Question 5
Firm of architects and its partners: professional income, remuneration and interest within section 40(b), and each partner's taxable income (as set, 1961 Act, AY 2021-22)
13.75 marks
- Time to write
- About 28 minutes
From an older CBCS paper
Question
Question 5 · 13.75 marksAshima (age 33 years) and Saniya (age 31 years) both are resident individuals and equal partners in Seeya & Associates (a firm of Architects). The firm's Profit and Loss account for the year ended 31.3.2021 is as given below:
Dr. Profit and Loss A/c for the year ended 31.3.2021 Cr.
| Particulars | Amount (Rs.) | Particulars | Amount (Rs.) |
|---|---|---|---|
| To Household expenses | 22,400 | By Receipts from clients | 9,54,000 |
| To Bad debts | 1,200 | By Commission | 50,000 |
| To Provision for bad debts | 9,600 | By Sundry receipts | 1,16,000 |
| To Fire insurance | 2,000 | By Bad debts recovered (earlier allowed as deduction) | 14,000 |
| To Salary to Staff | 66,000 | By Interest on Govt. securities | 1,34,000 |
| To Salary to Ashima | 2,50,000 | ||
| To Salary to Saniya | 2,50,000 | ||
| To Loss of cash by an employee through embezzlement | 14,000 | ||
| To Interest on loan taken to pay income tax | 12,000 | ||
| To Interest on capital to Ashima @ 25 % | 1,25,000 | ||
| To Interest on capital to Saniya @ 25 % | 1,25,000 | ||
| To Depreciation on building and furniture | 27,200 | ||
| To Advertisement Revenue expenses | 9,600 | ||
| To General expenses | 9,400 | ||
| To Net profit (Rs.) | 3,44,600 | ||
| 12,68,000 | 12,68,000 |
Other information is as follows: i) The general expenses include personal expenses amounting to Rs. 1,700. ii) Business income of Rs. 9,000, which accrued during the previous year ending 31.3.2021, has not been recorded in the Profit and loss A/c. iii) Ashima contributes a sum of Rs. 1,40,000 towards a public provident fund in her own name. iv) Depreciation on the building and furniture comes to Rs. 30,000 as per the tax provisions. v) Salary to staff includes a payment of Rs. 12,000 made out of India, on which tax has neither been deducted at source nor paid to the government. vi) The firm Seeya & Associates does not wish to opt for the scheme of presumptive taxation u/s 44ADA. vii) Conditions of Section 184 and 40(b) stand satisfied. viii) Personal income and the investments of partners: • Interest from a savings account opened at the post office in the joint names of both Ashima and Saniya: Rs. 70,000 for each partner. • Saniya received a gift of an Apple Series 7 Smart watch, which is worth Rs. 80,000, from a friend. • Dividend from an Indian Company: Rs. 4,80,000 each. For the assessment year 2021-22, determine the taxable income of the firm and of the partners. The partners are not opting for the new tax regime under section 115BAC.
Paper note: The as-set version: set and answered under the Income-tax Act, 1961 for assessment year 2021-22 (previous year 2020-21), with the dates as printed. The account is printed as two sides; it is shown here as one four-column table, each row holding the left-hand item and, where there is one, the right-hand item. "To" and "By" were put before the items as connecting words, and "(Rs.)" after "Net profit"; both sides total 12,68,000 as printed. Ashima and Saniya are resident individuals; the question gives no residential status history.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- taxable incomeHead by head: each income under its head, exempt items marked exempt, then the deductions and the tax.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Adjustments to the net profit 4½ marks 8 min
- 2 Interest on capital and the remuneration limit 2.2 marks 4 min
- 3 Taxable income of the firm 1½ marks 3 min
- 4 Partners' income from the firm 1½ marks 3 min
- 5 Partners' other income: interest, dividend and the gift 2½ marks 4 min
- 6 Deductions and taxable income of the partners 1½ marks 2 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 28 minutes for 13.75 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
- Status. The firm meets sections 184 and 40(b), so it is assessed as a firm; it computes its income in the normal way, not under the presumptive scheme for professions. The partners' share of profit is exempt in their hands (section 10(2A)). Both partners are working partners and do not opt for section 115BAC. The option counts only if exercised in the prescribed manner: with the section 139(1) return by a person with no business or professional income, or on or before the section 139(1) due date by one who has such income (section 115BAC(5)).
- Capital. Interest at 25% of ₹1,25,000 means a capital of ₹5,00,000 each; interest is allowed only up to 12% simple interest (section 40(b)(iv)), ₹60,000 each.
- Post office savings interest in joint names: the limit goes with the account. CBDT Notification No. 32/2011 (S.O. 1296(E), under section 10(15)(i)) exempts up to ₹7,000 where the account is a joint one, so this one account's ₹7,000 is shared equally, ₹3,500 each; the rest of each partner's ₹70,000 is taxable.
- Dividends received on or after 1 April 2020 are taxable in the shareholder's hands (Finance Act, 2020, section 7 (clause (e), a further proviso to section 10(34): no exemption for a dividend received on or after 1 April 2020 other than one on which tax under section 115-O has been paid) and section 59 (section 115-O confined to dividends declared, distributed or paid on or before 31 March 2020)).
Profits and gains of the profession
| Particulars | Rs. | Rs. |
|---|---|---|
| Net profit as per the profit and loss account | 3,44,600 | |
| Add: household expenses (personal, not for the profession) | 22,400 | |
| Add: provision for bad debts (only a debt actually written off is allowed, section 36(1)(vii)) | 9,600 | |
| Add: salary to partners (considered below) | 5,00,000 | |
| Add: interest on a loan taken to pay income tax | 12,000 | |
| Add: interest on capital above 12% (₹65,000 × 2) | 1,30,000 | |
| Add: depreciation charged in the books | 27,200 | |
| Add: personal expenses within general expenses | 1,700 | |
| Add: salary paid outside India without tax deducted (section 40(a)(iii)) | 12,000 | |
| Add: professional income accrued but not recorded | 9,000 | 7,23,900 |
| 10,68,500 | ||
| Less: depreciation under the tax provisions (section 32) | 30,000 | |
| Less: interest on Government securities (income from other sources) | 1,34,000 | 1,64,000 |
| Book profit | 9,04,500 | |
| Less: salary to partners allowed (below) | 5,00,000 | |
| Profits and gains of the profession | 4,04,500 |
- Interest on the loan to pay income tax: income tax is not deductible (section 40(a)(ii)), and money borrowed to pay it is not capital borrowed for the profession, so its interest is not allowed under section 36(1)(iii).
- Loss of cash by an employee's embezzlement (₹14,000): a loss incidental to carrying on the profession, allowed as it stands in the account.
- Bad debts recovered (₹14,000): they were allowed earlier, so the recovery is income (section 41(4)); it is already credited, so no change.
- Bad debts written off (₹1,200), fire insurance, staff salary (other than the ₹12,000), advertisement and the rest of the general expenses are allowed.
- Unrecorded income of ₹9,000 accrued in the year, so it is added; the firm follows the accrual basis.
- Commission and sundry receipts are receipts of the profession and stay in the profit.
Partners' remuneration within section 40(b)
| Book profit | Limit | Rs. |
|---|---|---|
| First ₹3,00,000 | ₹1,50,000 or 90% of ₹3,00,000, whichever is more | 2,70,000 |
| Balance ₹6,04,500 | 60% | 3,62,700 |
| Limit | 6,32,700 |
Salary paid, ₹2,50,000 × 2 = ₹5,00,000, is within the limit and allowed in full (section 40(b)(v)).
| Particulars | Rs. |
|---|---|
| Profits and gains of business or profession | 4,04,500 |
| Income from other sources: interest on Government securities | 1,34,000 |
| Gross total income = taxable income of the firm | 5,38,500 |
Taxable income of the partners
Salary and interest received from the firm are income under the head Profits and gains of business or profession, to the extent allowed to the firm (section 28(v)).
| Particulars | Ashima (Rs.) | Saniya (Rs.) |
|---|---|---|
| Salary from the firm | 2,50,000 | 2,50,000 |
| Interest on capital at 12% | 60,000 | 60,000 |
| Profits and gains of business or profession | 3,10,000 | 3,10,000 |
| Post office savings interest (70,000 − 3,500) | 66,500 | 66,500 |
| Dividend from an Indian company | 4,80,000 | 4,80,000 |
| Gross total income | 8,56,500 | 8,56,500 |
| Less: section 80C, public provident fund | 1,40,000 | Nil |
| Less: section 80TTA, savings interest (limit ₹10,000; a post office savings account of the partners, not of the firm, section 80TTA(1)-(2)) | 10,000 | 10,000 |
| Taxable income | 7,06,500 | 8,46,500 |
- Share of profit from the firm: exempt (section 10(2A)).
- Saniya's smart watch (₹80,000) from a friend: a watch is not property for section 56(2)(x): the Explanation to section 56(2)(vii) lists immovable property, shares and securities, jewellery, archaeological collections, drawings, paintings, sculptures, works of art and bullion, and a smart watch is none of these. Not taxable.
- Ashima's public provident fund deposit (₹1,40,000): within the limit of ₹1,50,000 (section 80C(2)(v)).
Where the 13.75 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Adjustments to the net profit | 4.5 |
| 2 | Interest on capital and the remuneration limit | 2.25 |
| 3 | Taxable income of the firm | 1.5 |
| 4 | Partners' income from the firm | 1.5 |
| 5 | Partners' other income: interest, dividend and the gift | 2.5 |
| 6 | Deductions and taxable income of the partners | 1.5 |
| Total | 13.75 |
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