Section 40b determines the maximum amount of remuneration and interest on capital payable to a partner under Income Tax Act. The amount over the specified limit is not allowed as a deduction to a partnership firm.
Remuneration to Partners
Remuneration includes salary, bonus, commission .Remuneration in partnership firm is allowed as a deduction if following conditions are satisfied
- Remuneration is allowed only to working partners.
- Remuneration must be authorised by partnership deed and according to the terms of partnership deed. Also the amount of salary or manner of its computation is to be mentioned in the deed. If there is not any such provision in deed then no deduction is allowed. Normally people mentions in deed that salary is allowed to partners as per maximum limit defined under this section. This clause satisfies the condition for quantum of deduction.
- It should be related to the period of the partnership deed. If there is another partnership deed for another period then such deed’s provisions will be considered for that period.
- It is not allowed if tax is paid on presumptive basis under section 44AD or section 44ADA.
- Remuneration should be within the permissible limits as mentioned below. Please note that this limit is for total salary to all partners and not per partner.
|Amount deductible as remuneration under section 40(b)
|If book profit is negative
|If book profit is positive- On first Rs. 3 lakh of book profit On the balance of book profit
|Rs. 1,50,000 or 90% of book profit whichever is more 60% of book profit
Calculation of book profit
Profit as per Profit & Loss a/c – xxx
Add- Remuneration to partners if debited to Profit and loss a/c
Add- Brought forward business loss, deduction under section 80C
to 80U if debited to profit and loss a/c
Less – Income under house property, capital gain, other
sources if credited to profit and loss a/c
Book Profits xxx
Book profit = Rs. 9 Lakhs
Maximum allowed salary = 3,00,000*90% + 6,00,000*60% = Rs. 6.3 lakhs
Remuneration which is allowed as expenses in the hands of partnership firm will be taxable in the hands of receiving partner as “Income from Business or Profession”.
If such remuneration is not allowed as expense in hands of partnership firm then it will not be taxable in the hands of partners.
Interest on Partner’s Capital
For deduction of interest following conditions must be satisfied –
- Payment of Interest can be made to working or non-working partner.
- Payment of Interest must be authorized by the partnership deed and It should be related to the period of the partnership deed. If there is another partnership deed for another period then such deed’s provisions will be considered for that period.
- The rate of interest should not exceed 12%. If the amount of interest exceeds 12% of the capital then such excess amount is disallowed.
- It is not allowed if the tax is paid on presumptive basis under section 44AD or section 44ADA.
- If a person is a partner in a firm on behalf or for the benefit of any other person then any interest paid to such person otherwise as a representative capacity shall not be taken into account for the purpose of this section. Interest paid to such person as a representative capacity and to person so represented is taken into account.
- If interest is paid to a partner on behalf or for the benefit of any other person then such interest is not disallowed under this section.
- If the firm receives interest on drawings from partner then it is taxable in the hands of the firm.
When it is said that remuneration or interest is not allowed, it means that it is not allowed as deduction for calculating net taxable profit. The firm can still pay it to the partner in cash, there is no restriction on it under partnership act.
The amounts which are deductible as remuneration or interest in the hands of the firm under section 40b are taxable in the hands of the partner which are receiving such amounts under the head Profit from business/profession. However, if the amount is disallowed in hands of firm, then such amounts are exempt in the hands of partner.
No TDS is to be deducted by partnership firm on salary or interest paid or credited to partner. TDS is not required to be deducted even when such salary or remuneration is taxable in the hands of partner. For more information, you can read – TDS on Salary to Partners
A partnership firm is assessed as a firm for income tax purpose when some conditions are fulfilled – Section 184
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.