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Partner’s Remuneration And How It Is Calculated?

By Ektha Surana

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Updated on: Jul 13th, 2023

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10 min read

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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.

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 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: 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:

  1. Remuneration is only paid to working partners
  2. 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.
  3. The remuneration should be for a period from the date on which such partnership came into existence (i.e. date of partnership deed) and not from any period prior.
  4. The remuneration should be within the permissible limits (Refer next paragraph)

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)

Book ProfitLimit
On the first Rs.3,00,000 of book-profit or lossRs.1,50,000 or 90% of the book-profit, whichever is higher
On remaining balance of book-profit60% of the book-profit

Calculation of book profits:

Book ProfitLimit
(i) Profit as per Profit & Loss account (P&L)xxxx
(ii) Add: Remuneration to partners, if debited in the P&L abovexxxx
(iii) Add: Interest paid to partners, if debited in the P&L abovexxxx
(iv) Less: 12% Interest as allowed under Section 40(b)(xxxx)
Book Profitsxxxx

Example on Partners Remuneration Calculation:


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.

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:

  1. Interest payment must be authorized/approved in the partnership deed.
  2. The rate of interest paid should not exceed 12%. If the amount of interest exceeds 12% of the capital, the excess amount is disallowed.
  3. The remuneration should be for a period from the date on which such partnership came into existence (i.e. date of 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, entire interest amount will be allowed as 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.

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

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.

FAQs

 Is interest on a partner’s capital taxable?

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.

Can sleeping partners get a salary?

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.

Is it mandatory to pay remuneration to the partner?

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.

What is the difference between salary and 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.

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About the Author

Multitasking between pouring myself coffees and poring over the ever-changing tax laws. Here, I've authored 100+ blogs on income tax and simplified complex income tax topics like the intimidating crypto tax rules, old vs new tax regime debate, changes in debt funds taxation, budget analysis and more. Some combinations I like- tax and content, finance & startups, technology & psychology, fitness & neuroscience. Read more

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