Section 40(b) - Payment of interest, salary etc. made by firm to its partners - Income Tax - Ready Reckoner - Income Tax

Section 40(b) : Payment of Interest, Salary, Bonus, commission or Remuneration made by firm to its partners Interest and remuneration paid to the partners by a firm are not deductible. However, the interest and remuneration paid to partners by a firm are deductible if all the following conditions are satisfied: i. Payment of salary, bonus, commission or remuneration, by whatever named called is to a working partner. If it is paid to a non-working partner, the same shall be disallowed. ii. The remuneration shall be admissible only if the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. iii. The payment of remuneration and interest should relate to a period falling after the date of partnership deed. That means, the partnership deed should not provide for payment of remuneration and interest from retrospective effect. vi. Payment of Interest can be made to working or non-working partner. If a firm pays interest to a partner and the partner pays interest to the firm on his drawings, then the interest shall not be netted off. The interest received by the firm from the partners on their drawings is taxable in the hands of the firm as income under head of PGBP. The interest paid by the firm to the partners is allowable as per section 40(b) . Interest paid by the firm to its partners on their fixed capital account, current capital account and loan account is allowable as deduction to the firm provided the partnership deed specifically authorizes the payment of interest on fixed capital account, current capital account and loan account. If the partnership deed authorizes the payment of interest on fixed capital account then interest on current capital account and loan account shall not be allowed as deduction to the firm. The payment of interest to a partner should not exceed the amount calculated at the rate of 12% per annum simple interest (any interest in excess will be disallowed). If interest payable to partners, as per partnership deed, is lower than 12 %, then only interest authorised by partnership deed is deductible, if other conditions are satisfied. [ circular no. 12/2019 , dated 19.06.2019 ] v. The payment of remuneration should not exceed the following amounts (Any amount in excess shall be disallowed) On the first 3,00,000 [6,00,000/- w.e.f. 01.04.2025 Substituted Vide Finance (No. 2) Act, 2024 ] of book profit or in case of loss 1,50,000 [ 3,00,000/- w.e.f. 01.04.2025 Substituted Vide Finance (No. 2) Act, 2024 ] or at the rate of 90% of the book profit, whichever is more. On the balance of book profits At the rate of 60% Following adjustment should be made to the Net Profit under PGBP for computation of Books Profits: Only the income u/h PGBP is to be taken Current year and brought forward depreciation is to be deducted. ( Section 32 ) Brought forward losses will not be deducted. ( Section 72 ) Chapter VI-A deductions are also not to be deducted. Remuneration is to be added back if it is debited to Profit Loss A/c. Interest paid to the partners to the extent it is deductible shall not be added back. CONDITIONS FOR ALLOWABILITY OF REMUNERATION AND INTEREST PAID BY THE FIRM TO ITS PARTNERS S.No Allowability of Remuneration Allowability of Interest 1. To a working partner. To a working/ non-working partner. 2. To an individual only. To any partner. 3. Should be authorized by partnership deed. Should be authorized by partnership deed. 4. In the partnership deed: either specify the amount of remuneration payable to each partner or lay down the manner of quantification of remuneration to each partner. Rate of interest should be specified in the partnership deed. 5. Remuneration should not be retrospective. Interest should not be retrospective. When Recipient of Interest Acts in a Representative Capacity Explanation 1 to Section 40(b) Where an individual is a partner in a firm in a representative capacity, then interest paid by the firm to him in individual capacity, shall not be taken into account for the purposes of Section 40(b) and if the interest is paid to such individual as partner in representative capacity then such interest shall be taken into account for the purpose of this section. Explanation 2 to Section 40(b) Where an individual is a partner in a firm in his individual capacity then, interest paid by the firm to such individual shall not be taken into account for the purposes of Section 40(b) , if such interest is received by him on behalf, or for the benefit of any other person. Note :- Salary paid to partner representing his HUF has to be disallowed, further salary paid to partners in their individual capacity who had joined firm as partners representing their respective HUF s too has to be disallowed. Working partner means an individual who is actively engaged in conducting the affairs of the business of the firm of which he is a partner. Remuneration to partner as well as Interest is not allowed if tax is paid on presumptive basis u/s 44AD or section 44ADA .