of Income Tax Act places some restrictions and conditions on the deductions of expenses
available to an assessee assessable as a partnership firm in relation to the remuneration
and interest payable to the partners of such firm. The deductions regarding salary
to partners and any payment of interest to partners cannot exceed
the monetory limits specified u/s 40(b) and are available subject to the fulfillment
of conditions mentioned therein.
conditions must be satisfied before claiming any deduction in respect of salary/remuneration
or interest payable to partner by a partnership firm.
to be paid must be a working partner:
The partners of a partnership firm whose accounts are to be credited with the salary,
remuneration, commission, bonus or by whatever name called, by the firm, must be
working partners and not the silent partners. Working partner in general terms means
the partner who is actively engaged in the business of the partnership firm and
is not a partner for merely enjoying the profits/benefits of the partnership business.
If a partner is not a working partner then remuneration to such partner will not
be eligible for deduction as per section 40(b) of Income Tax Act 1961. Explanation
4 to section 40(b) provides meaning of working partner as an
individual who is actively engaged in conducting the affairs of the business or
profession of the firm of which he is a partner.
or interest must be authorized by the Partnership Deed:
As per section 40(b) only that salary, remuneration, bonus, commission etc payable
to working partners or any payment of interest payable to any partner will be allowed
as deduction only if it is authorized by the partnership deed. If the partnership
deed doesnot contain such provisions then the such deductions may be disallowed
if the same is claimed by the partnership firm.
of remuneration is must: CBDT
in its circular no. 739 dt 25/03/1996 have clarified that no deduction under section
40(b)(v) will be admissible unless the partnership deed either specifies the amount
of remuneration payable to each individual working partner or lays down the manner
of quantifying such remuneration.
Thus quantification of remuneration is required
to be there in the partnership deed for it to be considered as authorized by the
partnership deed and to avoid any disallowance u/s 40(b). It is seen that in many
cases the partnership deed contains clauses like the following
The partners have agreed that the remuneration
to a working partner will be the amount of remuneration allowable under the provisions
of section 40(b)(v) of the Income-tax Act and the amount of remuneration to working
partner will be as may be mutually agreed upon between partners at the end of the
If such a clause is contained in the partnership
deed then remuneration to partners may be disallowed as per section 40(b) in view
of the above circular.
Commissioner of Income Tax Versus M/s. Anil
Hardware Store  323 ITR 368 (HP) where remuneration clause in partnership
deed was in line with section 40(b) and It was contended on behalf of the revenue
that in respect of the profits upto Rs.75,000/-, even in the partnership deed, the
word upto Rs.50,000/- or 90% of the book profits have been used which shows that
the partnership deed does not exactly determine the remuneration of the partners.
But it was held that The CBDT circular referred to above lays down two conditions.
Either the amount of remuneration payable should be specified or the manner of quantifying
the remuneration should be specified. In the present case, the manner of fixing
the remuneration of the partners has been specified. Hence deduction was allowed.
No Remuneration to be allowed which relates
to any period falling prior to the date of such partnership deed:
As per section 40(b)(iii) the remuneration
will be allowed as deduction only for that period onwards wherefrom the partnership
deed authorizes such remuneration. Thus if a Partnership deed is executed on 01-04-2009
which doesnot authorizes payment of remuneration to the partners
and subsequently the deed is amended by a subordinate partnership deed to provide
for such authorization on 01-04-2010 then remuneration to partners will not be allowed
for period between 01-04-2009 to 01-04-2010 since during that period it is not authorized
by the deed.
Remuneration exceeding the limit prescribed
u/s 40(b) to be disallowed:
As per section 40(b)(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 will
on the first Rs.3,00,000 of the book-profit or in case of a loss
or at the rate of 90 per cent. of the book-profit, whichever is more;
on the balance of the book-profit
the rate of 60 per cent.
Explanation 3 to section 40(b)
defines "book-profit" as to mean 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
Any interest to any partner exceeding 12% disallowed:
As per Section 40(b)(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 12[twelve] per cent simple interest
per annum shall be disallowed. Thus payment of any simple interest to any partner
is allowed only to the extent of 12% per annum as deduction as per section 40(b).
Even if the partnership deed authorizes any payment of higher rate of interest than
12% to any partner, the excess of interest will not be deducted.
It is here to be noted that where remuneration/salary
etc is allowable only to the working partners as per section 40(b)(iii) but payment
of interest not exceeding 12% per annum is allowable to any partner whether working
or not, since the word any partner is used in 40(b)(iv).
As per explanation 1 to section 40(b)
where an individual is a partner in a firm on behalf, or for the benefit, of any
other person(i.e Partner in a representative capacity), 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 section 40(b);
But 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
Explanation 2 to section 40(b) further provides
that 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.
Amit Bajaj Advocate,
Bajaj & Bajaj Advocates,