rahul Garg, partner, Asire Consulting.
A partnership structure essentially involves several individuals bringing in capital to start a business and the profits are then distributed as per the arrangement and the capital brought in.
Often consultancy firms and law firms have the cleanest of partnership structures.
When a partner wants to exit or retire, he could take his portion of the capital, which in most cases would have appreciated over the years.
This also comes around the time when the partnership structures were already under the tax department’s scrutiny following a court ruling.
The Madras High Court in a recent judgment said that the benefits of the presumptive scheme are available only to certain individuals engaged in certain businesses. “Interest and salary received by assessee (tax payers) not carrying on business independently but only as a partner in a firm could not be construed as business income and therefore not eligible for applying the presumptive interest rate of 8%,” the court ruled.
Industry trackers say several structures including sole partnership, joint venture, or an LLP were being explored while computing taxation under the presumptive taxation. The tax regulations have other conditions too including the size of the partnership firm to determine which firms can and cannot be eligible to offer their income on presumptive basis, say tax experts.