In all most all the partnership agreements ,provision for salary is included and amount of Partner remuneration is decided with mutual consent .However Income Tax act does not allow full amount of partner's salary as expense. A formula /% of book profit is allowed as partner's remuneration .There are some conditions also which are to be complied to claim deduction of salary as expense in P & L account of partnership firm.Partner's Salary is dealt under Section 40(b) of the Income Tax Act 1961.

Conditions are defined in section 40(b) of the income tax act.
  1. Salary must be paid to working partner only.
  2. Salary must be written/authorised by the Partnership deed and must be quantified.
  3. Salary must be related to the period after the partnership deed date.
  4. Salary allowed under income tax act will be limited to  of % of Book profit as given below .

Salary here means: salary ,commission ,remuneration (or any name whatever name called)

Now detail of each condition.

1. Working partner: salary to sleeping partner is not allowed .and working partner definition has been given in explanation 4 of the section 40(b)
  • working partner means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner
Working partner in general terms means the partner who is actively engaged in the business of the partnership firm and is not a partner for merely enjoying the profits/benefits of the partnership business. If a partner is not a working partner then remuneration to such partner will not be eligible for deduction as per section 40(b) of Income Tax Act 1961. 

2.Salary must be written/authorised by the Partnership deed:To claim the expense of salary of partner in p& L salary should be authorised by the partnership deed and it should also be according to the conditions/terms defined in the partnership deed.
  • Clause in partnership should be clear and 
  • amount should be defined.

Board has issued a Circular : No. 739, dated 25-3-1996. also related to clause in partnership deed for salary to partners

Whether for assessment years subsequent to assessment year 1996-97, no deduction under section 40(b)(v) will be admissible unless partnership deed either specifies amount of remuneration payable to each individual working partner or lays down manner of quantifying such remuneration

1. The Board have received representations seeking clarification regarding dis allowance of remuneration paid to the working partners as provided under section 40(b)(v) of the Income-tax Act. In particular, the representations have referred to two types of clauses which are generally incorporated in the partnership deeds. These are :

(i) The partners have agreed that the remuneration to a working partner will be the amount of remuneration allowable under the provisions of section 40(b)(v) of the Income-tax Act; and

(ii) The amount of remuneration to working partner will be as may be mutually agreed upon between partners at the end of the year.

It has been represented that the Assessing Officers are not allowing deduction on the basis of these and similar clauses in the course of scrutiny assessments for the reason that they neither specify the amount of remuneration to each individual nor lay down the manner of quantifying such remuneration.

2. The Board have considered the representations. Since the amended provisions of section 40(b) have been introduced only with effect from the assessment year 1993-94 and these may not have been understood correctly the Board are of the view that liberal approach may be taken for the initial years. It has been decided that for the assessment years 1993-94 to 1996-97 deduction for remuneration to a working partner may be allowed on the basis of the clauses of the type mentioned at 1(i) above.

3. In cases where neither the amount has been quantified nor even the limit of total remuneration has been specified but the same has been left to be determined by the partners at the end of the accounting period, in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of the firms income.

4. It is clarified that for the assessment years subsequent to the assessment year 1996-97, no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.

The above circular is very clear so ,from ay 1996-97 onwards amount should be defined in the partnership deed.

However the above circular is held ultra virus to Act provision in Commissioner of Income Tax Versus M/s. Anil Hardware Store [2010] 323 ITR 368 (HP).

3.Salary should be related to the period after the partnership deed date: The salary as per partnership deed should be after the partnership deed.If payment is related to period earlier than the date of partnership deed ,then it will be disallowed as expense.

4.Salary must be with in limit of % of Book profit.: As per section following % has been defined with in which salary can be claimed for partners.% chart is given below

Latest rates applicable for calculation of Partner's salary .(applicable to FY 2012-13 ,13-14)
  •  Common rate for both type of Firm whether covered under 44AA or not 
  • On the First three lakh of the Profit or In case of Loss: 150000 or 90 % of profit which ever is more
  • On balance profit:60% of the profit

Profession notified under section 44AA
  • legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration ,profession of authorised representative, the profession of film artist (actor, cameraman, director, music director, art director, dance director, editor, singer, lyricist, story writer, screen play writer, dialogue writer and dress designer),Profession of Company Secretary,Profession of Information Technology.
Calculation Of book Profit.

Explanation 3 to section 40(b) defines “book-profit” as to mean the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.Step by step calculations .
  1. Take profit as per P& L account.
  2. Add back salary given to partners if debited in p& L earlier.
  3. Make adjustment for expenses allowed/disallowed as per section 28- 44D.
  4. If expenses /Income of other head like house property or income from other source,capital gain has been debited /credit then reverse back the such amount from profit & loss account.
  5. As the depreciation b/f is covered under section 32(2) ,so adjustment should be made for b/f depreciation to calculate the book profit but adjustment can be done only up to maximum of profit of current year before depreciation minus b/f loss of the previous years .





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