The following conditions must be satisfied before claiming any deduction in respect of salary/remuneration or interest payable to partner by a partnership firm.

Partner 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.

Remuneration 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.

Quantification 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 year.

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.

However In Commissioner of Income Tax Versus M/s. Anil Hardware Store [2010] 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 be disallowed:

                     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 net profit.

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 clause.

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,
Jalandhar city
Email: amitbajajadvocate@hotmail.com
Webpage: http://amitbajajadvocate.blogspot.com/
M +919815243335