Can the firm deduct the salary, interest or commission it pays to partners?

A partnership firm can pay its partners a salary, interest on capital or a commission if the partnership deed says so, but it cannot treat those payments as expenses when it works out its taxable income. The Income Tax Ordinance adds them back, so the firm pays tax on its profit before any partner’s drawings.

What does the law say?

Section 21 lists deductions that are not allowed in computing income under the head “Income from Business”. Its opening words say that, except as otherwise provided in the Ordinance, no deduction is allowed for any of the items that follow.

Clause (j) of that list is:

any profit on debt, brokerage, commission, salary or other remuneration paid by an association of persons to a member of the association

Section 80(2)(a) says an association of persons includes a firm, and section 92(1) taxes an association of persons separately from its members. Read together, a firm computes its own business income, and clause (j) stops it from reducing that income by what it pays to partners.

What does clause (j) cover?

The clause lists five kinds of payment:

Payment to a partner	Caught by clause (j)?
Monthly salary to a working partner	Yes, “salary”
Interest or mark-up on a partner’s capital or loan	Yes, “profit on debt”
Commission on sales a partner brings in	Yes, “commission”
Brokerage paid to a partner	Yes, “brokerage”
Bonus, fee or allowance to a partner	Yes, if it is “other remuneration”

The clause turns on who is paid. It applies only to payments to “a member of the association”. Salary paid to staff who are not partners, or interest paid to a bank, is outside clause (j) and is tested under the ordinary rules for business expenses.

How does it work in practice?

The firm’s accounts may show partners’ salaries and interest as charges against profit, because the partnership deed provides for them. For tax, the firm adds those amounts back when it computes income under the head “Income from Business”. Tax is then worked out on the higher figure at the rates for associations of persons.

What each partner takes home is a matter between the partners. The tax computation does not change whether the firm calls the payment salary, interest or a share of profit.

Worked example (illustrative figures)

Hassan and Iqra run a printing firm in Rawalpindi. The deed gives each working partner a salary of Rs. 100,000 a month and 10% interest on capital. Hassan has Rs. 3,000,000 of capital in the firm and Iqra Rs. 2,000,000. For tax year 2027 the firm’s accounts show:

Item	Rs.
Profit before partners’ salary and interest	7,000,000
Less: partners’ salaries (2 x Rs. 100,000 x 12)	(2,400,000)
Less: interest on capital (10% of Rs. 5,000,000)	(500,000)
Profit shown in the accounts	4,100,000

For tax:

1. Start with the accounting profit: Rs. 4,100,000.
2. Add back partners’ salaries under section 21(j): Rs. 2,400,000.
3. Add back interest on capital under section 21(j): Rs. 500,000.
4. Business income of the firm: Rs. 4,100,000 + Rs. 2,400,000 + Rs. 500,000 = Rs. 7,000,000.

The firm is taxed on Rs. 7,000,000, the same figure it would have had with no salary or interest at all.

What if …?

What if a partner’s family member works in the firm? If that person is not a member of the association, clause (j) does not apply to their salary. Whether the salary is allowed then depends on the general deduction rules and the other clauses of section 21.

What if a company is one of the partners? A company member is still “a member of the association”, so payments to it under clause (j) are not deductible either. The first proviso to section 92(1) separately excludes the company’s share of income from the AOP’s total income.

What if the partner has lent money on paper as a loan, not capital? Clause (j) says “any profit on debt”, without distinguishing capital from loans. Interest on either kind of balance, paid to a member, is covered.

Common mistakes

• Treating the partnership deed as deciding the tax. The deed can fix salaries and interest between partners. Section 21(j) still disallows them for the firm’s income tax.
• Assuming only “salary” is caught. The clause also names profit on debt, brokerage, commission and “other remuneration”.
• Reading clause (j) as a ban on paying partners. It only removes the tax deduction. It does not stop the firm from paying.
• Assuming the partner’s side is settled by clause (j). The clause is about the firm’s computation. How the payment is treated in the partner’s own return is not stated in sections 21 or 92.

What to check in the official text

Read the opening words of section 21 and clause (j), and section 92(1) with its provisos. Check the rest of section 21 for other disallowances that may apply to payments to non-partners. The rates at which the firm’s income is then taxed are in Division I of Part I of the First Schedule and are covered on a separate page.