Partnership firm is taxable in India as a separate business entity. After creating a deed of Partnership, the managing partner has to apply for a permanent account number with the tax department.
Every year, tax return has to be filed with the government on or before the due date of filing by calculating taxable business income of the firm.
While calculating tax liability, you need to give special Importance to interest on capital and remuneration to partners paid during the year, as these expenses are allowed based on certain conditions.
Remuneration to partners is allowed as business expenditure if following conditions are satisfied;
- Payment of remuneration or salary and commission is authorised by the partnership deed, and
- Its paid to a working partner for the period falling after the date of the partnership deed
To claim salary, bonus, commission or remuneration as a business expenditure, you must draft your Partnership deed in such a way that it specifies the exact amount payable to each partner or lays down the manner of quantum of such salary, commission, remuneration and other things.
If you don’t want to specify the exact amount then at least the manner of fixing remuneration or salary and commission should be clearly stated in the deed.
Based on above conditions if partners are paid remuneration in accordance to the terms and conditions of partnership deed and the amount paid does not exceed the maximum amount allowed under section 40(b), then the firm is allowed to claim it as a business expenditure.
Maximum Permissible Remuneration to partners
To calculate maximum permissible limit for allowing remuneration to working partners as deductible business expenditure, we first require calculating book profit of the firm.
On the first Rs. 3, 00,000 of book profits or in case of loss, maximum remuneration allowed is Rs. 1,50,000 or 90% of the book profits, whichever is higher. On the balance amount of the book profits, 60% is allowed.
|Book Profit||Maximum Remuneration allowed|
|On the first Rs. 3,00,000 of book profits or in case of loss||Rs. 150000 or 90% of the book profits, whichever is higher.|
|On the balance of the book profits (i.e. book profit – Rs. 3,00,000)||60% of the balance book profits|
To calculate book profit for the purpose of calculation of remuneration to partners, you need to follow below steps;
- Step -1:- Find out taxable net profit before allowing interest on capital and remuneration to partners as allowable expenditure.
- Step -2:- Compute deduction allowable portion of interest on capital
- Step – 3:- to find out book profit for calculation of maximum permissible remuneration to working partners, deduct step -2 from step-1
While calculating book profit, we should not consider income from any other head or brought forward losses or deduction under chapter VIA.
Example to calculate firm’s taxable business income
ABC & Co, a partnership firm consisting of three partners, reports Rs. 5, 62,000 as its net profit before allowing interest on capital and remuneration to partners as expenses. Here are other items it reports;
- Salary paid as authorised by the deed of partnership is Rs. 20,000 per month. It’s paid to all three working partners.
- Interest on capital paid as per the partnership deed is at the rate of 15%.
- Capital amount eligible for interest calculation is Rs. 6, 00,000.
Lets calculate firm’s taxable business income;
Step-1:- Calculate Book Profit for the calculation of maximum permissible salary
|Particulars||Amount in Rupees|
|Net Profit before allowing interest and remuneration||5,62,000|
|Less: interest on capital(Even though partnership deed allowed taking 15% on capital amount as interest, income tax allowed deduction at the rate of 12%)(6, 00,000*12%)||(72,000)|
|Book profit for calculating maximum permissible remuneration to partners||4,90,000|
Step-2:- Calculating maximum permissible Remuneration
|Sr. No||Particulars||Amount in Rupees|
|A||Book Profit as calculated in step-1||4,90,000|
|B||On the first Rs. 300000 book profit (Rs. 150000 or 90% of Rs. 300000, whichever is higher)||2,70,000|
|C||60% of the balance book profit i.e. 1,90,000 (60% of Rs. 490000 minus Rs. 300000)||1,14,000|
|E||Salary paid as per deed (20000*3*12)||7,20,000|
|F||Salary to partners allowed as deductible business expenses (least of D or E)||3,84,000|
Step-3:- Profits and Gains from business or profession = Step -1 minus Step-2 = Rs. 4, 90,000 – Rs. 3, 84,000 = Rs. 1, 06,000
Interest on capital is also not allowed based on the amount paid by the firm. You have to calculate the maximum limit of interest on capital allowed to a firm based on the conditions of section 40 (b) of Income Tax Act, 1961 to claim it tax deductible. If payments of the whole year is higher than this limit, then your allowed expenses will be restricted to the maximum limit as calculated based on section 40(b).