1. Introduction
In this article we shall deliberate on the issue, whether GST is applicable on payments of salary, interest on capital, share of profit and other payments by a partnership firm to its partners.
The Indian Partnership Act 1932 defines a partnership as a relation between two or more persons who agree to share the profits of a business run by them all or by one or more persons acting for them all.
Thus sharing of profits should be the intent while forming a partnership. Generally apart from share of profits, salary and interest on capital also is paid by the partnership firm to its partners.
Under Income Tax Act, 1961, the deductions regarding salary to partners and any payment of interest to partners cannot exceed the monetary limits specified u/s 40(b) and are available subject to the fulfillment of conditions mentioned therein viz payment to working partner, authorization and quantification in partnership deed.
Lets start our deliberations on applicability of GST on payment to partners.
2. GST on Partners Salary
Confusion generally arises about treatment of GST in regard to partners salary, whether it will be regarded as supply of service or not by the partner to the firm.
It may be noted that salary paid in regard to services rendered by an employee to the employer in course of or in relation to his employment is not treated as supply of services as per Para 1 of Schedule-III of the CGST Act,2017. Thus no GST is applicable on salary to employees.
Now the question arises as to whether a partner can be regarded as employee or not in order to apply exclusion of Para 1 of Schedule-III on salary paid to the partners.
In this regard it is important to note that in the case of CIT v R. M Chidambram Pillai (1976) Supreme Court has held that partner is not an employee of the firm. The firm is not a legal person and there cannot be a contract of service between a firm and one of its partners, since contract of employment requires two distinct persons, viz employer and employee. A man cannot be his own employer. It was accordingly held by SC in this case that partner salary is only profit known by different name.
In view of above, a partner is not an employee and thus salary of partner cannot be covered under GST exclusion under Para 1 of Schedule-III of the CGST Act,2017.
Does it mean that partners salary would be subject to GST. For arriving at the answer we need to see the substance of payment of salary to partner.
As objective of a partnership is sharing of profits and the payment of partner salary is made by a firm out of its profits (appropriation of profit) , such payment is nothing but a share of profit in the firm which being a transaction / application of money will not be exigible to GST.
2.1 Advance Ruling:
Karnataka AAR vide order dated 04.05.2020 pronounced in Advance Ruling No. KAR ADRG 30/2020 against the application filed by Anil Kumar Agrawal has inter-alia examined the issue of treatment under GST law of partners salary and held that GST is not applicable on partners salary.
The deliberation was made at para 7.7 of the order of AAR which is reproduced below:-
The applicant is in receipt of certain amount termed as partner’s salary from the firm where the applicant is also a partner. The applicant has not furnished any documents relevant to the issue, such as copy of agreement, appointment order etc, so as to decide whether the applicant is employee of the partnership firm or not. In case the applicant is a working partner and is getting salary then the said salary is neither supply of goods nor supply of service in terms of clause 1 of Schedule III of CGST Act 2017. Further, in case if the applicant is in receipt of the amount towards his share of profit from the said partnership firm, then also the said income is not under purview of GST as the share of profit is nothing but application of money and hence the said salary is not required to be included in the aggregate turnover for registration under the provisions of GST Act.
The reasons given by Karnataka AAR non applicability of GST on partners salary is that such services are outside scope of supply in terms of clause 1 of Schedule III of the CGST Act, 2017 (working partner equated to an employee ) or else it being a share of profit and being transaction in money, which has been excluded from definition of good as well as service.
Though as per Supreme Court decision cited supra a partner cannot be treated as employee. However still , GST will not be applicable on partner’s salary it being a share of profit and nothing but application of money.
2.2 Will Partner’s salary be included in aggregate turnover of the partner:
As per Section 22 (1) of the CGST Act, 2017 a person is required to obtain GST registration in case its aggregate turnover exceeds Rs 40 lakhs / 20 lakhs / 10 lakhs. For details Click here.
Now question arises whether the salary received by partner will be included in the aggregate turnover , as it covers exempt supplies which include non-taxable supplies as well.
In this regard it may be noted that partner salary received by a partner being a non-supply / outside scope of supply will not be included in its aggregate turnover for the purpose of determining the registration requirement of such partner.
3. GST on Interest on Capital to partners
As per Income Tax Act, 1961, maximum interest @ 12% can be given on capital infused by partners in the partnership firm. Now question arises in regard to applicability of GST on such interest paid.
The interest on capital is paid out of profits earned by the partnership firm as per clauses in the partnership deed. Accordingly such interest is in substance nothing but share of profit and being transaction in money / application of money, it shall be outside the scope of supply. Accordingly no GST shall be applicable on interest on capital paid by the partnership firm to its partners.
Further as discussed supra, interest on partner capital being outside scope of supply, same shall also not be included in the aggregate turnover for the purpose of determining the registration requirement of the partner.
However it may be noted that if a partner is earning interest on FDR from Bank same will be included in aggregate turnover , it being an exempt supply which forms part of aggregate turnover.
4. GST on Share of profit
As per Ruling of Karnataka AAR as discussed supra that the share of profit is nothing but application of money and hence will not be taxable under GST law.
Further as money is excluded from the definition of goods (Sec 2(52) of the CGST Act) and services (Sec 2(102) of the CGST Act) and thus distribution of share of profit by a firm to its partners would be non-supply / outside scope of supply and thus would not be included in the aggregate turnover of the partner.
5. Concluding remarks
All kinds of payments to partners viz salary, interest and share of profit, made by the partnership firm out of its profits, would not be exigible to GST. It is suggested that such payments are regulated through the partnership deed to avoid issues both under Income Tax and GST Law.
It may however be noted here that GST would very much be applicable on other supplies by partner to its firm like partner giving its commercial premises on rent to the partnership firm.
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Frah Saeed is a law graduate specializing in the core field of indirect taxes and is the Co-founder of taxwallah.com. She has authored many publications on GST and is into full-time consultancy on GST to big corporates. She as a part of taxwallah.com heads a team comprising of Chartered Accountants and Advocates and plays a key role in our mission to disseminate GST knowledge to all.
