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INCOME TAX QUESTIONS & ANSWERS SERIES PART - VII

Sub: Sections 40(b)(v) & 40A(2)(a) of the Income Tax Act, 1961

Dear Friends,

Today we are going to consider problem based on provisions of Sections 40(b)(v) & 40A(2)(a) of the Income Tax Act, 1961.

PROBLEM: M/s. X & Co., a partnership firm consisting of three partners enhanced working partners salary from Rs. 25,000/- to Rs. 50,000/- per month for each partner. The increase was in accordance with terms and conditions of Partnership Deed /authorised by Partnership Deed.

The Assessing Officer during course of assessment contended that the remuneration paid to working partners @Rs 50,000/- per partner per month is excessive and applied Section 40A(2)(a) though the payment was within statutory limit as specified in Section 40(b)(v). Whether action of AO is right ?

Whether AO disallowed increase in remuneration within terms of Partnership Deed

LET'S CONSIDER APPLICABLE SECTIONS OF IT ACT, 1961

SECTION 40(b)(v) provides that: Remuneration to Partners 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 authorized 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:

(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 per cent. of the book-profit, whichever is more;

(b) on the balance of the book-profit at 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 net profit.

SECTION 40A(2)(a) deals with powers of disallowance of expenditure on related party by Assessing Officer

Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub- section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction:

 

ANSWER TO ABOVE QUERIES

The facts of the case are similar to the facts in CIT Vs. Great City Manufacturing Co.(2013) 351ITR156, wherein the High Court observed that Section 40(b)(v) prescribed the limit of remuneration to working partners , and deduction is allowable up to such limit while computing the business income. If remuneration pad is within the ceiling limit provided under Section 40(b)(v) , then recourse to provisions of Section 40A(2)(a) cannot be taken.

The Assessing Officer is only required to ensure that the remuneration is paid to the working partners mentioned in Partnership Deed, the terms and conditions of the Deed provided the payment of such remuneration to the working partners and the remuneration is within the limits prescribed under Section 40(b)(v) of the Act, 1961. If these conditions are complied with ,then the AO cannot disallowed any part of remuneration on the ground that it is in excess or it is excessive.

 

In view of the bone judgement , the increased remuneration ,which is authorized by the Partnership Deed and is within limits specified under Section 40(b)(v) and paid to working partners , cannot be disallowed by invoking provisions of Section 40A(2)(a) of the Income Tax Act, 1961.

The action of Assessing Officer n above mentioned case was not appropriate.

DISCLAIMER: The above write up is an attempt to share information and knowledge with our readers. The view expressed here are the personal views of the author and same should not be considered as a professional advice. It is advisable to consult with your tax consultant before acting on any part of this article.

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