Learn All about Remuneration to Partners in Partnership Firm

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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:

  • Remuneration
  • Interest on Capital Introduced
  • Share of Profit

Remuneration to Partners:

Meaning:

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)
Loss150,000
Up to 3 Lakh90% of Book Profit or Rs 150,000;
whichever is more
More than 3 Lakh60% 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 of Partners:

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:

Meaning:

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:

Interest received by partners is taxable as Business Income in their hands.

Share of Profit:

Meaning:

The phrase share of Profit assumes the percentage of profit distributed among the partners. It is generally distributed among all the partners.

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.

The 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 of Partners:

Whether 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.

Conclusion:

The 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.

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Whether 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 support@legalwiz.in for personalised solutions.

About the Author:

CS Prachi Prajapati
Company Secretary with a forte in content writing! Started as a trainee, she is now leading as a Content Writer and a Product Developer on technical hand of LegalWiz.in. The author finds her prospect to carve out a valuable position Legal and Secretarial field.

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