A partnership firm is set up with the goal of making a profit. There can be two types of partners: a working partner who both 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.
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:
Partnership Firms are allowed to deduct the Interest and Remuneration paid to Partners as expense 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.
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.
Remuneration in a partnership firm consists of salary, bonus, and commission. To qualify for deduction of Partners Remuneration, the following conditions must be satisfied:
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)
Book Profit | Limit |
On the first Rs.3,00,000 of book-profit or loss | Rs.1,50,000 or 90% of the book-profit, whichever is higher |
On remaining balance of book-profit | 60% of the book-profit |
Calculation of book profits:
Book Profit | Limit |
(i) Profit as per Profit & Loss account (P&L) | xxxx |
(ii) Add: Remuneration to partners, if debited in the P&L above | xxxx |
(iii) Add: Interest paid to partners, if debited in the P&L above | xxxx |
(iv) Less: 12% Interest as allowed under Section 40(b) | (xxxx) |
Book Profits | xxxx |
Book profit = Rs. 9 Lakhs
Maximum allowed salary = 3,00,000 * 90% + 6,00,000 * 60% = Rs 6.3 lakhs
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.
Interest on Partner’s Capital:
In order for interest to be eligible for deduction, the following conditions must be met:
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, entire interest amount will be allowed as deduction.
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.
No TDS (Tax Deducted at Source) needs to be deducted by the partnership firm 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 is the percentage of profit distributed among partners; irrespective of whether working or sleeping partner. 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 is not just applicable to profit sharing, it also applies 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 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.
According to Section 28, the business partner will be subject to taxation on the interest earned on capital. This means the income generated from interest will be taxable under profits and gains from business and profession.
Sleeping partners exclusively contribute investments to a business and do not participate in administrative or managerial tasks. It is the working partner who assumes responsibility for the daily operations of the firm. Consequently, sleeping partners do not receive a salary; instead, they receive a share of profits derived from the business. The distribution of such profits is based on each partner's respective share in the business.
Remuneration from a firm is applicable only to working partners who actively manage the affairs of the firm, whether partially or entirely. Non-individual partners, such as companies, are not considered working partners and thus are not eligible for remuneration.
Remuneration is specifically reserved for working partners in a firm, who actively participate in managing its affairs. Whether they are involved partially or fully, these working partners are entitled to receive remuneration. However, non-individual partners like companies do not fall under the category of working partners and therefore are not eligible to receive remuneration.