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 40b of the Income-tax Act, 1961.
Section 40b of the 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 the 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 as per section 40b
The Remunerations paid to partners include salary, bonus, and commission. There are some important points which needs to be considered while applying provisions of this section, the same is given as under-
| Such remuneration should be paid only to the working partners. |
| It should be authorized 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. |
| 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. |
The maximum limit of remuneration for allowable deduction is given as under-
| Book Profit | The maximum amount of deduction allowable as remuneration |
|---|---|
| On first Rs. 3 Lakh of book profits, or In case of loss | Rs. 1,50,000 or 90% of book profit, whichever is more |
| On the balance of book profit | 60% 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-
Example-
Book Profit of a partnership firm is Rs. 9 Lakh
Maximum remuneration allowable as per section 40b of the 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 according to section 40b of the Income Tax Act
Now the question is how to calculate section 40b book profit and the solution is here-
| Particulars | Amount |
|---|---|
| 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 | *** |
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Interest on Capital paid to Partners
As per section 40b of the 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. |
| If interest is paid to a partner on behalf of or for the benefits of any other person then such interest is not allowed under this section. |
TDS on Interest and remuneration paid to partner as per section 40b of the income tax act
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. The reason of this is here-
Salary of remuneration paid to the partners is not taxable in the hands of partners as salary but it is considered as income from the business. As there is no employer-employee relationship exists between partner and partnership firm hence TDS is not required to be deducted by the partnership firm, and
as per explanation 2 of section 15, “Any salary, bonus, commission or remuneration, by whatever name called due to, or received by, a partner of a firm from the firm shall not be regarded as salary.”
Therefore, no TDS is to be deducted on salary paid to the partners.
Here it is to be noted that salary paid to any partner (working or non-working) is not liable to TDS.
Also Read-
🎯 Section 44AD of Income Tax Act- Presumptive Scheme
🎯 Section 44ADA of Income Tax Act- Presumptive Scheme for professionals
🎯 Section 44AA of Income Tax Act- who is required to maintained books of accounts
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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)