Partner’s Remuneration And How It is Calculated?

A partnership firm is set up to earn profit. There can be two types of partners: a working partner who invests in the firm and manages its operations and a silent partner who only invests without being actively involved in the firm's 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.

Budget 2024 - Increase in Limit for Partner's Remuneration u/s 40(b)

The limit for the partner's remuneration as provided in Section 40(b) were last updated in the year 2010. This budget proposes to amend the limit on the partner's remuneration as per the below table:

Further, a new provision has been added via Section 194T, wherein the TDS will be required to be deducted for any salary, remuneration, bonus or commision payments made to a partner by a firm at the rate of 10% if payment in a financial year exceeds Rs. 20,000.

What is Partner’s Remuneration?

A partner’s remuneration is the salary, bonus, or commission paid to a partner by a partnership firm. Similar to regular employees, partners receive monthly payments for their contribution to the firm. Partners receive the following compensation for their work:

• Remuneration
• Interest on Capital Invested
• Share of Profit

Deduction of Partners Remuneration

Partnership Firms are allowed to deduct the Interest and Remuneration paid to Partners as expenses when arriving at their ‘Profits and Gains from Business and Profession’ (PGBP). However, Section 40(b) has specified a maximum limit up to which the deduction can be claimed on interest and remuneration amounts.

However, this is not allowed if partnership firms choose to pay tax on a presumptive basis under section 44AD or section 44ADA.

Section 40(b) of the Income Tax Act: Remuneration and Interest to Partner

Section 40(b) of the Income Tax Act specifies the ceiling limit for the compensation and capital interest that can be paid to a partner. Any amount exceeding this limit is ineligible for deduction.

Conditions for Claiming Deduction of Partners Remuneration

Remuneration in a partnership firm consists of salary, bonus, and commission. To qualify for deduction of Partners Remuneration, the following conditions must be satisfied:

• Remuneration is only paid to working partners
• Remuneration should be authorized by the partnership deed. The deed should mention the amount of salary or the method of calculation. If the deed does not include such provisions, no deduction is allowed. Practically, people specify in the deed that the salary is allowed to partners within the maximum limit defined under this section, which satisfies the deduction requirement.
• The remuneration should be for a period starting from the date on which such partnership came into existence (i.e., the date of the partnership deed) and not from any period prior.
• The remuneration should be within the permissible limits (Refer to next paragraph)
• Interest on partner's capital is allowed maximum at a maximum rate of 12% p.a simple interest.
• It should be related to the period of the partnership deed. If the partnership deed is renewed, then such renewed provisions will be considered for that period.

Maximum Permissible Limit under Section 40(b)

Maximum permissible limit under Section 40(b) is as follows: 
(Please note that this limit applies to the total salary of all partners, not per partner)

Calculation of book profits:

In simple words, Book Profit means PGBP before Remuneration

Example on Partners Remuneration Calculation:

Remuneration that is deductible as expenses for the partnership firm will be considered taxable income for the receiving partner as "Income from Business or Profession".

If the remuneration is not allowed as an expense for the partnership firm, it will not be taxable for the partners.

Conditions for Claiming Deduction of Interest Paid to Partner

Interest on Partner’s Capital:

In order for interest to be eligible for deduction, the following conditions must be met:

• Interest payment must be authorized/approved in the partnership deed.
• The rate of interest paid should not exceed 12%. If the amount of interest exceeds 12% of the capital, the excess amount is disallowed.
• It is not allowed if the partnership firm chooses to pay tax on a presumptive basis under section 44AD or section 44ADA.
• The remuneration should be for a period starting from the date on which such partnership came into existence (i.e., the date of the partnership deed) and not from any period prior.

Partner in Representative Capacity

If a person is a partner in a representative capacity (i.e. acting on behalf of another person rather than in their personal capacity) then any interest paid by the firm directly to that individual, in their personal capacity, will be exempt from the conditions and maximum limit set for disallowance. Therefore, the entire interest amount will be allowed as a deduction. 

Partner Remuneration & Interest: Important Points to Note

When it is stated that remuneration or interest is not allowed, it means that it is not allowed as a deduction for calculating the net taxable profit. The firm can still pay it to the partner in cash, as there are no restrictions on it under the Partnership Act.

The amounts that are deductible as remuneration or interest in the hands of the firm under Section 40(b) are taxable for the partner receiving those amounts under the head "Profit from Business/Profession." However, if the amount is disallowed in the hands of the firm, it is exempt in the hands of the partner.

The partnership firm does not need to deduct TDS (Tax Deducted at Source) on salary or interest paid or credited to a partner. TDS is not required even if such salary or remuneration is taxable in the hands of the partner. 

Share of Profit

Share of Profit is the percentage of profit distributed among partners, regardless of whether they are working or sleeping partners. The partners mutually decide on the ratio in which they will share profits. If the Partnership Deed does not specify the ratio, the profits can be distributed equally among them.

This ratio applies not only to profit sharing but also when partners need to divide losses. The entire profit need not be distributed among partners. A part of the profit can be kept separate for reserve and surplus.

Irrespective of whether you are a working or sleeping partner, the share of profit received is exempt from tax under Section 10(2A) of the Income Tax Act.