To form a partnership firm in India, two or more individuals can come together by signing a contract, popularly known as partnership deed. These individuals are known as partners.
Based on your contract or agreement, as a partner, you are liable to tax for following incomes allowed as tax deductions to a partnership firm while calculating tax liability.
- Share of profit
- Interest on capital
- Salary, bonus, commission or any remuneration
Share of Profit
Share of profit from a partnership firm after allowing deductions for interest, salary, bonus, commission or remunerations paid to partners shall be fully exempted from tax in the hands of partners.
It’s exempted because on this profit the partnership firm has already paid tax.
After calculating firm’s profit, it will be distributed according to the percentage and terms and conditions of the agreement or deed. Share of profit has to be divided in sync with the Partnership agreement.
It’s mandatory to mention your share of profit and loss in the Partnership deed.
If you don’t mention it then interest, salary, bonus, commission or remuneration to partners will not be allowed as tax deductions while calculating firm’s tax liabilities.
Interest on partner’s capital
Interest on partner’s capital is tax deductible if this term and condition has been included into the partnership deed.
Section 40(b) has also mentioned a maximum ceiling limit to claim interest on capital as tax deduction for a partnership firm.
As per this section, interest on partner’s capital is allowed as business expenditure up to a maximum simple rate of interest of 12%.
This means if a firm is paying interest on capital at a rate higher than 12%, then amount of interest paid over and above the rate of 12% will not be allowed as expenditure while calculating taxable business income. Only interest at the rate of 12% will be allowed as tax deductible.
In above case, partners have received the whole interest as per partnership deed. Out of the amount received, 12% as allowed tax deductible to firm will be taxable in the hands of partners. The balance left out, which is not allowed as tax deductible to firm, will not be taxed in the hands of partners.
In cases where the interest rate is less than or equal to 12%, the whole amount paid towards interest on capital is tax deductible to the partnership firm and as such taxable in the hands of the partner.
Salary, bonus, commission or remuneration
Salary, bonus,commission or remuneration to partners is allowed as tax deduction up to a maximum permissible limit calculated based on the book profit as arrived by the firm based on the conditions to section 40(b) of income tax act,1961.
You can read our earlier article on how to calculate maximum permissible remuneration allowed as tax deduction to a firm.
If salary, bonus, commission or remuneration to partners are not allowed as tax deductible expenditure, then the whole disallowed amount will not be taxable in the hands of the partners.
If a portion of the salary, bonus,commission or remuneration is disallowed, then only that portion which is disallowed to the firm will not be taxable in the hands of partners. The balance which is allowed as tax deductible expenditure, is taxable in the hands of partners.
Above discussions can be summarized in below points;
- If the whole amount towards interest, salary, bonus, commission or remuneration to partners are allowed as tax deduction while calculating firm’s business income, then the whole amount is chargeable to tax in the hands of partners.
- If a portion of the whole amount towards interest, salary, bonus, commission or remuneration is not allowed as expenditure to the firm, then the portion not allowed will not be taxable in the hands of partners. The portion of the whole amount allowed as tax deductible to the firm is taxable in the hands of partners.
- Share of profit is not taxable in the hands of partner
