Section 40(b) deals with the allowability of remuneration and interest to partners. Specific conditions need to be fulfilled under section 40(b) to govern the provisions of remuneration to partners:
- Remuneration should be paid only to working partners
- Such payment should be authorised by partnership deed
- It should not pertain to period prior to partnership deed
- It should not exceed the permissible limit.
Note: Section 40(b) defines Working partner as one who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner.
Specific conditions to be fulfilled for Interest payments under section 40(b) are:
- Payments should be authorised by partnership deed
- It should not pertain to period prior to partnership deed
- Rate of interest should not exceed 12% per annum
- Interest payable outside India will not be allowed unless tax has been deducted at source.
- Amount of interest paid in respect of capital borrowed must be for the purposes of the business and profession.
Reference:
As Per 40(b), of the Income Tax Act, 1961-
Amounts not deductible.
- Notwithstanding anything to the contrary in sections 30 to [38], the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”,—
(b) in the case of any firm assessable as such,—
(i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as “remuneration”) to any partner who is not a working partner; or
(ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed; or
(iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorised by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorization for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or
(iv) any payment of interest to any partner which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of [twelve] per cent simple interest per annum; or
(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder :—
| (a) | on the first Rs. 3,00,000 of the book-profit or in case of a loss | Rs.1,50,000 or at the rate of 90 percent of the book-profit, whichever is more; |
| (b) | on the balance of the book-profit | at the rate of 60 per cent |
Provided that in relation to any payment under this clause to the partner during the previous year relevant to the assessment year commencing on the 1st day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment.
Explanation 1.—Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as “partner in a representative capacity” and “person so represented”, respectively),—
(i) interest paid by the firm to such individual otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this clause;
(ii) interest paid by the firm to such individual as partner in a representative capacity and interest paid by the firm to the person so represented shall be taken into account for the purposes of this clause.
Explanation 2.—Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf, or for the benefit, of any other person.
Explanation 3.—For the purposes of this clause, “book-profit” means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.
Explanation 4.—For the purposes of this clause, “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;