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A partnership firm is set up with the goal of making a profit. A person can be a working partner in a partnership firm who has invested as well as manages the operations of the firm. Otherwise, a silent partner who has invested in the firm but does not involve in its operations. Partners are rewarded based on the efforts put in. The payment terms are subjective and are mentioned in the remuneration clause of the partnership deed.
Remuneration is the salary, bonus, or commission paid to a person; in this case, a partner’s remuneration is the salary, bonus, or commission paid to a partner by a partnership firm. Like any other employee, partners get paid every month for their work. The financial returns to partners consist of the following components:
Partners who actively participate in the operations of the firm are eligible for remuneration on a monthly basis. Depending on the remuneration clause mentioned in the Partnership Deed, even sleeping partners can get remuneration.
The Partnership Deed will be designed based on the mutual understanding of the partners. However, the rewards provided must comply with the maximum limit specified for partnership firms under the Income Tax Act.
In the case of an individual working partner, the remuneration payable is considered as an expense deducted from the profit made by the firm. Further, the Partnership Deed must include a clause agreeing to the payment of remuneration to working partners. The maximum remuneration allowed for deduction under the Income Tax Act are summarised below.
|On the first Rs.3,00,000 of the book-profit or loss||Rs.1,50,000 or 90% of the book-profit, whichever is higher|
|On the remaining balance of book-profit||60% of the book-profit|
Note: The maximum limit specified in the above table is not for an individual partner but represents the aggregate limit covering the remuneration of all partners.
The remuneration received by partners is taxable under ‘Business Income’ head. You must know that the share of profit is different from this remuneration.
Partners who have invested capital to the firm, in cash or any other mode, must be paid with interest on their investment. Non-cash capital will be evaluated in monetary terms too. The rate of interest is usually prescribed in the Partnership Deed; it is not mandatory. Prescribing the rate will eliminate ambiguity and disputes on the matter.
On the other hand, the rate can be changed by the partners at any time. Only the partners who have invested capital to the company can receive the interest.
A maximum of 12% p.a is allowed as interest under the Income Tax Act. Any interest exceeding this threshold is disallowed to be considered as a deduction from the firm’s business income. Such income is taxable under the ‘Business Income’ head for the partners.
Share of Profit is the percentage of profit distributed among partners; irrespective of working or sleeping status. The partners must decide themselves on the ratio to share the profit. If the Partnership Deed does not specify the ratio, the profit can be distributed equally among them.
This ratio is not just applicable to profit sharing, it also stands the same for loss sharing. The entire profit need not be distributed among partners. A part of the profit can be kept separate for the purpose of reserve and surplus.
Irrespective of you being a working or sleeping partner, the share of profit received is exempt from tax under Section 10(2A) of the Income Tax Act.