Remuneration to Partners in Partnership Firm

When two or more people come together with aim of business they form partnership firm. Aim of Partnership firm registration is to earn profit. In partnership firm partners divide there roles and responsibilities as per partnership agreement. They Agrees for to contribute capital in firm. Partners run business with aim of taking salary , remuneration , interest on capital and profit share from partnership firm. As there in income firm and partners need to understand taxation and treatment of this income in firm and personal income tax return. In below article we discussion about partners remuneration , interest to partner and share in profit of firm.

Firm returns in below category

• Partners Remuneration
• Interest to Partners
• Share in profit

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Remuneration to Partners

Partners work in firm as per role and responsibilities. As like an employee of firm , partners works in firm and in return we expect salary. The term Remuneration includes salary , bonus , commission. In most of firm partners mutually agrees on remuneration amount. Remuneration depends on work of partners, capital contribution, goodwill of partner, education background.

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Eligibility to Pay Remuneration to Partners

Partnership Deed is key document which define road map of firm. The eligibility to pay remuneration to partners is defined in partnership agreement. Remuneration can be paid to active partner , sleeping partner , non active partner. It’s a mutual understanding of partners to whom to pay remuneration, amount of remuneration , date of pay remuneration. Firm may have below point for defiling Eligibility to Pay Remuneration to Partners.

• Calculation of remuneration
• Who is eligible for remuneration
• When to pay remuneration
• Fixed or variable remuneration

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Remuneration to Partners calculation as per Income Tax Act

As per section 40(b) of Income Tax Act 1961 given calculation guideline for allowable remuneration payable to partners. Means calculation of remuneration as per Section 40(b) is allowed as expenses from partners firm income tax calculation. Amount is which is over and above Section 40(b) calculation will be added back in profit. Remuneration had to be paid to working partner. If remuneration clause is missing in partnership deed then it is now an allowable expenditure in Partnership firm Tax filing. ‘Book profit’ means the net profit computed under the head ‘Business or Profession’ as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.

Key Points to understand taxation of remuneration to partners.

• The remuneration is allowable expenditure in firm is it is paid to working partner
• Partnership deed must have clause about remuneration. Most of partnership deed as term of remuneration allowed as per Income Tax Act Section 40(b)
• Remuneration should be as per updated firm deed
• Remuneration not allowed if tax is paid as per 44ADA presumptive basis
• Remuneration above 40(b) shall be added back in partnership firm

 

Book Profit (Rs)	Maximum Deductible Amount (Rs)
Loss	150,000
Up to 3 Lakh	90% of Book Profit or Rs 150,000; whichever is more
More than 3 Lakh	60% of Book Profit

 

Example : M/s ABC Consulting Book profit is 9 Lac then remuneration calculation shall be Maximum allowed salary = 3,00,000*90% + 6,00,000*60% = Rs. 6.3 lakhs.

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Income Tax on Remuneration in Partners Hand

Remuneration paid to partners is taxable in hands of partners as business income. Means as remuneration amount reduced from calculation of partnership firm hence its chargeable in hand of partners. Income tax rate as applicable  to individual is applicable to partners. Due date of filing partner ITR shall be due date of filing of Firm ITR.

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Interest on Capital to Partners

Partners contribute capital in firm in terms of monetary and non monetary terms. In return of capital contribution partners expect interest income. Firm can pay interest on monetary or non monetary capital contribution. Partnership firm deed have clause about rate of interest. Simply its is an opportunity cost of money for partners. Partnership firm must have clause about interest payable to partners.

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What is Rate of Interest  ?

The rate of interest on capital for partnership firm is generally defined under Firm deed. Although it is not compulsory to provide interest rate in firm deed. However mentioning interest rate in deed remove ambiguity of payment. If partners want to change rate on interest on capital contribution clause then firm need to amend partnership agreement.

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Interest Paid to Partners Allowed in Income Tax Act 1961

Interest paid to partner allowed under Income Tax Act 1961. Under income Tax Act maximum allowable deduction for interest paid to partners is 12%. Amount exceed 12% is disallowed in income tax calculation of firm. Means this amount will be charged back in partnership firm taxable income.

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Interest Paid to Partners Taxability in Partners hand

Interest received form partnership firm on capital contribution is taxable in hands of partner as business income. Income tax rate as applicable on interest to partners is same as of Individual person.

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What is Partnership Profit Share ?

Aim of partnership firm is to earn profit. Partners share profit of firm as per there mutual profit and loss sharing terms. Partners withdraw profit share from firm as per there mutual understanding.

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Calculation of Partnership Profit & Loss sharing

The profit and loss sharing ration is decided by partners mutually. Partners consider factor of capital contribution, good of partner etc. for deciding profit and loss sharing ratio.  In case firm is not having any ration then partners withdraw profit equally from firm. It is not compulsory to distribute profit form from firm. Its partners mutual decision to transfer profit.

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Income Tax on Partners Profit Share in Partners Hand

Profit share received from partnership firm in hand of partner is 100% exempt under Section 10(2A) of the Income Tax Act. As Partnership firm already paid income tax on profit of firm hence profit share is exempt in hand of partner. No tax in partners personal income tax return.

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Conclusion

Partners withdraw profit share form firm , remuneration and interest on capital all this calculation as governed by Partnership deed. For tax planning of firm as well as partners it is important to draft partnership deed with above clauses. The returns paid in excess of the given limits are disallowed and double taxed. In the books of the partnership firm, it is taxed at a flat rate of 30% with other applicable cess, etc. Remuneration and interest on capital is allowed only upto certain extent as per Income Tax Act 1961. To avoid double taxation take care of above provisions in your firm agreement.