When running a partnership firm, understanding the finer points of how partners are compensated is important.
Among the various financial terms used, "partner’s salary" and "partner’s remuneration" are often the source of confusion.
While both terms relate to the compensation paid to partners for their services, they are distinct concepts, each with specific tax and legal implications.
Let’s understand the key differences between the two, and why it matters for compliance and financial planning in a partnership firm.
What is a Partner’s Salary?
Partner’s salary refers to a fixed amount that a partner receives for the services they provide to the partnership firm.
This salary is predetermined and is agreed upon in the partnership deed—the document that governs the operation and functioning of the partnership.
The partner’s salary is paid for the work performed in the firm, such as managing day-to-day operations or overseeing specific projects.
This is similar to a salary paid to an employee, but in the case of a partner, it is a distribution of the firm profits, subject to certain limits as laid out by tax laws.
Partner’s salary is not dependent on the profits of the firm, unlike the distribution of profits which can vary depending on the firm’s financial performance.
From a taxation perspective, the salary paid to a partner is treated as income, and the partner is liable to pay tax according to the individual tax slabs.
The firm, in turn, can claim the salary paid as an expense under Section 40(b) of the Income Tax Act, subject to the prescribed limits.
What is Partner’s Remuneration?
Partner’s remuneration is a broader term that encompasses not just the salary but any additional payments that a partner may receive for their work or contribution to the partnership firm.
This includes bonuses, commissions, and incentives that vary depending on the firm’s profitability or the partner’s performance.
While a partner’s salary is fixed, remuneration can fluctuate based on the firm’s financial health or individual achievements. For instance, if a partner brings in a large client or significantly contributes to increasing the firm’s profits, they may receive extra remuneration as a reward for their efforts.
Like salary, remuneration is also subject to tax as income. However, the calculation of remuneration can be more complex, as it may include performance-based payments that vary from year to year.
The Role of the Partnership Deed in Salary and Remuneration
One key point to note is that both partner’s salary and remuneration must be clearly defined in the partnership deed.
The partnership deed serves as the foundational document for the operation of the firm and outlines how profits, losses, and other compensation—including salary and remuneration—are to be distributed among the partners.
Without a partnership deed, a firm cannot legally pay a salary or remuneration to its partners, as there would be no legal framework or agreed-upon terms.
Thus, partners need to agree on the terms of compensation, including the amount, method of calculation, and payment frequency, and document them in the partnership deed.
Also Read: What is a Limited Liability Partnership (LLP) in India?
Key Differences Between Partner’s Salary and Remuneration
While both salary and remuneration serve as compensation for a partner’s services to the firm, they differ in several significant ways:
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Nature of Payment: A partner’s salary is a fixed, regular payment made to a partner, similar to an employee’s salary. In contrast, remuneration includes both fixed payments and variable components like bonuses or commissions, which depend on individual or firm performance.
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Basis of Calculation: Salary is generally calculated as a fixed sum, while remuneration can include bonuses or other forms of additional compensation that are tied to the performance or achievements of the partner.
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Tax Treatment: Both salary and remuneration are taxable as income, but the way they are taxed can differ. Remuneration may be subject to different tax treatments depending on the nature of the payments (e.g., performance-based bonuses may be taxed differently than a fixed salary).
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Accounting Treatment: From the firm’s perspective, the salary paid to a partner is deducted as an expense, subject to the limits set by the Income Tax Act. Remuneration, being more varied, may have different accounting treatments depending on its components.
Legal and Tax Provisions for Partners
Under the Income Tax Act, both salary and remuneration paid to partners are subject to specific legal and tax provisions.
Section 40(b) of the Income Tax Act specifies the limits and conditions under which salary and remuneration can be paid to partners, allowing the firm to claim tax deductions for such payments.
Partner’s Salary: The salary paid to a partner can be claimed as a deduction by the firm if it is specified in the partnership deed. However, there are limits to how much a firm can pay as a salary. For example:
- If the firm’s book profits are less than ₹3 lakh, it can pay up to ₹1.5 lakh as remuneration to all partners combined.
- If the firm’s book profits exceed ₹3 lakh, the remuneration can be a percentage of the firm’s profits—up to 90% of the book profit, depending on the number of partners in the firm.
Partner’s Remuneration: Remuneration, being a broader term, includes both fixed salary and performance-based payments like bonuses.
These payments also have to comply with the limits set by Section 40(b) of the Income Tax Act. However, because remuneration includes more components than salary, the calculation of allowable deductions can be more complex.
Statutory Limits and Calculation of Remuneration
As mentioned earlier, Section 40(b) sets statutory limits on the salary and remuneration that can be paid to partners.
For example, in a partnership with two or more partners, the total salary and remuneration paid should not exceed the following:
- 90% of the firm’s book profit, if the firm’s book profit is above ₹3 lakh, provided the total remuneration for all partners does not exceed this percentage. In firms with a turnover exceeding ₹10 crore, these limits may differ, and it is essential to consult with tax professionals to determine the exact limits and deductions.
These limits ensure that the payments made to partners are reasonable and do not excessively burden the firm’s finances while also ensuring that partners are fairly compensated for their contributions.
Latest Updates: Budget 2024
The Budget 2024 introduced changes to partner compensation:
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TDS on Partner Payments: A 10% TDS (Tax Deducted at Source) will apply to partner payments exceeding ₹20,000 annually.
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Revised Remuneration Limits: Working partners can now receive up to ₹6,00,000 on the first ₹6,00,000 of book profit, effective from April 2025.
These updates call for firms to adjust their compensation structures to remain compliant with new tax regulations.
Example: Calculating Partner’s Salary and Remuneration
Let’s take an example for better clarity.
Suppose a partnership firm has a total book profit of ₹8 lakh in a financial year. According to the partnership deed, Partner A is entitled to a fixed salary of ₹2 lakh, while Partner B receives a base salary of ₹1.5 lakh and a 10% bonus on the firm’s profits.
In this case:
- Partner A will receive a fixed salary of ₹2 lakh, which is fully deductible by the firm, subject to the limits under Section 40(b).
- Partner B’s base salary of ₹1.5 lakh is also fixed and deductible, while their 10% bonus (₹80,000) will be considered as remuneration and subject to performance-based deductions or taxation.
Tax Deductions for the Firm
Both partner’s salary and remuneration are deductible by the partnership firm, reducing the firm’s taxable income.
However, this is only true if the payments are within the prescribed limits. If the payments exceed the limits set under Section 40(b), the excess amount will not be deductible, meaning the firm will have to pay tax on the amount that exceeds the legal limits.
It’s important to note that while both salary and remuneration are taxable for the partner, the firm gets the benefit of deductions, which lowers the firm’s overall tax liability.
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Stay Clear, Stay Compliant!
While the terms partner’s salary and partner’s remuneration may seem interchangeable at first, they are distinctly different in their nature, calculation, and tax treatment.
Understanding these differences is important for both the partners and the firm to ensure legal compliance, appropriate tax deductions, and fair compensation for everyone involved.
By ensuring that the partnership deed clearly defines both salary and remuneration and by staying within the legal limits set by the Income Tax Act, firms can structure their compensation models effectively while avoiding tax complications
Understanding these key differences can help partners and firms make informed decisions and maintain healthy financial practices.
