The Income Tax Department has laid out a host of very specific guidelines regarding the remuneration paid out to the partners in an LLP. While LLP compliance is relatively straightforward, it behaves any partner in one to pay attention to the few requirements there are.
An LLP is a business entity that offers the combined benefits of partnerships and private limited companies. It comprises partners who share limited liability for the enterprise.
What are the returns?
Since it is such an essential aspect of running any business, rules regarding how the remuneration is paid are mentioned in the LLP agreement itself. Each partner will, therefore, want maximum investment return for their efforts, and so, partners must know about the kinds of returns available so that they can balance the agreement in the right way. Here are the three most prominent forms of returns when dealing with an LLP.
- Interest on capital
- Profit share
Types of Returns Explained
This phrase includes everything from bonuses and commissions to the base salary that a partner or employee receives. Usually, it is paid to partners who take an active effort in helping the LLP grow and expand. It is a form of payment that is proportional to the work being done and doesn’t have much connection to the capital produced by them at the onset of the partnership.
This is a form of payment that has direct connections to the capital introduced by them at the start of building the business. It does not have anything to do with their current work. Each partner must have contributed a share or percentage of the total capital needed at the time of starting the partnership, and their interest return is a fixed share of this amount. Hence, the interest they receive will be some percentage of this amount they have invested themselves.
This return is available when the LLP starts making a profit or turns cash positive. This form of return takes into consideration both the amount of work they have put in and the capital they have earlier invested. As soon as the LLP begins to make money, the profit is analysed and split into chunks according to work done, and capital introduced and then split amongst the partners accordingly.
Eligibility to Receive Returns
Which partners get returns and which doesn’t is purely decided on by the clauses registered in the LLP agreement. Even if a partner is working, inactive, sleeping, active or non-working, if it is specifically mentioned in the LLP agreement that they are to receive a percentage of the profit or interest, then they must be given that amount irrespective of whether they deserve it or have done any work. But, this being said, there is a maximum limit on remunerations given out by the LLP as per the Income Tax Act. Also, the LLP agreement cannot provide any remuneration or return retrospectively to a time before the agreement was in force.
Amount deductible under the Income Tax Act:
- The deduction is possible only if the remuneration is received by a working partner or individual
- The payment of remuneration must be duly authorised and registered within the LLP agreement
- The payment due must not exceed the amounts stated below
- If a partner has received more remuneration than what is detailed below, that excess amount is not valid for any deduction and tax must be paid on it
- The remuneration received by the partners is taxed as Business Income. Share of profit is not included in the same section as remuneration
- For both working and non-working members, the share of profit returns is exempted as per Section 10(2A) of the Income Tax Act
- Interest received on the capital invested by them is also taxed as Business Income
- Also, for the first three lakhs earned, remuneration cannot exceed ₹1,50,000 or 90% of book profit, whichever adds up to be more
- When in balance with profit, the remuneration cannot exceed 60% of the book profit earned by the LLP
- The interest obtained by the LLP on drawings from partners is charged as profits and gains of business as far as taxation is concerned
- An LLP will be taxed the same way a partnership is. This means their income is liable to be taxed at 30%. However, LLPs are not eligible for the benefits of Section 44AD, which allows firms not to keep books if their income falls below 8% of the total gross
- As the LLP does not distribute dividends like a company, it is not eligible for any laws under the dividend distribution tax.
- The maximum interest rate permissible under the Income Tax Act is 12%.
- Above this share, anything received by the partners is taxable.
- The LLP Agreement must clearly specify what the exact interest rate is and how it will be paid.
What incomes are not allowed any deductions?
Not all types of income received from an LLP are allowed tax deductions. Here’s a look at the types of income that do not receive any reduction.
- Salary and remuneration received by non-working partners
- Remuneration received by partners in cases where it goes against what is mentioned and authorised in the LLP agreement
- If remuneration aligns with what is mentioned in the agreement, but relates to a much older piece of the deed, and does not comply with the modified deed
- If returns from interest surpass 12% per annum
- Remuneration paid exceeds the limits set by the Income Tax Act.