The phrase ‘remunerations’ includes any salary, commission, bonus, or remuneration (by whatever name called) that is paid to partners. The partners who actively contribute to the operations of the Partnership are eligible to get remuneration. Much like an employee, these partners receive rewards for their work monthly.

We expect a return wherever we put our efforts. The business is build up with an objective of returns and this is considered the ultimate goal of any businessman. And about Partnership, Partnership Firm is registered with the primary objective of profit.

This article will try to give you an insight regarding the financial returns and remunerations paid to partners in a partnership firm.

Partner’s role in the firm is not limited to investment. Some of them stay connected with the business full-time. And others contribute by lending their goodwill or skills for the business. Rewards vary in terms of investment. And the biggest efforts are rewarded with maximum returns. However, the partners are required to balance the payment terms on a subjective basis for all.

Terms like these are incorporated in the remuneration clause itself during Partnership Registration. But before finalizing the terms, you are required to understand all aspects of financial returns to partners. This is useful in making a well-informed decision besides tax planning.

The financial returns to partners of the Partnership Firms are categorized into three heads given below:

  1. Remuneration
  2. Share of Profit
  3. Interest on Capital Introduced

Check Your Eligibility For Remuneration

The eligibility for remunerations paid to partners is particularly dealt with by and is subjected to the remuneration clause in Partnership Deed. it does not matter if you are working or not, if you are an active or sleeping partner, you will be rewarded with the remuneration if the partnership deed has allowed doing so. In the end, it is the mutual understanding of partners to put in a partnership deed. The nature of reward suggests offering remuneration to active partners, so does the Income Tax Law. It further provides a maximum limit for remunerations paid to partners in a partnership firm.

Amount Deductible Under Income Tax Act 

  • The remuneration is permitted as a deduction from profit when it is paid to an individual working partner. Here, the deduction is referred to as the deduction of expense from the profit of the firm.
  • A partnership deed should authorize paying remuneration to the working partners.
  • IT Act further mentions the maximum permitted amount, as mentioned below. Any amount that is paid more than this limit is not a permitted deduction.

When in loss- Rs. 1,50,000 is the maximum deductible amount.

Book profit up to 3 lakh- 90% of Book Profit or Rs. 1,50,000; whichever is more is the maximum deductible amount.

Book Profit of more than 3 lakh- 60% of Book Profit is the maximum deductible amount

It is crucial to note here that limit does not apply to the individual partner but to all partners. This simply means that the maximum amount calculated above is the total payable to all partners.

Taxability in the hands of Partners

Remuneration is taxable in hands of partners as Business Income. However, it should be noted that remuneration income is different from the share of profit.

Provisions related to Interest & Remunerations Paid to Partners under Section 40(b) of the Income Tax Act, 1961

Section 40(b) of the Income Tax Act places certain constraints and conditions on the deductions of expenses available to an assessed assessable as a partnership firm in relation to the remuneration and interest payable to the partners of such firm. The deductions related to salary to partners and any payment of interest to partners cannot exceed the monetary limits mentioned under section 40(b) and are available subject to the fulfillment of conditions specified therein.

The conditions listed below should be satisfied before claiming any deduction related to salary/ remuneration or interest payable to a partner by a partnership firm.

  • Remuneration must be paid only to the working partners

According to Section 40(b), a working partner is one who is actively engaged in the affairs of the business or profession of the firm in which he is a partner. For being a working partner, he/ she has to be actively engaged in the affairs of the firm. A partner is said to be actively engaged in the affairs of the firm when he devotes even if a part and not the entirety of his working hours.

Another crucial point to observe here is that the definition of “working partner” in Explanation 4 contemplates an individual. Hence, a partner other than an individual (for instance a company) cannot be a working partner.

In cases where a company is a partner in a particular firm, a director or shareholder of the concerned company can very well be an employee of the firm in which the company is a partner. Any remuneration/ salary that is paid by the firm to such an employee would be completely outside the ambit of disallowance under section 40(b). This is because the individual who is an employee of the firm is not a partner in the concerned firm.

  • Authorization by the Partnership Deed

any payment of remuneration, salary, commission, or bonus by whatever name called to a working partner is not permitted as a deduction, in case the payment is not authorized by partnership deed or it is not by the terms of partnership deed. The partnership deed should be carrying clear instructions as to the quantum of remuneration to be paid to the working partners.

  • Should not be about a period before Partnership Deed

The remuneration that is paid to the working partners will be permitted as a deduction to the firm from the date of the specified partnership deed and not from any period before it.

As a result, in case a firm incorporates the clause regarding payment of remuneration to the working partners by executing an appropriate deed as on July 1st, however effective from April 1st, the firm would receive a deduction for the remuneration paid to its working partners from July 1st onwards however not for the period from April 1st to June 30th.

  • Must not exceed the permissible limit

The maximum amount of remuneration, salary, commission, or bonus to all the partners during the previous year must not exceed the limits listed below:

On the initial 3 lakhs of book profit or in case of incurring a loss- Rs. 1,50,000 or 90% of book profits (whichever is higher).

On the balance book profit 60% of book profit.

Calculation of Book Profit

Books profit means the net profit as depicted in the profit and loss account which is calculated according to the manner laid down in chapter IV-D as increased by the amount of remuneration paid to concerned partners which are permitted as a deduction in the profit and loss account. Book profit is calculated in the ways mentioned below:

  1. Deduct interest in case it is not deducted.
  2. Net profit as per profit and loss account.
  3. Add remuneration if already debited.
  4. Make adjustments for expenses as per section 28 to 44D.

Calculation of Partnership Profit And Loss Sharing

The ratio of sharing the profit and loss is mutually decided by the partners. Factors considered by partners include “Capital contribution, Good of partners, etc.”  If the partners have not decided nay ratio, then the profit earned is shared equally among them. Partners can also transfer their profit instead of sharing equally.

Income tax applicable on partner’s profit share

According to section 10(2A) of the income tax act, the profit share received by partners is 100% exempt. This is done because the partnership firm had already paid the income tax on profit of the firm. Thus, the partners are exempt from it.

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