For every effort, we seek a return. The business is formed with aim of returns and that is the ultimate goal of any businessman. And Partnership? Well, Partnership Firm is registered with the main object of profit. I’m leading you to discuss the financial returns and remuneration to partners in a partnership firm.
Role of a partner in the firm is not limited to investment. Few stay connect with business for full-time. And others lend their goodwill or skills for business. Different investment finds different rewards. And the greatest efforts are rewarded with maximum returns. But, the partners need to balance the payment terms on the subjective basis for all.
Generally, such terms are incorporated in remuneration clause itself during Partnership Registration. But, before you finalise the terms, you need to understand all aspects of financial returns to partners. This helps to make an informed decision apart from tax planning.
The financial returns to partners of the Partnership Firm are divided in following three heads:
- Interest on Capital Introduced
- Share of Profit
Remuneration to Partners:
The phrase remuneration includes any salary, bonus, commission, or remuneration (by whatever name called) paid to a partner. The partners actively contributing in operations of Partnership are eligible to receive remuneration. Much like an employee, these partners are rewarded for their work monthly.
Check if you are eligible for Remuneration:
The eligibility for remuneration is specifically dealt by and is subject to remuneration clause in Partnership Deed. Whether you are working or not, active or sleeping partner, you receive remuneration if partnership deed has allowed doing so. Ultimately, it is a mutual understanding of partners to put in partnership deed. The nature of reward suggests providing remuneration to active partners, so does the Income Tax law. It further provides maximum limit for remuneration in partnership firm.
Amount deductible under Income Tax Act:
- The remuneration is allowed as a deduction from profit when paid to an individual working partner. Here, deduction means to deduction of expense from the profit of the firm.
- Further, Partnership deed must authorise to pay remuneration to working partners.
- IT Act further provides the maximum allowable amount, as given below. Any amount paid in excess of such limit is not an allowable deduction.
|Book Profit (Rs)||Maximum Deductible Amount (Rs)|
|Up to 3 Lakh||90% of Book Profit or Rs 150,000; |
whichever is more
|More than 3 Lakh||60% of Book Profit|
It is important to note here that limit is
not applicable to individual partner, but all to partners. Which means that the
maximum amount calculated above is sum total payable to all partners.
Taxability in the hands
Remuneration is taxable in hands of partners as Business Income. But, note that remuneration income is different from the share of profit.
Interest on Capital Introduced:
Interest is paid to partners who have introduced the
capital whether by way of cash or any other mode. Non-cash capital (tangible or
intangible) is evaluated in monetary terms at the time of its introduction. The
interest is payable on the amount provided under the capital clause of the Partnership
Deed. It is the opportunity cost to invest in the business and therefore, they
are rewarded with interest.
What is the Rate of Interest?
The rate of interest is provided in the respective clause of Partnership Deed. Although it is not compulsory to prescribe the rate of interest in the agreement, it is preferred to do so. Prescribing the rate removes the chances of ambiguity or dispute on the matter. If required, the partners can anytime change the rate. You must take note that only the partners, who have introduced the capital, can receive the interest.
Amount deductible under Income Tax Act:
- Under the Income Tax Act, the maximum interest at the rate of 12% p.a.
is allowed. Any amount paid exceeding the effective rate is disallowed as a deduction
from the firm’s business income.
- For deduction under Income Tax, the partnership deed must authorise to
pay interest on capital. But, not necessarily the rate of interest.
Taxability in the hands of Partners:
received by partners is taxable as Business Income in their hands.
Share of Profit:
phrase share of Profit assumes the percentage of profit
distributed among the partners. It is generally distributed among all the
What is the Profit-sharing Ratio?
The ratio to share profit between partners is decided mutually by them. In case, the partnership deed does not provide any specific ratio, the profit is divided equally between all partners. While deciding the ratio, you should also note that this is the loss-sharing ratio as well.
partners need to decide what will the distributable amount. It is not necessary
to distribute all the profit. The tendency is to reserve a part of the total
profit for reinvestment in the business.
Taxability in the hands
you are a working partner or non-working partner, the share of profit is exempt.
The concerned provision is provided under Section 10(2A) of the Income Tax Act.
different types of returns are defined so that the partners are rewarded for
their participation. While drafting the partnership deed, the partners must
keep all these clauses in mind. While you may allow all kind of financial
rewards through Partnership Deed, the taxability is calculated under the Income
Tax Act. Even to pay the remuneration or interest, you must consider their taxability.
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. Further, it is also taxed in hands of partners at the
applicable rate. Remuneration to partners and interest on capital are allowed
to be deducted as a business expense only up to the provided limit.
is an online legal service provider. Our team of professionals helps SMEs to
set up and maintain their business by taking care of all legal formalities. From
business registration, tax filings to Intellectual Property registration, we
ensure quality service at affordable cost.
it’s Partnership Registration or change in remuneration clause in partnership
deed, LegalWiz.in experts make it easier for you. Connect with LW experts at email@example.com
for personalised solutions.