Partner’s Remuneration, salary & Interest on capital – Section 40b under Income Tax Act

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Partner’s Remuneration, salary & Interest on capital – Section 40b under Income Tax Act

Interest on capital of partner and Remuneration in the form of salary, bonus or commission paid to the partners is allowed as deduction to a partnership firm under section 40b of Income tax, 1961. However, there is certain maximum limit upto which such deduction is available on Partner’s Remuneration and Interest on capital of partners. Amount paid above that limit is not allowed as a deduction to a partnership firm under Income Tax Act.

Remuneration to Partners

Remuneration payable to partners includes salary, bonus, commission. The maximum limit of remuneration allowed as deduction is –

Book ProfitMaximum Amount of deduction availableIn case of loss, or On first Rs. 3 lakh of book profitRs. 1,50,000 or 90% of book profit, whichever is moreOn the balance of book profit60% of book profit

Lets take an example to understand it better. For instance, BabaTax Partnership Firm has paid Rs 7,50,000 of Remuneration to its partners. Its book profit is Rs 10,00,000. The maximum amount of deduction available under section 40b of Income tax, 1961 is-

Book ProfitMaximum Amount of deduction availableOn first Rs. 3 lakh of book profit, higher of –

( Rs 3,00,000 X 90% ), or

Rs 1,50,0002,70,000On the balance Rs 7 lakh of book profit (Rs 7,00,000 X 60%)4,20,000Total6.90,000

Therefore, the excess amount of Partner’s remuneration paid Rs 60,000 (Rs 7,50,000 – Rs 6,90,000) will be disallowed for the calculation of income tax purpose.

However, for claiming the deduction of remuneration, the following conditions must be satisfied-

• Remuneration is paid only to working partners.
• Remuneration must be authorized by partnership deed and consistent with partnership deed.
• Current partnership deed cannot authorize the payment of remuneration for any earlier period.

Correct Calculation of Income Tax for 2019-2020How to Calculate of book profit?

The book profit is calculated as follows-

ParticularAmount in RsProfit as per Profit and Loss a/cxxxAdd- Remuneration to partners, if debited to Profit and loss a/cxxxAdd- Brought forward business loss, deduction under section 80C

to 80U, if debited to profit and loss a/cxxxLess– Income under house property, capital gain, other sources if credited to profit and loss a/cxxxBook Profit xxxTax on Pension : Income from Pension and Family pension in IndiaInterest on Capital of Partners

The maximum amount of interest paid on the partner’s capital allowed as deduction is 12% p.a.

For example, BabaTax firm paid interest @ 15% on the capital of partners. Capital contributed by all partners amounts to Rs 6 lakh. The maximum amount of deduction available under section 40b of Income tax, 1961 is-

ParticularAmount in RsInterest on capital paid (Rs 6,00,000 X 15%)90,000Maximum interest allowed (Rs 6,00,000 X 12%)72,000Interest not allowed as deduction18,000

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

• Payment of Interest must be authorized and consistent with partnership deed.
• Current or New partnership deed cannot authorize the payment of interest for any earlier period.

Advance Tax liability : Calculation, Due dates, InterestImportant points to note

1. Payment of Interest on capital can be made to working or non-working partner. However, Remuneration is paid only to working partners.
2. If the partner makes drawing of fund from firm and firm receives interest on drawings from partner then it is taxable in the hands of the firm.
3. There is no restriction on payment of remuneration or interest under Partnership Act, 1932. However, there is restriction only on calculating net taxable profit for calculating income tax liability under Income tax Act, 1961.
4. No TDS is to be deducted by partnership firm on salary or interest paid or credited to partner.
5. Working partner under Income Tax Act 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.
6. No deduction of Partner’s remuneration and Interest on partner’s capital is available in case of payment of Income tax on presumptive basis under section 44AD or section 44ADA.

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