Income Tax on Remuneration to partners in a partnership firm
Introduction:
Partnership firms are one of the most common forms of business structures in India. Under the partnership, two or more two persons come together with an objective to earn profits by engaging in any business activity. The partners get back their return in three forms: (a) Interest on Capital (b) Remuneration (c) Profit share. Interest on capital is the reward at a fixed rate in return for the investment made by the partners in the firm whereas the remuneration is given to the partners who devote their time to the effective working of the firm. It is also important to know that the partnership firm can claim such interest or remuneration as an expense while doing IT Return Filing. This article discusses the various concepts relating to the partnership along with income tax provisions relating to the remuneration to the partners.
Remuneration to Partners
What is Remuneration to Partners?
The word ‘Remuneration’ includes any salary, bonus, commission, or remuneration (by whatever name called) paid to a partner. The partners actively work and give their contribution to the operations of the partnership firm like any other employee. The roles & duties of each partner can also be defined through the partnership deed. In return for their services, the firm makes payment to the partners either in the form of salary, bonus, commission, or remuneration. Any such payments made to a partner are termed “Remuneration”.
Generally, the “Remuneration Clause” is mentioned in the partnership deed itself which provides the manner in which remuneration shall be allowed to the partners for their efforts. Having a ‘Remuneration Clause’ in the partnership deed is very important from the point of view of tax planning.
Eligibility criteria for remuneration to partners in Partnership Firm
As already discussed above, the eligibility for remuneration to partners is specified in the “Remuneration Clause” in the partnership deed. Who will get remuneration, whether sleeping partners will get remuneration or not, what will be the amount of remuneration? all such questions are dealt with by the “Remuneration Clause”. Having a “Remuneration Clause” in the partnership deed is very important. In absence of the “Remuneration Clause”, the partnership firm cannot give any remuneration to partners.
What is the limit of remuneration as per the Income Tax Act?
As per the Income Tax law, the partnership firm shall not be allowed the deduction for the partner’s remuneration as an expense if such remuneration is in excess of the limits specified under the law. So, one should know the limits prescribed as per the Income Tax law.
Following are the maximum limits of allowable remuneration under the Income Tax Act:
|
Book Profits |
Allowable Maximum Remuneration (eligible as expenditure for the firm) |
|
In case the firm is in a loss |
Rs. 1,50,000 |
|
For first Rs. 3 Lakhs of book profits |
Rs. 1,50,0000 or 90% of book profits whichever is higher |
|
For the balance of the book profits |
60% of the balance book profits |
What is the meaning of Book Profit for the purpose of partner’s remuneration?
- ‘Book Profit’ means the net profit of the partnership firm after the deduction for all the expenses and losses.
- While computing the ‘Book Profits’ for the purpose of section 40(b)(v) of the Act, all incomes such as capital gain, interest, rental income, income from other sources, etc., which do not fall under the head ‘Profits or Gains of Business or Profession’ should be excluded. [Circular No. 12/2019 dated 19.06.2019]
Calculation of Book Profits:
|
Particulars |
Amount |
|
Profit as per Profit & Loss A/c |
xxx |
|
Add: Remuneration and interest paid to partners (if already debited to P&L) |
xxx |
|
Add: Brought Forward Business Losses |
xxx |
|
Add: Deduction under section 80C to 80U (in debited to P&L) |
xxx |
|
Less: Income under House Property, Capital Gain, Other Sources (if already credited to P&L) |
xxx |
|
Less: Interest up to 12% allowable u/s 40(b) |
(xxx) |
|
Book Profits |
xxx |
What is the importance of the ‘Remuneration Clause’ in the Partnership Deed?
- Remuneration to the partners is allowed as per the Income Act only when it is authorized by and is in accordance with the partnership deed. It means that the partnership deed should have a specific clause for giving remuneration to the partners of the firm. In absence of the specific clause, the claim for remuneration as an expense shall be disallowed in the hands of the firm.
- In some cases, the partnership deed does not specify the amount of remuneration. It just mentions that the remuneration to working partners will be the amount of remuneration allowable under the provisions of section 40(b). Similarly, some partnership deed mentions that the amount of remuneration to working partners will be as mutually agreed upon between the partners as the end of the year. The CBDT has issued a circular on this issue:
|
The CBDT vide it's Circular No. 739 dated 25.03.1996 clarified that no deduction under section 40(b) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. |
However, there are various decisions by the judiciary which contradict the CBDT circular as above. But it is advisable to incorporate the ‘Remuneration clause’ in the deed to avoid any future litigation.
Is remuneration allowable for a sleeping partner?
According to the conditions laid down by section 40(b), payment of salary, bonus, commission, or remuneration (by whatever name called), shall not be allowed to a non-working partner. In simple words, only the working partner shall be entitled to the remuneration.
Who is a ‘Working Partner’ for remuneration as per Income Tax Act?
As per Explanation 4 to section 40(b), “Working Partner” means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner. Thus, only individuals are capable of being working partners.
Is remuneration taxable in the hands of the partners?
Yes, the remuneration received by the partner from the partnership firm is taxable as part of his PGBP income (Profits & Gains from Business or Profession). The partner should declare remuneration and interest from the firm as taxable income during the e-filing of income tax return.
Is TDS liable for remuneration to partners?
The partnership firm need not deduct TDS on remuneration paid to the partners under section 192 of the Income Tax Act.
Conclusion:
The partnership firm carries the highest tax rate of 30% plus surcharge & cess as per the Income Tax Act. But the partnership firm (including LLP) is allowed deductions in the form of interest on capital & remuneration to partners. These deductions may be utilized by the partnership firms in a smart manner for tax planning and reducing the tax burden substantially. You should take utmost care while drafting a partnership deed in case of a new partnership. Even in the case of existing partnership firms, you could modify or amend the existing deeds to suit income tax purposes.
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