Most of the partnership firms includes clause related to partners salary in their partnership treaty. Salary to partner can be amount specified or agreed by the partners and as specified in the partnership deed. However for income tax purpose the salary paid to the working partner needs to be calculated as defined under section 40(b). Salary calculated as per section 40(b) is allowed expenditure for the purpose of calculating the taxable income of the partnership firm. Before moving to see the section 40(b) provisions and its actual calculation let us understand some concepts related to book profit and the partner.
Book Profit means Net profit of the partnership firm after giving the true effect of section 28 to 44D added back by any partners salary debited to profit and loss account. For the purpose of giving the effect of section 28 to 44D following should be noted;
- Income which are chargeable under other head of income shall be excluded from net profit
- Any brought forward losses shall not be deducted from net profit
- Any deduction under chapter VIA shall not deducted from net profit
The resulted amount of profit is book profit for the purpose of section 40(b).
Working Partner means a partner of the firm who is actively engaged in conducting the affairs of the firms. Active participation shall include but not restricted to planning, organizing, directing, staffing and controlling the core business activities viz. marketing, production, finance and human resources etc. In other words any partner who does not work on routine basis for the affairs of the partnership firm is not an Working Partner for the purpose of section 40(b).
There are few conditions also which are to be fulfilled to claim the deduction of partner’s salary as expense while computing the taxable income of the partnership firm as per section 40(b). The conditions are as follows;
1. Partners Salary shall be paid to working partners only
Salary paid to working partner is only allowed to claim as deduction under section 40(b) of the Income Tax Act, 1961. Salary paid to other than working partner is not allowed. Any partner who is merely enjoying the profits and not actively engages himself in routing affairs of the firms is not a working partner for the purpose of section 40(b).
2. Partners Salary shall be authorized by the partnership deed
Any payment to working partner by whatever name called whether Commission, bonus, salary will not be allowed unless it is authorized by the partnership deed. It should also be in accordance of the payment outline as per the partnership deed.
For claiming the deduction of partners salary, quantum of deduction shall also be mention in the partnership deed. The partners salary clause should not be left undecided, undermined or to be decided basis refer to case Sood Briji & Associates vs. CIT.
3. Partners Salary shall be for the period after the commencement of partnership firm
All such payments shall be post the partnership existence. In other words any payment prior to partnership comes in existence would not be allowed as deduction.
4. Partners Salary shall not exceed the limits specified under section 40(b)
Section 40(b) defines the limits for the purpose of deduction of partner’s salary while calculating the taxable income of the partnership firms. This limits are applicable to both professional firm and non-professional firm. Also there is no specific difference between limited liability partnership.
From Assessment year 2010-11 onwards
|Book profit||Maximum Amount deductible|
|If the book profit is negative||Rs. 1,50,000|
|a. In case of positive book profita. On first Rs. 3 lakhsb. On the balance of the book profit||Higher of Rs. 1,50,000 or 90%60% of balance book profit|
Up to Assessment year 2009-10 onwards; Before AY 2010-11, the limits were defines separately for professionals and non-professionals.
In case of professional firm
|a. On first Rs. 1 lakhs of book profit or in case of loss||Higher of Rs. 50,000 or 90% of book profit|
|b. On the next Rs. 1,00,000 of the book profit||40% of balance book profit|
|c. On the balance of the book profit||60% of next Rs. 1 laks|
In case of any other firm
|a. On first Rs. 75,000 of book profit or in case of loss||Higher of Rs. 50,000 or 90% of book profit|
|b. On the next Rs. 75,000 of book profit||60% of next Rs. 75,000|
|c. On the balance of the book profit||40% of balance book profit|