Partners remuneration and interest
Partners remuneration and interest Section 40(b) of the Income Tax Act imposes certain restrictions and conditions on the deductions allowed for expenses incurred by a partnership firm in relation to the remuneration and interest payable to its partners. Partners remuneration and interest These deductions for partner salaries and interest payments are subject to monetary limits specified under section 40(b) and can only be claimed if certain conditions are met. Partners remuneration and interest Before claiming any deduction for partner salary/remuneration or interest payable, the following conditions must be satisfied by the partnership firm.
Interest and remuneration must be paid to working partners.
Partners remuneration and interest For a partner to receive interest and remuneration, they must be actively involved in the operations of the partnership firm, known as a working partner. Partners remuneration and interest A working partner is someone who actively participates in managing the business rather than merely sharing in the profits. Partners remuneration and interest If a partner is not actively engaged in the firm’s affairs, any remuneration paid to them will not qualify for deduction under section 40(b) of the Income Tax Act, 1961. Partners remuneration and interest Explanation 4 to section 40(b) defines a working partner as an individual actively involved in managing the business or profession of the firm in which they are a partner.
Remuneration or interest payable to partners must be authorised by the partnership deed.
According to section 40(b), deductions for salary, remuneration, bonus, commission, or interest payable to partners are only permitted if authorised by the partnership deed. If these provisions are not outlined in the partnership deed, the deductions claimed by the partnership firm may be disallowed.
Specification of remuneration for partners in the partnership deed is mandatory.
The CBDT, in its Circular No. 739 dated March 25, 1996, clarified that deduction under section 40(b)(v) will only be allowed if the partnership deed either specifies the amount of remuneration payable to each individual working partner or outlines the method for quantifying such remuneration.
Therefore, it is necessary for the partnership deed to include quantification of remuneration to be considered as authorised by the partnership deed and to prevent any Partners remuneration and interest disallowance under section 40(b). Partners remuneration and interest It is observed that in numerous instances, the partnership deed includes clauses similar to the following
If the partnership deed contains a clause stating that the remuneration to a working partner will Partners remuneration and interest be determined based on the provisions of section 40(b)(v) of the Income Tax Act and will be mutually agreed upon between partners at the end of the year, then the remuneration to partners may be subject to disallowance under section 40(b) according to the aforementioned circular.
In the case of Commissioner of Income Tax Versus M/s. In the case of Anil Hardware Store [2010] 323 ITR 368 (HP), where the remuneration clause in the partnership deed was in accordance with section 40(b) of the Income Tax Act, the revenue contended that. It was argued that even though the partnership deed mentioned “upto Rs.50,000/- or 90% of the book profits” for profits up to Rs.75,000/-, it did not exactly specify the remuneration. However, it was held that the CBDT circular requires either the specified amount of remuneration or the manner of quantifying it to be specified. In this case, the manner of fixing the remuneration of the partners was specified, and hence the deduction was allowed.
No interest and remuneration to partners shall be allowed if it pertains to any period preceding the date of such partnership deed.
According to section 40(b)(iii), remuneration will be eligible for deduction only for the period during which the partnership deed authorises such remuneration. Therefore, if a partnership deed is executed on April 1, 2009, without authorising the payment of remuneration to the partners, and subsequently amended by a subordinate partnership deed to provide for such authorization on April 1, 2010, then remuneration to partners will not be allowed for the period between April 1, 2009, and April 1, 2010, as it is not authorised by the deed during that period.
Remuneration exceeding the limit prescribed under section 40(b) will be disallowed for partners.
As per section 40(b)(v), any payment of remuneration to any partner who is a working partner, authorised by and in accordance with the terms of the partnership deed, and relating to any period after the date of such partnership deed, will be disallowed if the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as follows:
(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 percent of the book-profit, whichever is more.
(b) On the balance of the book-profit at the rate of 60 percent.
Any interest to any partner exceeding 12% will be disallowed.
According to Section 40(b)(iv), any payment of interest to any partner, which is authorised by and in accordance with the terms of the partnership deed, and relates to any period after the date of such partnership deed, will be disallowed if the amount exceeds the calculated amount at a rate of 12% simple interest per annum. Partners remuneration and interest
Therefore, deductions for payment of simple interest to any partner are allowed only up to 12% per annum as per Section 40(b). Even if the partnership deed authorises a higher rate of interest than 12% to any partner, the excess interest will not be deductible.
It should be noted that while remuneration or salary is allowable only to working partners as per Section 40(b)(iii), payment of interest not exceeding 12% per annum is allowable to any partner, whether working or not, as the term “any partner” is used in Section 40(b)(iv). According to Explanation 1 to Section 40(b), if 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, other than as a partner in a representative capacity, shall not be considered for the purposes of Section 40(b). Partners remuneration and interest However, interest paid by the firm to such an individual as a partner in a representative capacity, and interest paid by the firm to the person so represented, shall be considered for the purposes of this clause.
Conclusion
Section 40(b) of the Income Tax Act lays down provisions regarding the deduction of expenses related to remuneration and interest payable to partners in a partnership firm. These deductions are subject to various conditions, including the requirement for authorization in the partnership deed and limitations on the amounts that can be deducted.
Partners remuneration and interest Remuneration must be quantified and authorised in the partnership deed, and it is allowed only for working partners. Similarly, interest payments are allowed up to 12% per annum, irrespective of whether the partner is working or not. However, interest paid to a partner in a representative capacity is treated differently. It is important for partnership deeds to comply with these provisions to avoid disallowance of deductions under Section 40(b).
SOURCES: https://cleartax.in/s/partner-remuneration-taxation
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