Controversies in Budget Amendments on Partner Remuneration under Income Tax Act, 1961

Section 40 the Income Tax Act, 1961 (the Act) relates to “Amounts not deductible” under the head business or profession. Clause b of the said section outlines the limit within which any partnership firm can claim deduction towards remuneration and interest paid to partners. The section defines the terms remuneration as inclusive of any payment of salary, bonus, commission or remuneration, by whatever name called.

Hon. Finance Minister Nirmala Sitharaman has delivered her 7^th consecutive budget speech on 23^rd July 2024. In her budget speech she has proposed to alter upward revision in the limit specified u/s. 40b of the Income Tax Act, 1961 (the Act). The article intends to speak about the possible alternative effective date of provisions for claim of enhance remuneration.

Specified condition to claim remuneration as deduction:

♦ Payable only to working partner.

♦ Remuneration must be authorised by a partnership deed

♦ Remuneration must be in accordance with the terms of a partnership deed

♦ Post authorisation or modification shall not validate prior period remuneration.

♦ Remuneration must be within the limits specified in the Act.

The clause specifying the limits for allowable remuneration and conditions was first inserted by Finance Act 1992 w.e.f. 1.4.1993 and effected from AY 1993-94. Due to newly inserted limits and conditions, necessary amendments in terms of partnership were required. To avoid such chaos, a proviso was added validating the amendments made in terms of partnership during any time in the previous year.

The compliance to the conditions of section 40b of the Act was further clarified by the Income Tax Department vide their circular no. 739, dated 25-3-1996. Para 4 of the circular has clarified that for the assessment years subsequent to the assessment year 1996-97, no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.

Income Tax Department further vide circular no. 12/2019 on “Assessment of Firms” has categorically specified that payment of remuneration to a working partner should be authorized by the partnership deed, be in accordance with the terms of the partnership deed, should relate to a period after the partnership deed and should also not exceed the maximum amounts prescribed therein.

The Finance (No. 2) Act, 2024 (passed on 16^th August 2024) has proposed upward revision in the permissible limit for claim of remuneration.  Clause 14 of The Finance (No. 2) Act, 2024 has made upward revision in limit for 1^st slab of Rs. 3 lakhs to Rs. 6 lakh and minimum allowable remuneration from Rs. 1.5 lakh to Rs. 3 lakhs. The said change was effective from 1^st April 2024 and shall applies to AY 2025-26.

Considering this pre-amendment specified limits for permissible remuneration:

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

Revised Specified limits for allowable remuneration effective from 01.04.2024:

a) on the first, Rs. 6,00,000 of the book-profit or in case of a loss – Rs. 3,00,000 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

The enhance limit was upgraded on 16.08.2024, the date on which budget was passed, making this effective from 1^st April 2024. The important question is that can a partnership firm claim the enhance remuneration effective from 1^st April 2024, despite having later updation in terms of the partnership deed?

Historical background shows that in the past enough time was given to the assessee to change the partnership deed through inserting proviso. There is no such proviso, clarificatory circular is available till date. There might be situation wherein a person has amended the partnership deed pursuant to this change and he will be allowed remuneration considering old limit for pre-amended period and new limit for post-amendment period. Further, any change in LLP agreement needs timely filing with ROC or any registered partnership firm with registrar of firm will result in time consuming exercise.

One can definitely argue that law cannot expect to do what is not possible. It can be argued that once partnership deed was amended after passing of budget 2024, but before end of the year is valid considering history.

Further a new liability under TDS provisions is inserted in the statute. Any payment of interest or remuneration to partners (above Rs. 20000), are now liable for tax deduction @ 10%. Tax deduction was required to be made at the time of credit to the account of payment whichever is earlier. Considering this provision of tax deduction needs to be made from withdrawal made by the partners considering this as payment against interest or remuneration. Alternat situation is maintenance of separate accounts for interest and remuneration and withdrawal is affected through capital balance. In that case, this being capital withdrawal, the partner’s interest will be reduced to that extent.

Calculation of remuneration of the partner depends on the book profit of the firm, which in case is practically determined once the books of the firm are closed for the financial year. This means that firm shall be required to close the annual accounts immediately after end of financial year considering the due date for deposition of TDS of March Quarter is the 30th of April. So, to deduct the TDS on partner remuneration for the year ended on 31st March, the books of accounts of the firm need to be closed before the due date for TDS deposit. Else the firm has to incurred additional liability of interest, penalty and late fees for violation of TDS provisions.

The provisions related to partnership are two sides of the coin. On one side permissible remuneration limits were enhanced on the other side time for finalisation of accounts was curtailed.