All about interest paid to partner in a partnership firm!

Section 40(b)(iv) of the Income Tax Act, 1961 disallows any payment of interest unless:

• It is authorised by and is paid in accordance with the terms of the partnership deed and
• It relates to any period falling after the date of such partnership deed.

The amount to be disallowed is the amount calculated in excess of 12% simple interest per annum. Thus, payment of any simple interest to any partner is allowed only to the extent of 12% per annum. It is immaterial that the partnership deed authorizes any payment of higher rate of interest than 12% to any partner. The excess of interest will not be deducted even if authorised by partnership deed.

There is no condition that the interest is to be paid to the working partner as it is for payment of remuneration i.e. payment of interest not exceeding 12% per annum is allowable to any partner whether working or not.

As per explanation 1 to section 40(b) where 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 otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of section 40(b).

But interest paid by the firm to such individual as partner in a representative capacity shall be considered into account for the purposes of this clause.

Explanation 2 to section 40(b) further provides that where an individual is a partner in a firm individual capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause if such interest is received by him on behalf or for the benefit of any other person.

The amount of interest received by the partner shall be taxable in the hands of partner under the head income from profit and gain of business and profession (PGBP). This amount shall be included to the extent of deduction that was made available to the firm i.e. (Max 12%)