Whether it is a startup or a time-honoured enterprise, the remuneration payable to partners of a firm has both legal and fiscal significance. The Indian Partnership Act, 1932, and the LLP Act, 2008, allow partners to receive compensation such as salary, bonus, commission, or interest on capital, provided the terms are clearly mentioned in the partnership or LLP agreement, under Section 40(b) of the Income Tax Act, 1961, such remuneration.
In this blog, we will explore the statutory framework governing partner remuneration, including permissible limits, documentation requirements, and the tax implications applicable to both the firm and its partners.
Legal Framework of Partners’ Remuneration
The Indian Partnership Act, 1932, does not mandate any fixed structure for paying remuneration to partners. The payment of compensation is a matter of mutual agreement between the partners, usually outlined in the partnership deed. As per Section 13 of The Indian Partnership Act, 1932, a partner is not entitled to receive any remuneration for taking part in the conduct of business unless otherwise agreed by the partners.
The basis for making payment to the partner is found in the explicit clauses of a valid partnership agreement.
The LLP Act, 2008, governs Limited Liability Partnerships (LLPs), and similar principles apply. The LLP Agreement must clearly specify remuneration; otherwise, partners may not be able to claim compensation for services provided.
Forms of Partner Remuneration
Partner remuneration can take several forms, including:
- Fixed salary for services rendered.
- Commission based on performance or revenue targets.
- Interest on capital introduced.
- Bonus or incentive payments.
- Share in net profits after tax.
The classification and disclosure of such amounts must be consistent in the books of accounts and aligned with the terms set forth in the partnership deed or LLP agreement.
Permissible Limits under Income Tax Law
Section 40(b) of the Income Tax Act, 1961 imposes restrictions on the admissibility of remuneration to partners as a deductible business expense by the partnership firm. The following conditions must be satisfied for such payments to be allowable:
- A written partnership deed must exist to prove the existence of a partnership.
- The deed must specify the manner of computation of remuneration.
- The remuneration must be paid only to working partners.
As per Rule 6DD of the Income Tax Rules and the second proviso to Section 40(b)(v), the amount of allowable remuneration is limited as follows:
- On the first ₹6,00,000 of book profit or in case of a loss: Maximum deduction is ₹3,00,000 or 90% of book profit, whichever is higher.
- On the balance of the book profit: 60% of the balance.
Any amount paid in excess of the prescribed limits is disallowed and added back to the firm’s taxable income.
Tax Implications of Partners’ Remuneration
Remuneration, including salary, commission, or bonus, received by a partner from a firm is taxable as “Business or Profession Income” under Section 28(v) of the Income Tax Act, 1961. The income earned by the partner is eligible for a deduction of related expenses incurred in earning such income.
It is important to note:
- Share of profit is exempted in the hands of the partner under Section 10(2A) of the Income Tax Act, 1961.
- Interest received on capital is taxable, subject to a maximum rate of 12% p.a. as per Section 40(b)(iv) of the Income Tax Act, 1961
- TDS is not applicable to salary or remuneration paid by a firm to its partners.
Remuneration in LLPs
LLP is a separate legal entity compared to a partnership firm; the principles under Section 40(b) of the Income Tax Act, 1961, also apply to LLPs. Remuneration paid to designated working partners is also subject to the same deduction limits. The LLP agreement must authorize such payments and define the computation method.
Compliance
The following documentation is essential for lawful and tax-compliant remuneration:
- A valid partnership or LLP agreement specifying remuneration terms.
- Proper board resolutions (for LLPs) or written consent.
- Accounting entries substantiating payments.
- Consistency in reporting such income in partners’ tax returns.
- Disclosure in tax audit reports (Form 3CD) under Clause 18.
Section 194T of the Income Tax Act, 1961: TDS on Partner’s Remuneration
Effective from April 1, 2025, the Finance Act, 2024 introduced Section 194T to expand tax compliance obligations on firms and LLPs.
- Applicability: TDS is deducted at the rate of 10% on payments such as salary, remuneration, interest, bonus, or commission made to partners if such payments exceed ₹20,000 in a financial year.
- Point of Dedication: TDS must be deducted at the time of credit to the partner’s account or at the time of actual payment, whichever is earlier.
- Exemptions: Payments such as capital account withdrawals or reimbursements of business expenses are excluded from the purview of this provision.
Impact on Partner’s Tax Liability
- Taxable Income: The amount subjected to TDS will form part of the partner’s taxable income and must be disclosed under the head “Profits and Gains from Business or Profession.”
- Advance Tax: Partners may become liable to discharge advance tax obligations if the TDS deducted does not sufficiently cover their overall tax liability.
- Deductions: Expenditure incurred wholly and exclusively for earning this income may be claimed by the partner while computing their taxable business income.
Compliance Audit Considerations
Under Section 44AB of the Income Tax Act, 1961, firms exceeding the prescribed turnover are subject to tax audit. The tax auditor is required to report details of remuneration paid to partners and examine whether such payments are within the permissible limits under Section 40(b) of the Income Tax Act, 1961. Any deviation is flagged in the audit report and may attract disallowance during assessment.
Furthermore, scrutiny assessments under Section 143(3) or reassessment under Section 147 of the Income Tax Act, 1961 may also test the commercial expediency, genuineness, and documentation of such payments. Hence, transparency and regular internal audits are crucial.
Conclusion
Remuneration is a crucial aspect of business, whether for partners or employees. Its legitimacy and tax deductibility depend on adherence to legal documentation, specified limits, and precise accounting. Firms must take a structured approach in drafting deeds, maintaining transparency, and complying with statutory provisions to prevent unnecessary disputes and ensure compliance.
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