Interest and Remuneration paid or payable to partners under Sec 40B

Introduction-

Section 40(b) of Income Tax Act provides some specific conditions for payment of Remuneration includes salary, bonus, commission etc. and Interest paid to partners.

Conditions-

1. Remuneration includes salary, bonus, commission etc. is allowed when it is clearly mentioned in Partnership deed made under Partnership Act.
2. No Interest & Remuneration to partners are allowed, if it’s related to any period falling prior to the date of such partnership deed
3. Remuneration paid to working partners only are allowed as deduction, subject to the limit prescribed under Section 40(b) of Income Tax Act.
4. Remuneration paid to non-working partners (i.e. sleeping partners) is disallowed under income tax.
5. Interest paid to partners whether working or non-working (sleeping partner) are allowed to the extent of 12%, if it is clearly mentioned in the partnership deed.
6. It is not allowed if tax is paid on presumptive basis Under section 44AD or Under section 44ADA

Limit prescribed under section 40(B) for remuneration paid to working partners- If any remuneration paid to working partners in the form of commission, bonus or salary etc. is allowed maximum to the extent as under-

1. In case of loss (book profit is negative)- Rs. 1,50,000
2. In case of book profit up to Rs. 3 lakhs - Rs 1,50,000 or 90% of book profits* (whichever is higher)
3. On the balance book profit- 60% of book profits*.

* Book Profits means

• Net Profit as calculated after debiting expenditure like remuneration (like salary, commission, bonus etc.) and Interest paid or payable to partners
• Remuneration (Salary, Bonus, Commission etc.) paid or payable to Partners (if debiting profit & loss account earlier)
• Interest paid or payable to Partners (if debiting profit & loss account earlier)

(If the firm has Profit and not paying Remuneration & Interest to partners)

Example 1-

M/s XYZ & Co., partnership firm have three working partners or having net profit during the financial year 2017-18 is Rs. 5,00,000. If the said firm has not paid any Interest or Remuneration to partners during the financial year. So, what is the eligible amount under section 40(b) to pay as remuneration to their partners, if it is allowed under partnership deed of the said firm?

Answer-

1. On first 3 lakhs Book profit- Maximum of Rs. 1,50,000 or Rs. 2,70,000 i.e. (90% of Rs. 3,00,000) comes to Rs. 2,70,000. 
2. On balance of book profits- 60% of Rs. 2,00,000 (Rs. 5,00,000- 3,00,000) i.e. Rs. 1,20,000
3. Total Amount eligible for remuneration under section 40(b) is Rs. 2,70,000 + 1,20,000 = Rs. 3,90,000/- 

(If the firm has loss and not paying Remuneration & Interest to partners)

Example 2-

M/s XYZ & Co., partnership firm have three working partners or having net loss during the financial year 2017-18 is Rs. 3,00,000. If the said firm has not paid any Interest or Remuneration to partners during the financial year. So, what is the eligible amount under section 40(b) to pay as remuneration to their partners, if it is allowed under partnership deed of the said firm?

Answer-

In case of loss- Maximum of Rs. 1,50,000 or Rs. 0 i.e. (90% of Rs. minus3,00,000) comes to Rs. 1,50,000.

(If the firm has Profit and paying Remuneration & Interest to partners)

Example 3-

M/s XYZ & Co., partnership firm have three working partners or having net profit during the financial year 2017-18 is Rs. 5,00,000 after allowing remuneration to partners of Rs. 3,00,000 and Interest of Rs. 2,00,000 during the financial year. So, what is the eligible amount under section 40(b) to pay as remuneration to their partners, if it is allowed under partnership deed of the said firm?

Answer-

Calculation of Book Profit-

Net Profit as per profit & loss account- Rs. 5,00,000

Add: Remuneration paid to partners Rs. 3,00,000

Add: Interest paid to partners Rs. 2,00,000

Total Book Profits- Rs. = 10,00,000 {i.e. Rs. 5,00,000 (net profit) + Rs. 3,00,000 (remuneration) + Rs. 2,00,000 (interest)}

Remuneration allowed under section 40(b)-

1. On first 3 lakhs Book profit- Maximum of Rs. 1,50,000 or Rs. 2,70,000 i.e. (90% of Rs. 3,00,000) comes to Rs. 2,70,000.
2. On balance of book profits- 60% of Rs. 7,00,000 (Rs. 10,00,000- 3,00,000) i.e. Rs. 4,20,000
3. Total Amount eligible for remuneration under section 40(b) is Rs. 2,70,000 + 4,20,000 = Rs. 6,90,000/-

So, the firm has paid remuneration of Rs. 3,00,000 is allowed under Income Tax Act.

 Payment of Interest paid/payable to Partners-

Interest paid to partners whether working or non-working is allowed up to the extent of 12% under section 40(b). Any excess amount paid to partners are disallowed under Income Tax Act. If the firm charged interest on drawings it is taxable in the hands of the firm.

The amounts which are deductible under section 40 (b) as remuneration or interest in the hands of firm are taxable in the hands of partners under the head Profit from business/profession. Otherwise, if the amount is disallowed in hands of firm, then such amount is exempted in the hands of partners.

Example 4-

M/s XYZ & Co., partnership firm have three partners. What is the eligible amount under section 40(b) to pay as interest to their partners, if it is allowed under partnership deed of the said firm?

Answer-

The firm can pay interest to their partners to the extent of 12% allowed under section 40(b) of the Income Tax Act.

Example 5-

M/s XYZ & Co., partnership firm have three partners, Mr. X has balance of Rs. 5,00,000, Mr. Y has balance of Rs. 6,00,000 or Mr. Z have balance of Rs. 5,00,000 as on 01.04.2017. There is no addition or withdrawal during the financial year. The firm has paid Rs. 2,40,000 (i.e. 15% as allowed under partnership deed) to their partners as interest during the financial year 2017-18, Whether it is eligible for deduction under section 40(b)?

Answer-

Under section 40(b) the interest paid to partners are allowed to the extent of Rs. 1,92,000 {i.e. 12% of (Rs. 5,00,000+6,00,000+5,00,000)}. The firm has paid Rs. 2,40,000 so the balance amount Rs. 48,000 (i.e. Rs. 2,40,000- Rs.1,92,000) is disallowed under Income tax.