Section 40b of Income-tax Act- (AY 2020-21) Remuneration and Interest paid to Partners

Under the Income Tax Act, Salary, Bonus, Interest, or Remuneration paid to a working partner is an allowable expense, which is subject to certain limits. If it is paid to a non-working partner, the same shall be disallowed. Under this post, we will discuss the provision contained under section Section 40b of Income tax Act.

Section 40b of Income tax Act

Interest on the capital of working partner and Remuneration in the form of salary, bonus, or commission paid to the partners is allowed as a deduction to a partnership firm under section 40b of Income Tax Act, 1961.

However, there are certain limits up to which such deduction is available to allow as allowable expenditure under the Act. Amount paid above the limit is not allowed as a deduction to the partnership firm. Here we are going to discuss section (40b) in two parts-

A) Limit of Remuneration paid to partners.

B) Limit of Interest paid to partners.

Remuneration paid to partner

The Remunerations paid to partners include salary, bonus, and commission. The maximum limit of remuneration for allowable deduction is given as under-

Book ProfitThe maximum amount of deduction allowable as remuneration
On first Rs. 3 Lakh of book profits, or In case of lossRs. 1,50,000 or 90% of book profit, whichever is more
On the balance of book profit60% of the book profit

Also read- Tax Audit Limit For AY 2020-21 | FY 2019-20- Know about Tax Audit u/s 44AB of The Income Tax Act

For calculation purpose, it can be understood with an example-


👉 Book Profit of a partnership firm is Rs. 9 Lakh

👉 Maximum remuneration allowable as per section 40b of Income Tax Act = 3 Lakh*90% + 6 Lakh*60% = 6.3 Lakh

Note- 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 and profession” and if such remuneration is not allowed as expenses in the hands of partnership firm then it will not be taxable in the hands of partners.

Calculation of Book Profit

Now the question is how to calculate book profit and the solution is here-

Profit as per profit & loss a/c***
Add- Remuneration paid to partners (if debited to P & L A/c)***
Add- Brought forward business loss, deduction u/s 80C to 80U, only if debited to profit & loss a/c***
Less- Income under the head House Property, Capital Gain, Other Sources (if credited to profit and loss a/c)***
Book Profit for the purpose of section 40b of Income Tax Act***

Must Read- Section 80D of Income Tax Act- Know the Deduction Limit for AY 2020-21

Interest on Capital paid to Partners

As per section 40b of Income Tax Act, the maximum allowable interest is 12%. p.a. on the partner’s capital.

However, for claiming the deduction of interest paid on a partner’s capital, the following condition must be satisfied-

👉 Payment of interest can be made to working or non-working partners.

👉 Payment of Interest must be authorized by the partnership deed and it should be related to the period of partnership deed. If there is another deed for another period then such provisions shall be considered for that particular period.

👉 The rate of interest should not be exceeded 12%, if the amount of interest exceeds 12% of the capital then such amount shall be disallowed.

👉 If tax is paid on presumptive taxation basis e.g section 44AD or section 44ADA then interest will not be allowed.

👉 If the firm receives interest on drawings from partners then it is taxable in the hands of the firm.

Also Read-

🎯 Section 44AD of Income Tax Act- Presumptive Scheme

🎯 Section 44ADA of Income Tax Act- Presumptive Scheme for professionals

Important points to be considered

There are some important points which needs to be considered while applying the above-mentioned provisions, the same is given as under-

👉 Such remuneration should be paid only to the working partners.

👉 It should be authorised by the partnership deed.

👉 It should not pertain to a period prior to the Partnership Deed.

👉 It should not exceed the permissible limit as given above.

👉 No TDS is to be deducted by the partnership firm on salary or interest paid or credited to partners. TDS is not required to be deducted even when such salary or remuneration is taxable in the hands of the partner.

👉 A 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.

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Disclaimer: The information contained in the above article are solely for informational purpose after exercising due care. However, it does not constitute professional advice or a formal recommendation. The author does not own any responsibility for any loss or damage caused to any person, directly or indirectly, for any action taken on the basis of the above article.

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Compiled by- CA Chirag Agarwal (Practicing Chartered Accountants)

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