Nov 88 min read

Remuneration to Partners: How is it Calculated?

Updated: Nov 14

Profit is the goal of a partnership firm, like any other business. A silent partner makes investments without getting involved in the business's activities, whereas a working partner invests in the company and monitors its operations. Rewards for partners are allocated according to their level of effort. The remuneration clause of the partnership document specifies the subjective parameters of payment. In this article, we will discuss the concept of remuneration to partners in a partnership firm in detail.

What is Remuneration to Partners?

The salary, commission, or bonus that a partnership corporation pays a partner is known as their remuneration. Partners are paid every month for their service to the company, just like regular workers do. In exchange for their labour, partners are paid the following:

Interest on invested capital as compensation
Profit-sharing

Deduction of Remuneration to Partners

A partnership firm's "Profits and Gains from Business and Profession" (PGBP) might include the interest and compensation given to partners as an expense. However, Section 40(b) has set a maximum amount deducted from interest and compensation. It is not permitted, though, if partnership firms decide to use section 44AD or section 44ADA to pay taxes on a presumptive basis.

Section 40(b) of the Income Tax Act

The Income Tax Act's Section 40(b) addresses the allowance of remuneration paid to a business partner. It is relevant to all businesses, irrespective of whether they are Indian Partnership Act-registered or not. The maximum amount of compensation that a business can give a working partner is specified in Section 40(b) of the Income Tax Act. According to this section, whatever payment is made to a business partner may be deducted as long as it stays within the limits laid.

Conditions to Claim Deduction for Remuneration to Partners

The only person who should receive such compensation is the working partner. A working partner is a person who actively participates in handling the business or profession of the company of which he is a partner, according to Explanation 4 to Section 40(b). A partner must take an active role in managing the firm's business or profession to be considered a working partner. Even if a partner dedicates a portion of his working hours to managing the firm's activities, he might still be considered actively involved. It is important to keep in mind that Explanation 4's definition of "working partner" takes into consideration a specific person. Therefore, a partner who is not an individual—for instance, a business—cannot be a working partner. A chairman or shareholder of an organisation that is a partner in a firm may also work for the firm in which the company is a partner. Section 40(b) would entirely forego any pay or compensation that the company paid to such an employee. The reason for this is that the person who works for the company is not a partner. Section 40(b) allows a company to pay its partners but not other employees.
The Partnership Deed should approve it. Any salary, bonus, commission, or other compensation paid to a working partner under any name is not deductible if the partnership deed fails to authorise the payment or does not comply with its provisions. Clear instructions regarding the amount of compensation to the working partners must be included in the partnership deed.
It must not be related to a time before the Partnership Deed. It will be possible for the company to deduct the compensation provided to the working partners from the date of the partnership deed, rather than from any time before. Such updated provisions will be taken into consideration for that time frame if the partnership deed is renewed. The company would receive a deduction for the compensation paid to its working partners starting on July 1st, but not for the period from April 1st to June 30th, if, for example, it incorporates the clause relating to the payment of remuneration to the working partners by executing an appropriate deed as of July 1st, but efficacious from April 1st.
All partners should not have received more than the permitted limitations in salary, bonuses, commissions, or other forms of compensation over the preceding year.
A simple interest rate of no more than 12% per year may be charged on a partner's capital.

Maximum Permissible Limit under Section 40(b)

The following is the highest amount that can be paid under Section 40(b) (note that this limit relates to the total remuneration of all partners, not per partner.)

Book Profit	Limit
First Rs.3,00,000 of book profit or loss	Rs.1,50,000 or 90% of the book profit (whichever is higher)
Remaining balance of book-profit	60% of the book-profit

Calculation of Book Profit

The net profit stated in the profit and loss account, calculated by the guidelines in chapters IV–D, plus the amount of compensation paid to partners, which is allowed as a deduction in the profit and loss account, is known as book profit. Here is the method for calculating book profit:

Profit as per Profit & Loss account (P&L)	xxxx
(+) Remuneration to partners (if debited in the P&L)	xxxx
(+) Interest paid to partners (if debited in the P&L)	xxxx
(-) Interest under Section 40(b)	(xxxx)
Book Profits	xxxx

Illustration

Here is an example showing partner compensation in a few scenarios:

Book Profit or loss	Calculation of Partners Remuneration	Max Remuneration Allowed
Rs. 900,000	Higher of Rs. 3,00,000 90% + Rs. 6,00,000 60% = Rs 630,000 Or Rs. Rs.150,000	Rs 630,000
Rs. 500,000	Higher of Rs. 3,00,000 90% + Rs. 2,00,000 60% = Rs 390,000 Or Rs.150,000	Rs 390,000
Rs. 200,000	Higher of Rs. 2,00,000 * 90% Rs 180,000 Or Rs.150,000	Rs 180,000
Rs. 200,000 Loss	Higher of Rs. 0 * 90% = Rs 0 Or Rs.150,000	Rs 150,000

Conditions to Claim Deduction for Interest Payable to Partners

The conditions that follow must be fulfilled for interest to be deductible:

The partnership document has to authorise or approve interest payments.
The interest rate paid shouldn't be higher than 12%. The excess amount is strictly forbidden if the interest surpasses 12% of the capital.
If the partnership firm decides to pay taxes on an assumed basis under section 44AD or section 44ADA, this is not permitted.
The compensation must be for a period beginning on the date the partnership deed was signed, the date the partnership came into existence, and not from any time before that.

Share of Profit

The percentage of profit divided among partners, whether sleeping or working partners, is known as the "share of profit." The partners agree on the profit-sharing ratio. They may divide the profits equally if the partnership deed is silent on the ratio. This ratio is applicable when partners share losses in addition to profit sharing. Partners do not have to split the entire earnings. You can set aside a portion of the profit for reserves and excess. Section 10(2A) of the Income Tax Act excludes the profit share from taxation regardless of whether you are a sleeping or working partner.

Budget 2024 Update: Increase in Limit for Partner's Remuneration under Section 40B

The last revision to the partner's remuneration limit as provided in Section 40(b) was made in 2010. According to the table below, this budget suggests changing the partner's compensation limit:

Book Profit	Limit
First Rs.6,00,000 of book profit or loss	Rs.3,00,000 or 90% of the book profit (whichever is higher)
Remaining balance of book-profit	60% of the book-profit

Additionally, a new provision under Section 194T, states that if a firm pays a partner more than Rs. 20,000 in a fiscal year, TDS must be deducted at 10% from any salary, remuneration, bonus, or commissions paid.

Conclusion

A crucial clause governing the payment of compensation to a business partner is Section 40B of the Income Tax Act. It outlines the highest compensation that can be granted to a worker and the criteria that must be met for the payment to be deductible. Businesses need to make sure they follow this section's guidelines to prevent any negative outcomes.

FAQ

Q1. What is partner remuneration?

Depending on their respective roles and duties, partners communicate within the firm. Partners want to be paid for their jobs because they work in the company just like employees do. Payment may be in the form of a commission, bonus, or salary. Most company associates have agreed on a money amount. Compensation is influenced by the partner's work, goodwill, capital contribution, and educational background.

Q2. Is partner remuneration taxable?

The receiving partner has to file any compensation that can be claimed as an expense in the partnership firm as "Income from Business or Profession." The payment is not taxable in the partners' hands if not permitted as an expense in the partnership firm's hands.

Q3. Is interest on a partner’s capital taxable?

Section 28 states that the business partners are subject to taxes on the capital interest earned. In this case, interest income will be taxable under business and professional earnings and gains tax.

Q4. Is it mandatory to pay remuneration to the partner?

Only employees who actively manage the business, fully or partially, are eligible for compensation from the company. Non-individual partners, like businesses, are not regarded as working partners and are therefore not entitled to compensation.

Q5. Is it mandatory for a partnership firm to give interest on a partner's capital?

No, paying interest on a partner's capital is not an obligation of a partnership firm. When calculating the firm's taxable income, interest is considered a deductible expense.

Q6. Can sleeping partners get a salary?

Sleeping partners do not take part in managerial or organisational duties; they only invest in a company. The working partner is in charge of running the company regularly. Sleeping partners get rewarded with a portion of the company's revenues instead of a salary. These profits are allocated according to each partner's stake in the company.

Q7. What is the difference between salary and remuneration?

Working partners in a company who actively manage its business are entitled to compensation. These working partners have a right to compensation regardless of their level of involvement. Non-individual partners, such as businesses, cannot be regarded as working partners and, as a result, are not entitled to salary.

Q8. What is Section 40(b) of the Income Tax Act?

The Income Tax Act's Section 40(b) specifies the upper limit for the deduction of compensation given to business partners.

Q9. Is Section 40(b) applicable to Limited Liability Partnerships (LLPs)?

No, limited liability partnerships (LLPs) are exempt from Section 40B. Only partnership firms are affected.

Q11. Who is considered a working partner under Section 40(b)?

A partner who actively takes part in the administration and operations of the company and is liable to be reimbursed for their services is known as a working partner.

Q12. Can the maximum deduction limit be increased?

Indeed, if the company has evidence that paying a larger salary is both in the firm's optimal interests and is justified by commercial expediency, the highest deduction limit mentioned in Section 40(b) may be raised.

Q13. How is remuneration paid to a deceased working partner treated from a tax perspective?

If a working partner passes away during the fiscal year, the company can deduct the compensation they received until that point. However, Section 40(b) prohibits deducting any compensation given to the dead partner's rightful heirs or representatives after their passing.

Q14. Can a partner be given both salary and share of profit?

Yes, a working partner may earn a salary and a portion of the company's profits, so long as the total compensation paid to the partner—including the salary and profit share—does not exceed the maximum deduction amount allowed by Section 40(b).

Q15. What is the maximum remuneration limit for a working partner?

Under Section 40(b), the highest compensation that can be provided to a working partner is 90% of the book profit or Rs. 1,50,000, whichever is higher in a loss.

Q16. What happens if a firm fails to comply with Section 40(b)?

Noncompliance with Section 40(b) will result in the excess compensation offered to the working partner being removed from the firm's income calculation and subject to taxation as if it were part of income.

Q17. Is there any penalty for non-compliance with Section 40(b)?

It is possible that the company could face penalties and fines under the Income Tax Act if it violates Section 40(b) requirements.

Q18. Is TDS applicable to the partner’s remuneration?

The TDS only applies when payments are given to a company employee. However, the TDS rules did not pertain to payments made in interest, bonuses, or commissions, or if you received compensation from the company as a partner.