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We’re sure you’ve at some point in your life considered a partnership with your best friends on your startling business idea. Ever wondered how your income as a partner would be taxed here in India?
Read on for a detailed explainer on the same.
A partnership firm or a Limited Liability Partnership (LLP) is a form of organisation wherein two or a few persons come together to run a business with a view of earning profits. Each such person is known as a partner, individually and a partnership firm collectively.
As per Section 2(23)(i) of the Income Tax Act, 1961 (‘the Act’), the ‘firm’ shall have the meaning assigned to it in the Indian Partnership Act, 1932, and shall include a limited liability partnership (LLP) as defined in the Limited Liability Partnership Act, 2008.
Partners in exchange for their service/capital receive the following from the firm:
a. Share of profit
c. Interest on capital or loan
Income of the firm is offered to tax at the following rates:
|A. Net Taxable Income||30%|
|B. Add: Surcharge if net taxable income exceeds INR 1 crore.||12%|
|C. Total tax including A & B||A+B|
|D. Add: Health & Education cess on C||4%|
The firm’s losses shall be carried forward by the firm and shall not be allocated to the partner.
This article discusses the tax implications of the above payments in the hands of both the firm and its partners under the Act.
The profit of the firm is taxed in the hands of the firm. Therefore, the partner's share in the total profit of the firm is exempt from tax in the hands of the partners as per section 10(2A) of the Act.
Payment of salary, commission, bonus or remuneration (by whatever name called) shall be treated as remuneration paid to the partners.
If the remuneration paid to partners is within the permissible limits as per section 40(b): The firm can claim a deduction from its taxable income, and the same shall be taxable in the hands of the partners.
If the remuneration exceeds the permissible limits: The firm cannot claim it as a deduction and shall be liable to pay tax. However, it will be exempt in the hands of the partner receiving such remuneration under the head 'Profits & Gains of Business or Profession.'
Conditions for claiming deduction under section 40(b)
The remuneration paid by the firm to its partners can be claimed as deduction from the total income of the firm as per section 40(b) of the Act provided the following conditions are fulfilled:
It is pertinent to note that deduction of remuneration is not allowed if the firm’s income is offered to tax on a presumptive basis under section 44AD or 44ADA under the Act.
The permissible limits specified under section 40(b)
Remuneration paid to all partners must be within permissible limits. Otherwise, the deduction of such payment will not be allowed to the firm.
The limit applies to the total remuneration of all partners collectively and not individually.
The permissible limit is as under:
a. If book profit is negative: INR 1,50,000
b. If book profit is positive: Remuneration allowed on book profit basis is as under;
|On the first INR 3 lacs of book profit:||On balance book profit|
|i) INR 1.5 lacs or INR 1.5 lacs
ii) 90% of the book profit xxx whichever is more
|60% of book profit|
E.g. If the book profit is INR 15 lacs, the remuneration permissible is calculated below:
|Book Profit||Permissible limits of remuneration|
|On the first three lacs of book profit||
a. INR 1.5 lacs or
b. INR 2.7 lacs (90% of INR 3 lacs),
c. whichever is more
d. Therefore, INR 2.7 lacs
|On the balance book profit||INR 7.2 lacs (60% of INR 15 lacs - INR 3 lacs)|
|Remuneration allowed as per section 40(b)||INR 9.9 lacs|
Calculation of Book Profits
|Profit as per Profit & Loss a/c||XXX|
|Add: Remuneration and interest paid to Partners only if debited to Profit & Loss a/c||XXX|
|Add: Brought forward business loss||XXX|
|Add: Deduction under section 80C to 80U only if debited to Profit & Loss a/c||XXX|
|Less: Income under house property, capital gain, other sources only if credited to profit and loss a/c||(XXX)|
|Less: Interest up to 12% as per section 40(b)||(XXX)|
TDS on remuneration
The firm is not required to deduct the tax at source under section 192- ‘TDS on Salary’ in respect of such remuneration paid. The same shall be treated as the partner’s income under the head 'Profits & Gains of Business or Profession'(section 28(v)) and, therefore, does not fall under the head ‘Salaries.’
The interest paid by the firm to its partners on their capital or loan shall be allowed as deduction in accordance with section 40(b) of the Act.
If the interest paid exceeds the permissible amount, the firm cannot claim it as a deduction and will have to discharge tax on such excess amount. However, such excess amount will be exempt in the hands of the partner receiving such interest under the head 'Profits & Gains of Business or Profession.'
Permissible amount and conditions for claiming deduction
The Act restricts the amount of interest paid to partners to 12% per annum simple interest. Any amount over 12% shall be disallowed as an expense. Unlike in the case of remuneration, the firm can make interest payments to both working and non-working partners. However, the same should be authorised by the partnership deed and should not relate to a period before the date of the partnership deed.
It is pertinent to note that deduction of interest is not allowed if the firm’s income is offered to tax on a presumptive basis under section 44AD or 44ADA under the Act.
Further, it is to be noted that the interest received by the firm from the partners on their drawings cannot be set off against the interest paid by the firm to the partners on capital/ loan.
Interest received in a representative or individual capacity
A partner in a representative capacity is an individual who is a partner in a firm on behalf of, or for the benefit of, any other person. E.g. A partner representing his HUF shall be called a partner in a representative capacity. The taxability of interest received by them shall depend on whether it is received in a representative capacity or their individual capacity. The tax positions are summarised as under:
|Partner in a representative capacity||Interest received in an individual capacity||The limit of section 40(b) is not applicable, i.e. interest more than 12% is allowed, but it should be reasonable.|
|Partner in an individual capacity||Interest received in a representative capacity|
TDS on Interest
Section 194A(3)(iv) excludes the payment of interest by the firm to its partners explicitly from the ambit of TDS. Therefore, TDS is not required to be done on such payments.
The Partnership Act, 1932 and The Limited Liability Partnership Act, 2008 does not place any restrictions on the payment of remuneration or interest to the partners. However, the Income Tax Act, 1961 lays down certain limits and conditions for availing deduction of such payments made for income tax purposes. The significant conditions are summarised below:
|Particulars||Deduction of remuneration||Deduction of interest|
|Payment to||Working partners||Working or non-working partners|
|Permissible amount|| For the first 3 lacs book profit: INR 1.5 lacs or 90% of INR 3 lacs, whichever is more
For the balance book profits: 60% of balance book profits
|12% per annum simple interest|
|Authorisation of payment||Authorised by the partnership deed and does not relate to a period before the date of the deed|
|Others||No deduction shall be allowed if the firm is assessed to tax on a presumptive basis under section 44AD or 44ADA of the Act.|
|TDS||No tax is required to be deducted at the source|
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