Payment of Interest, Bonus, Commission or Remuneration by firm to its partners - Section 40(b) - Income Tax - Ready Reckoner - Income Tax

Payment of Interest, Bonus, Commission or Remuneration by firm to its partners - Section 40(b) 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: Payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred as remuneration) is to a working partner. If it is paid to a non-working partner, the same shall be disallowed. 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. 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. The payment of interest to a partner should not exceed not amount calculated at the rate of 12% per annum simple interest (any amount 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 specified in the circular no. 12/2019 , dated 19.06.2019. Maximum permissible deduction for payment of remuneration to working partners:- deduction for payment of remuneration to working partners for both Business as well as professional firms has changed as under:- Book Profit % of amount of deduction (i) Loss or profit upto Rs. 3,00,000 Rs.1,50,000 or 90% of Book Profit whichever is more (ii) on the balance 60% of book profit Notes: - 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 the head Profits Gains of business or profession. 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, then interest on current capital account and loan account shall not be allowed as deduction to the firm. Computation of book profit: Following adjustment should be made to the Net profit under PGBP for computation of book profits: Only the income under the head 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 Account. Interest paid to the partners to the extent it is deductible shall not be added back. Notes:- Where the additional income declared during the survey was held to be income from business, the same shall be taken into consideration for determining the allowable remuneration to the partners. [ CIT v S.K. Srigiri Brothers 2 007 (11) TMI 72 - KARNATAKA HIGH COURT ] Interest from fixed deposit of spare funds which was declared as part of business income and which was accepted by Assessing officer then the same cannot be excluded from book profit for the purpose of determining allowable deduction of remuneration paid to partners. [ CIT v J.J. Industries 2013 (7) TMI 577 - GUJARAT HIGH COURT ]. Where conditions prescribed under section 40(b)(v) are satisfied, the A.O. cannot disallow any part of the remuneration under section 40(A)(2) on the ground that it is unreasonable and excessive. [ CIT Vs. Great City Manufacturing Co. - 2012 (12) TMI 875 - Allahabad HC ] The CBDT had, vide circular No. 739 Dated 25.03.1996 , clarified that no deduction under section 40(b)(v) will be admissiable unless the partnership deed either specifies the amount of remuneration payable to each individual working working partner or Lay down the manner of quantifying such remuneration. Explanation to Section 40(b) Where an individual is a partner in a firm in a Representative capacity receiving interest on Individual capacity , then section 40(b) not applicable on such interest. Where an individual is a partner in a firm in his Individual capacity receiving interest on Representative s capacity , then section 40(b) not applicable on such interest. 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 HUFs too has to be disallowed.