Taxation of Partner’s Salary: Income from Salaries or Business and Profession?

Partners in a partnership firm often receive remuneration for their services to the firm. However, the tax treatment of a partner’s salary is a subject of confusion for many. The question arises: Should a partner’s salary be taxed under Income from Salaries or Income from Business and Profession?

This blog explains the tax implications of salary paid to partners, the relevant provisions under the Income Tax Act, 1961, and the distinction between income from salary and income from business.

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Understanding the Salary of a Partner

In a partnership firm, partners are not considered employees of the firm. Instead, they are co-owners who share in the profits or losses of the business. However, many partnership firms pay a salary to their partners for the work they perform, such as management, supervision, or professional services.

While it may seem like salary, the treatment of a partner’s salary for tax purposes is different from that of a salaried employee.

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Taxability of Partner’s Salary Under Income Tax Act, 1961

The key provision governing the taxation of a partner’s salary is Section 28(v) of the Income Tax Act, 1961, which covers the income of a partnership firm. The taxation is determined based on the nature of the income and the business structure of the firm.

1. Income from Business and Profession

• Partners are not employees, so the salary or remuneration received by them is not considered Income from Salaries.
• Instead, the salary paid to partners is treated as business income under Section 28(v). This means that the firm deducts the salary paid to partners from its total business income before calculating the profits of the firm.
• The salary paid to the partner is considered a business expense for the firm and is deducted from the firm’s gross income while computing taxable income.

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Salary to Partners in the Firm’s Taxable Income

1. Deductibility:
   • The salary paid to a partner is a legitimate expense of the firm and is deductible from the firm’s total income.
   • The deduction is allowed only if the salary is paid according to the partnership deed and the limits specified under the deed.
2. Tax Treatment for Partners:
   • For the partner receiving the salary, the amount is included in their personal income and is taxed under Income from Business and Profession.
   • The salary paid to partners is treated as part of the profit-sharing ratio of the partnership firm and is reported under the head Income from Business or Profession in the partner’s individual tax return.

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Conditions for Salary to Partners

Under the Income Tax Act, the salary paid to partners must meet the following conditions to be deductible for the firm:

1. Payment as per Partnership Deed:
   • The salary must be paid according to the terms specified in the partnership deed. If the partnership deed specifies the salary, it is treated as a valid business expense.
2. Business Structure:
   • The partnership must not be a limited liability partnership (LLP) unless specifically mentioned in the deed, as the tax treatment may differ for LLPs.
3. Limits on Salary:
   • The salary paid to a partner should not exceed the limits specified under the Income Tax Act. For example, the salary should be reasonable and aligned with the services the partner provides.

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Example of Taxation of Partner’s Salary

Scenario 1: Partnership Firm Paying Salary to a Partner

Mr. X is a partner in a partnership firm, and his partnership deed specifies a monthly salary of ₹50,000. The firm’s income for the year is ₹10,00,000.

Firm’s Calculation:

• Gross Income of Firm: ₹10,00,000
• Salary Paid to Mr. X: ₹6,00,000 (₹50,000 per month × 12 months)
• Net Taxable Income of Firm: ₹10,00,000 – ₹6,00,000 = ₹4,00,000

Partner’s Calculation:

• Salary Received: ₹6,00,000
• Taxable under Income from Business and Profession: ₹6,00,000

Scenario 2: Salary Paid to Partner Above the Limits

Mr. Y is a partner in a partnership firm, and the partnership deed specifies a salary of ₹1,00,000 per month. However, the firm’s total income is ₹12,00,000, and the maximum salary a partner can claim under the partnership deed is ₹8,00,000.

• Salary Paid (exceeding the maximum allowed): ₹12,00,000
• Deductible Salary for the Firm: ₹8,00,000
• Excess Salary Paid: ₹4,00,000 will be added back to the firm’s income and taxed accordingly.

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Income Tax Filing for Partners

1. Income from Business and Profession:
   • The salary received by partners is reported as business income in their ITR.
   • The firm will issue a Form 16A (for TDS on salary) or similar statements if TDS is deducted on the salary.
2. Deduction for Salary Paid to Partners:
   • The partnership firm can claim a deduction for the salary paid to partners under the head Income from Business and Profession, provided it is as per the partnership deed.

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Frequently Asked Questions (FAQs)

1. Is the salary paid to partners taxed under “Income from Salaries”?

No, the salary paid to partners is not taxed under Income from Salaries. It is considered business income under Income from Business and Profession.

2. Can the salary paid to partners be deducted from the firm’s income?

Yes, the salary paid to partners is a deductible business expense provided it is stated in the partnership deed.

3. Do I need to pay tax on the salary I receive as a partner?

Yes, the salary received by partners is included in their personal income and taxed under Income from Business and Profession.

4. Can salary paid to partners exceed the partnership deed limits?

No, salary paid to partners must adhere to the limits set out in the partnership deed. If it exceeds the limits, the firm cannot deduct the excess salary as a business expense.

5. How is the salary of a partner treated in a limited liability partnership (LLP)?

In an LLP, the salary to partners is treated differently and is generally taxed as Income from Business or Profession for the partner.

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Conclusion

The salary paid to partners is not taxed under Income from Salaries but is instead considered Income from Business and Profession. Understanding the distinctions and tax implications of salary paid to partners is crucial for both the partnership firm and the individual partners. Ensuring proper documentation and adherence to partnership deed provisions can help optimize tax savings and avoid any potential disputes.

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