Interest and remuneration paid to partners by a firm are deductible if all the following conditions are satisfied :
1) Remuneration should be paid only to the working partner
Explanation 4 to section 40(b) defines working partner as one who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner. This definition is very general. It seems that a partner can be a working partner in more than one firm. If a partner is employed somewhere else too, he can still be a working partner in the firm. However, in all such situations the partner must be a working partner in the firm. In other words, merely because a person is working somewhere else too, such fact does not by itself debar him from being a working partner in a firm in which he is partner.
“working partner” contemplates an individual. Therefore a partner other than an individual cannot be a working partner.
2) Remuneration and Interest should be authorised by the partnership deed
The remuneration shall be admissible only if the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.
3) Remuneration and Interest should not pertain to a period prior to partnership
The remuneration and Interest paid for a period pertaining prior to the partnership deed shall not be admissible.
4) Remuneration and Interest should not exceed the permissible limit
- On the first ₹ 300,000 of book profit or in case of a loss
- ₹ 150,000 or at the rate of 90% of the book profit, whichever is more
- On the balance of book profits
- At the rate of 60% of Book Profits
The rate of interest payable to the partners shall not exceed 12% simple in per annum.
If a firm pays interest to a partner and the partner pays interest to the firm on his drawings, then the interest shall not be netted off. The interest received by the firm from the partners on their drawings is taxable in the hands of the firm as income under the head Profits and Gains of Business or Profession. The interest paid by the firm to the partners is allowable as per section 40(b).
Partner in a representative capacity :
If an individual is a partner in a firm in a representative capacity (that is on behalf and for the benefit of another person) and not in his personal capacity then interest paid by the firm to such individual in his personal capacity and not as a representative partner will not be subject to the conditions and ceiling as prescribed for disallowance. But interest paid by the firm to such individual as representative partner or person represented shall be subject to the conditions and ceiling as prescribed.
Interest received by a non-representative partner :
If interest is paid to an individual partner who is not the representative partner and the interest received by him is on behalf of another person, then such interest payment shall be allowed without applying the ceiling limits.