When it comes to claiming deductions in partnership firms, Section 40(b) of the Income Tax Act plays a crucial role. This section outlines the rules for allowing remuneration & interest paid by a firm to its partners. But it’s not as straightforward as it sounds.
Let’s break it down in simple terms — what it covers, the conditions for deductions, & common mistakes that can land you in trouble with the tax department.
🔍 What is Section 40(b) of Income Tax Act?
Section 40(b) of the Income Tax Act governs the conditions & limits for deducting partner remuneration & interest paid to them by the partnership firm. While these are legitimate business expenses, they aren’t automatically allowed as deductions.
So, yes, it contemplates the allowance of remuneration paid by a firm to its partners, but with strict checks and balances. "
🧾 What is Allowed Under Section 40(b)?
Here’s what a firm can deduct under this section:
- Remuneration to working partners – Salaries, bonuses, commissions, etc., provided the partnership deed authorises them.
- Interest paid to partners – The Maximum allowable rate is 12% per annum.
So if you’re paying a partner interest at 15%, the extra 3% won’t be allowed as a deduction."
📌 Conditions for Claiming Deductions Under Section 40(b)
To claim these deductions, the firm must meet specific conditions:
- The partnership deed must authorise the payment of interest or remuneration.
- The working partner must be actively involved in the business.
- The amount paid should not exceed the prescribed limits set under Section 40(b).
- Business expenses are not allowed as deductions if they don’t meet the above.
Failing any of these? Be ready for a disallowance during assessment.
🧮 Limits for Remuneration – Quick Reference Table
|
Book Profit (₹) |
Maximum Deductible Remuneration |
|
On the first ₹3 lakh |
₹1.5 lakh or 90% of book profit (whichever is higher) |
|
On the balance amount |
60% of the remaining book profit |
Note: This applies only to working partners.
❗ Interest on Capital to Partners – Capped at 12%
Many firms casually mention 15% or even 18% interest in their deeds. But here’s the catch — Section 40(b) allows firms & companies to claim a deduction of interest only up to 12%. Anything beyond that becomes a disallowed expense.
💡 Common Mistakes That Lead to Disallowance
- Vague partnership deed – Not mentioning exact remuneration terms.
- Paying interest to non-working partners – Not allowed.
- Paying before executing a deed – Payments made without a valid agreement won’t qualify.
- Changing terms mid-year without updating the deed – Not acceptable.
Always review your deed & align it with Section 40(b) compliance.
🧠 Why Is This Section Important for Tax Planning?
Section 40(b) isn’t just a compliance point. It can help reduce your firm’s tax liability, provided you follow the rules. Remuneration & interest are great tools to allocate firm income efficiently between partners & the firm itself — just don’t cross the legal thresholds.
🧾 Real-Life Example
Suppose a firm has a book profit of ₹10 lakh & two working partners. The maximum allowable remuneration would be:
- 90% of ₹3 lakh = ₹2.7 lakh
- 60% of ₹7 lakh = ₹4.2 lakh
Total eligible remuneration = ₹6.9 lakh
Anything paid beyond this limit won’t be allowed as a deduction under Section 40(b).
✅ Final Thoughts
In conclusion, Section 40(b) is your best friend if used correctly — & your worst enemy if you mess it up. The rules are clear: only pay what’s authorised, stay within limits, & always document it properly.
Thinking of revising your partnership deed or confused about whether your remuneration is deductible? Don’t take chances.
👉 Want to stay compliant & optimise your tax deductions smartly? Let our experts at Callmyca.com handle your firm’s taxes with precision. Book your consultation now & save yourself from future tax headaches.
