Section 40b Of Income Tax Act

Section 40(b) Of Income Tax Act AY 2020-21 | Remuneration and Interest to Partner Section 40b

Section 40(b) Of Income Tax bare Act Ay 2020-21: Section 40(b) of the Income Tax act, 1961 places some restrictions and conditions on the deduction of expenses by a firm in relation to the remuneration and interest payable to the partners. No capital expenditure or personal expenses are allowed and all the remuneration paid must be only and exclusively for business purposes. The remuneration is disallowed if the tax is paid on a presumptive basis under section 44AD. When remuneration if interest is disallowed it implies that it is not allowed as a deduction in the calculation of the net taxable profit. The partner can be paid through other means such as cash.

The various steps involved in the payment of remuneration and interest to the partner are as follows:

Section 40b Of Income Tax Act Calculation of Book Profit

Section 40b Of Income Tax Act Book profit is the net profit mentioned in the profit & loss account, increased by the amount of remuneration paid to or payable to the partners and is allowed as deduction in the profit & loss account. Book profit is computed in the following ways-

  • Net profit as per the profit & loss account
  • Add the amount of remuneration if already debited
  • Deduct the interest if not deducted previously
  • Make adjustments for expenses as per section(28), 44D.

If the amount of remuneration is expressed as expense in the hands of the firm, it will be taxable in the hands of the partner and if it is not expressed as expense in the hands of the firm, the amount of remuneration will not be taxable.

Interest Payable to Partners

For the interest payable to partners, the following conditions must be fulfilled-

  • The interest payable to the partners should be authorised and in accordance with the partnership deed.
  • The interest payable to the partners must not be from a retrospective effect. The period should be at a date falling after the time of the partnership deed.
  • The rate of interest payable should not exceed 12% simple interest per annum.

Partner in a Representative Capacity

If any individual who is a partner in the firm in a representative capacity on behalf of and for the benefit of another person and not in his personal capacity is paid interest by the firm in his personal capacity and not as a representative partner, will not be a subject to the conditions prescribed for allowance.

Computation of Income Of Partner Of A Firm

The partner’s share in the total income of the firm will be calculated as follows-

Total Income of the firm = Partner’s share in the profit of firm as per partnership deed / Total profit of the firm

The partner’s share in the total income of the firm will not be included in his total income and will be exempt in his hands.

Section 40(b) Of Income Tax Act for AY 2020-21

Certain conditions and guidelines are specified for the payment of remuneration to the partner by the firm. These are guided by Section 40(b) of the Income Tax Act.

As per Section 40(b) of the Income Tax Act 1961, Interest and salary paid to partners by the partnership firm can be deducted as an expense only if all the conditions mentioned below are being adhered to.

Remuneration Paid to Partners

The payment of remuneration, salary, bonus, commission or by whatever name called is allowed only in the case of a working partner. If the remuneration paid is to a non-working partner, it shall be disallowed. A working partner is actively engaged in the business activities of the firm of which he is a partner.

Also, the payment of remuneration should not exceed the below-mentioned limits.

Particulars Salary Allowed
On the first 3,00,000 of book profits or in a case of loss. Rs. 1,50,000 or at the rate of  90% of the book profit.
On the balance of the book profits At the rate of 60%

In case, the remuneration exceeds the limits mentioned above, it will be disallowed. The computation of net profit as shown in the P&L A/c for the previous year and increased by the aggregate remuneration paid or payable to the partners if such amount had been deducted while computing the net profit.

Payment of Interest to Partners

The payment of interest to any partner, whether working or non-working should not exceed the amount calculated at the rate of 12% p.a. simple interest. If the amount exceeds the limit it shall be disallowed.

The interest paid by the firm to the partners is allowable as per section 40(b) of the Income Tax Act, 1961. The interest received by the firm from the partners on their drawings is in the hands of the firm as income under the head Profits & Gains of Business or Profession is taxable and shall not be netted off.

If the partnership deed specifically authorizes the payment of interest on a fixed capital account, the current capital account and loan account, then the interest paid by the firm on their fixed capital account, the current capital and loan account to its partners is allowable as a deduction to the firm.

Mentioned in the Partnership Deed

The payment of remuneration to a working partner by the firm should be authorized by and should be in accordance with the terms and conditions of the partnership deed. Also, this amount will be allowed to be claimed as a deduction if the partnership deed specifies the amount payable to each individual working partner or it specifically lays down the manner of quantifying the remuneration.

The partnership deed should not provide for payment of remuneration from a retrospective effect. The payment of remuneration or interest should be at a date falling after the time of the partnership deed.

Conclusion on Section 40b

This guide and information are applicable to the financial year 2018-2019. Here we discussed the conditions that are required to be fulfilled in relation to the payment of remuneration to the partners by the firm. The partnership deed specifying the further details is of utmost importance and it should not mention payment of remuneration or interest in a retrospective interest. The amount of remuneration payable should be in a period after the date of the partnership deed.

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