Enhanced Limits for Partners Remuneration: Section 40(b) & 194T

Summary: Section 40(b) of the Income Tax Act, 1961, governs the conditions and limits for deducting partner remuneration in a partnership firm’s taxable income. It ensures that only working partners’ remuneration authorized by the partnership deed and within specified limits is deductible. The Finance Act 2024 revised these limits to Rs. 3,00,000 or 90% of the first Rs. 6,00,000 of book profits and 60% for the remaining book profits, effective from April 2025. This revision aims to align with increased business profits. Additionally, Section 194T introduces tax deduction at source (TDS) at 10% on partner remuneration exceeding Rs. 20,000 annually. While this enhances tax transparency and traceability, practical challenges may arise in reconciling taxable remuneration with TDS-deducted amounts, potentially complicating tax filings. For instance, disallowed remuneration under Section 40(b) may still appear on the partner’s Form 26AS despite being taxable in the firm’s hands, requiring careful adjustments.

Section 40(b) of the Income Tax Act,1961 – Enhancing the limit of allowable remuneration in the hands of the partnership firms and Section 194T

Cross Applicability

A partnership firm pays remuneration to its partners in various different forms like Interest on capital, salary, bonus, commission apart from the share of profit. The partnership firms are taxable at the rate of flat 30% on their income and the partners are taxed at slab rates. In order to discourage diversion of taxable profits from the hands of the firm to the partners and thus avoiding the tax, section 40(b) of the Income Tax Act,1961(‘ITA’) has mentioned certain conditions and prescribed a limit, up to which such remuneration shall be allowed as deduction in the hands of the firm. The amount which is allowable as expenditure in the hands of the firm shall be liable to tax in the hands of the partners under the head Profits and gains from business or profession (‘PGBP’).

Understanding section 40(b)

No amount of remuneration paid by a firm shall be allowed as deduction if –

• any payment of salary, bonus, commission or remuneration, is made to a non-working partner or
• any payment of remuneration to a working partner but is not authorised by terms of the partnership deed; or
• any payment of remuneration to a working partner, which is authorised by the terms of the partnership deed, but relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised.
  • For example, a firm paid remuneration to its working partners from April 2023 to March 2024. However, the clause for authorising the payment of remuneration was added on 01^st July 2023. In such case only such remuneration paid for on or after the period from 01^st July 2023 shall be considered for the purposes of allowability under the hands of the firm.
• any payment of interest to any partner which is authorised by the deed, in excess of the amount calculated at the rate of twelve per cent simple interest per annum; or
• 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:

Thus, it implies that remuneration shall be allowed only to the working partners, that is authorized by the deed and for the period after the same is authorized by the deed. Further, it shall be within the abovementioned limit.

For the purposes of this section book profit shall mean – “book-profit” means 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.

Amendment in the Budget 2024

With the increase in the levels of business operations and profits there was a need felt to relook at the maximum limit of allowable remuneration. Thus, the limits are enhanced by the Budget 2024. The revised limits applicable shall be as under –

The rest of the conditions remain similar. Thus, now additional amount of remuneration shall be allowed as deduction while computing its taxable income under the head PGBP.

Insertion of new section 194T – TDS on partner’s remuneration

As per the applicable provisions of ITA, the remuneration paid to the partners is not taxable under the salary head of income and so the section 192 for deduction of tax was not applicable on the partners of a firm. Similarly, the provisions of section 194A of the ITA were not applicable on the interest on capital paid to the partners. Thus, there was no specific section for deduction of tax on the remuneration paid by the firm to the partners.

In the Finance Act 2024, a new section 194T is to added for deduction of tax on remuneration paid to the partners.

Section 194T of the ITA – with effect from 01^st April 2025

Any person, being a firm, responsible for paying any sum in the nature of salary, remuneration, commission, bonus or interest to a partner of the firm, shall, at the time of credit of such sum to the account of the partner (including the capital account) or at the time of payment thereof, whichever is earlier shall, deduct tax thereon at the rate of 10%. Further, tax shall not be deducted where such sum or the aggregate of such sums credited or paid or likely to be credited or paid to the partner of the firm does not INR 20,000 during the financial year.

Thus, with effect from 01^st April 2025 the remuneration, interest, salary, etc. paid to the partners shall be liable to TDS.

This would bring a transparency in the taxability of the remuneration received by the partners and would make it traceable for the revenue.

However, there may be a practical difficulty in reconciling the taxable remuneration with the amount on which tax has been deducted in the hands of the partners. For example, ABC firm paid remuneration of INR 2,50,000 to each of its three partners during the financial year. As the amount exceeds INR 20,000 it deducted tax @10%, i.e 25,000 from each of the partner.

Now, let us assume a situation where the whole remuneration paid to the partners was not allowed as deduction as per section 40(b) and as per the provisions of section 40(b), only INR 6,00,000(total) was allowable remuneration. Thus, the amount of remuneration INR 1,50,000 would become taxable in the hands of firm and the partners would not be liable to pay tax on the same. However, the whole amount of remuneration shall be reflected on the Form 26AS of the partners. This may create a difficulty at the time of filing of return of income and may be required to be taken care of.

Conclusion

The increase in the allowable limit of remuneration is definitely a positive move for the partnership firms considering the increase in the levels of profits. Also, TDS on the same would make it more transparent and traceable. However, some clarity is awaited on the reconciliation of the amount taxable in the hands of the partners vis a vis the amount on which tax is to be withheld by the partnership firms.