How to Calculate Remuneration of Working Partner as per Income Tax?
The Income Tax Act places some limitations and conditions at the time of taking deductions of expenses available to a partnership firm in respect of remuneration and interest payable to the partners of the firm. The deductions with respect to salary paid to partners and interest payment to partners cannot exceed the monetary limits specified u/s 40(b) and such payment are available subject to the fulfillment of conditions mentioned therein. Section 40(b) allows remuneration to partners on book profit basis and such remuneration cannot exceed the limit prescribed under this provision. In this article we will learn on how to calculate the book profit and partners remuneration based on such book profit.
What are the conditions attached with section 40(b)?
As per section 40(b), interest, remuneration paid by firm/ LLP is allowed as deduction if following conditions are satisfied:
1. Remuneration to be allowed to working partners:
The partnership must make payment of remuneration to working partner of the firm, as per income tax act silent partners of the partnership firm. Working partner in general terms means the partner who is actively engaged in the business of the partnership firm and is not a partner for merely enjoying the profits/benefits of the partnership business. In case a partner is not a working partner then remuneration to such partner will not be eligible for deduction as per section 40(b) of Income Tax Act 1961.
2. Remuneration should be authorized by partnership deed:
As per section 40(b) of the income tax act only that salary, remuneration, bonus, commission etc payable to working partners will be allowed as deduction only if it is authorized by the partnership deed. In case the partnership deed does not contain any such provisions then the deductions may be disallowed if the same is claimed by the partnership firm.
CBDT in its circular no. 739 dt 25/03/1996 have clarified that no deduction under section 40(b) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.
Hence, the deed must provide the amount of remuneration to be paid to the partner in order to avoid any disallowance u/s 40(b).
3. Remuneration and Interest should relate to period falling after the date of partnership deed:
The interest and remuneration paid to the partners of the partnership firm must relate to the period falling after the date of partnership deed. That means the interest and remuneration should not be retrospective.
For instance, if the partnership deed is executed on 01/05/2020 than the remuneration paid to the partners should fall after this date. Any payment made to partners before this date shall stand disallowed u/s 40(b).
4. Interest on partner’s capital and loan is allowed at a maximum rate of 12% p.a. simple interest:
As per Section 40(b) any payment of interest to any partner which is authorised and is in accordance with, the terms of the partnership deed and relates to period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of 12% simple interest per annum shall be disallowed. Thus payment of any simple interest to any partner is allowed only to the extent of 12% per annum as deduction as per section 40(b). Even if the partnership deed authorizes any payment of higher rate of interest than 12% to any partner, the excess of interest will not be deducted.
5. Remuneration is allowed to partner on Book Profit basis:
As per section 40(b) remuneration to partners is allowed on book profit basis. The Book Profit is calculated as follows:
|Profit as per Profit & Loss a/c||XXX|
|Add :Remuneration to partners if debited to Profit and loss a/c||XXX|
|Add : Salary to partners if debited to Profit and loss a/c||XXX|
|Add : Bonus to partners if debited to Profit and loss a/c||XXX|
|Add : Commission to partners if debited to Profit and loss a/c||XXX|
|Less : Income under capital gain, other sources ,house property, if credited to profit and loss a/c||XXX|
|Book Profit as per section 40(b)||XXX|
In simple terms book profit means Profit and gains of business and profession before remuneration and maximum remuneration and deduction u/s 40(b) cannot exceed the below limit:
|Book Profit (Rs.)||Maximum Remuneration to partners|
|0 to Rs. 3 Lakhs||Higher of 90% of Book Profit or 1,50,000|
|More than Rs. 3 Lakhs||60 % on the balance book profit|
- It is not allowed if tax is paid on presumptive basis under section 44AD or section 44ADA
- If any individual is a partner in a firm on individual capacity and receiving interest on representative capacity then section 40(b) not applicable on such interest.
- If any individual is a partner in a firm on representative capacity and receiving interest on individual capacity then section 40(b) not applicable on such interest.
- If any individual is partner on representative capacity or individual capacity and received any remuneration then on such remuneration limit of section 40(b) shall apply.
ABC partnership firm has a profit of Rs. 5,00,00,000 (5 Crore) after charging interest on capital for partner A amounting to Rs. 15 lakhs which is calculated at the rate of 15% p.a. as per the agreement but before considering remuneration to partners. ABC firm consist of 3 working partners.
Let us calculate the maximum admissible remuneration to the working partners:
Calculation of book profit u/s 40(b)
|Net profit before partners remuneration||5,00,00,000|
|Add: Interest paid to Partner A in excess of 12% p.a. [15 lakhs – (15 lakhs X 12/15)]||3,00,000|
|Book Profit as per section 40(b)||5,03,00,000|
Calculation of maximum remuneration to working partner:
Maximum amount admissible as remuneration to working partner:
|Book Profit (Rs.)||Maximum Remuneration to partners||Remuneration|
|0 to Rs. 3 Lakhs||Higher of 90% of Book Profit or 1,50,000||2,70,000|
|More than Rs. 3 Lakhs||60 % on the balance book profit i.e. 5,00,00,000||3,00,00,000|
|Total admissible remuneration to partners||3,02,70,000|
Hence, ABC partnership can allow or pay a maximum of Rs. 3,02,70,000 as partners remuneration to all working partners.