Section 40(b): What Every Partner Should Know Complete Guide to Partner Remuneration for FY 2024-25 & 2025-26

 Every partnership firm faces the same dilemma during tax season: "How much can we pay our partners without crossing the line with tax authorities?" If you've ever found yourself in heated discussions about partner compensation, you're not alone. Section 40(b) of the Income Tax Act 1961 is that crucial piece of legislation that determines exactly how much your firm can deduct as partner remuneration while staying compliant with tax laws.

The recent amendments through Finance Act 2024 have significantly changed the game, making it essential for every partnership firm, working partner, and tax consultant to understand the updated rules. Let's break down Section 40(b) in a way that actually makes sense for your business.

Section 40B

What is Section 40(b) and Why Does It Matter?

Section 40(b) is an anti-avoidance provision designed to prevent partnership firms from artificially diverting profits to partners to avoid higher tax rates. Think of it as the tax department's way of ensuring partnerships don't game the system by calling all profits "partner salaries."

Without Section 40(b), partners could pay themselves astronomical amounts, leaving the firm's taxable income artificially low. This provision draws a clear line on what counts as legitimate, tax-deductible partner compensation versus what's considered profit distribution.

The Core Purpose

The Section 40(b) framework serves three main purposes:

• Prevents tax avoidance through excessive partner payments
• Ensures fair taxation between firms and individual partners
• Provides clear guidelines for legitimate business expense deductions

Section 40(b) Eligibility: Who Can Receive Deductible Remuneration?

Not every partner in your firm qualifies for Section 40(b) benefits. The law is very specific about eligibility criteria.

Working Partner Definition

Section 40(b) clearly defines that only "working partners" can receive deductible remuneration. According to Explanation 4, a working partner is "an individual who is actively engaged in conducting the affairs of the business or profession of the firm."

Eligible Partners:

• Partners actively managing day-to-day operations
• Those involved in strategic business decisions
• Partners contributing to business development and client relationships

Ineligible Partners:

• Silent/sleeping partners who only contribute capital
• Corporate partners (companies cannot be working partners)
• Partners not actively participating in firm affairs

Partnership Deed Requirements

For Section 40(b) deduction to be valid, your partnership deed must contain:

• Clear authorization for partner remuneration
• Specific payment terms and calculation methodology
• Effective dates for remuneration entitlement
• Detailed partner roles and responsibilities

Official Notice: 1. Maximum Remuneration Allowable As per Section 40(b) of Income Tax Act, 1961 (A)

Section 40(b) Monetary Limits: FY 2024-25 vs FY 2025-26

The Finance Act 2024 introduced significant changes to Section 40(b) limits, creating a two-tier system based on the financial year.

Current Limits for FY 2024-25 (AY 2025-26)

Book Profit Range	Maximum Allowable Remuneration
First ₹6,00,000 of book profit or in case of loss	₹3,00,000 or 90% of book profit (whichever is higher)
Balance above ₹6,00,000	60% of balance book profit

Enhanced Limits for FY 2024-25 Onward

Book Profit Range	Maximum Allowable Remuneration
First ₹6,00,000 of book profit or in case of loss	₹3,00,000 or 90% of book profit (whichever is higher)
Balance above ₹6,00,000	60% of balance book profit

Important Note: These Section 40(b) limits apply to the total remuneration of all partners combined, not individual partner maximums.

Book Profit Calculation Under Section 40(b)

Understanding book profit calculation is crucial for Section 40(b) compliance. Explanation 3 provides the statutory definition.

Book Profit Definition

Book profit under Section 40(b) means: "The net profit as shown in the profit and loss account, computed in the manner laid down in Chapter IV-D, as increased by the aggregate amount of remuneration paid or payable to all partners if such amount has been deducted while computing the net profit."

Step-by-Step Book Profit Calculation

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Book Profit Calculation for Section 40(b):

 

Step 1: Net Profit as per Profit & Loss Account

Step 2: Add: Partner remuneration (if already debited)

Step 3: Add: Interest paid to partners (if already debited)

Step 4: Less: Disallowed interest under Section 40(b)

Step 5: Add: Other adjustments per Sections 28-44D

Final Result: Book Profit for Section 40(b) purposes

Section 40(b) Calculation Examples: Real-World Applications

Let's work through practical examples to understand Section 40(b) calculations for different scenarios.

Example 1: FY 2024-25 with ₹6,00,000 Book Profit

Scenario: Partnership firm with book profit of ₹6,00,000 in FY 2024-25

Official IT Department Calculator Result:

• Maximum Allowable Remuneration: ₹5,40,000
• Calculation: Since ₹6,00,000 × 90% = ₹5,40,000 is higher than ₹3,00,000

This demonstrates that for book profits up to certain levels, the 90% rule dominates the Section 40(b) calculation.

Example 2: FY 2024-25 with ₹12,00,000 Book Profit

Step-by-Step Section 40(b) Calculation:

• First ₹6,00,000: Higher of ₹3,00,000 or (₹6,00,000 × 90%) = ₹5,40,000
• Balance ₹6,00,000: ₹6,00,000 × 60% = ₹3,60,000
• Total Maximum Remuneration: ₹5,40,000 + ₹3,60,000 = ₹9,00,000

Example 3: FY 2025-26 with ₹15,00,000 Book Profit

Enhanced Limits Section 40(b) Calculation:

• First ₹6,00,000: Higher of ₹3,00,000 or (₹6,00,000 × 90%) = ₹5,40,000
• Balance ₹9,00,000: ₹9,00,000 × 60% = ₹5,40,000
• Total Maximum Remuneration: ₹5,40,000 + ₹5,40,000 = ₹10,80,000

Interest on Partners' Capital: Section 40(b) Rules

Section 40(b) also governs interest payments to partners on their capital contributions.

Interest Payment Conditions

For interest to be deductible under Section 40(b):

• Authorization by partnership deed required
• Maximum 12% simple interest per annum allowed
• Compound interest strictly prohibited
• Proportionate calculation for capital variations during the year

Interest Disallowance Rules

Any interest payment exceeding 12% per annum is disallowed under Section 40(b). The excess amount gets added back to the firm's taxable income.

Section 194T: New TDS Rules Affecting Section 40(b)

Finance Act 2024 introduced Section 194T, creating additional compliance requirements for firms paying partner remuneration.

Section 194T Key Provisions

Aspect	Details
TDS Rate	10% on payments exceeding ₹20,000/year
Threshold	₹20,000 per financial year per partner
Applicable Payments	Salary, bonus, commission, interest under Section 40(b)
Due Date	Earlier of credit to account or actual payment

TDS Compliance Under Section 194T

Mandatory Requirements:

• TAN registration for partnership firms
• Quarterly TDS returns (Form 24Q) filing
• TDS certificates issuance to partners (Form 16A)
• Timely government deposits by prescribed due dates

Tax Implications: Section 40(b) Treatment

Understanding the tax treatment for both firms and partners is crucial for Section 40(b) compliance.

For Partnership Firms

Payment Type	Section 40(b) Treatment
Allowable remuneration	Deductible as business expense
Disallowed remuneration	Added to firm's taxable income
Firm tax rate	Flat 30% plus surcharge and cess

For Individual Partners

Receipt Type	Tax Treatment
Deductible remuneration	Taxable as business income
Disallowed remuneration	Tax-free in partner's hands
Profit share	Exempt under Section 10(2A)
Partner tax rates	Progressive individual slab rates

Common Section 40(b) Mistakes and How to Avoid Them

Many partnership firms stumble on seemingly small but significant Section 40(b) compliance issues.

1. Partnership Deed Problems

Common Mistake: Vague or outdated partnership deed language
Solution: Regularly update deeds with specific Section 40(b) compliant language

2. Working Partner Confusion

Common Mistake: Treating all partners as eligible for remuneration
Solution: Clearly document each partner's active business involvement

3. Book Profit Calculation Errors

Common Mistake: Incorrect book profit computation affecting Section 40(b) limits
Solution: Use systematic calculation methodology and professional verification

4. Interest Rate Violations

Common Mistake: Paying more than 12% interest and losing deduction
Solution: Cap all partner interest at 12% simple interest maximum

Section 40(b) Best Practices for Compliance

Implementing robust systems ensures smooth Section 40(b) compliance and audit readiness.

Documentation Requirements

Essential Section 40(b) Records:

• Updated partnership deeds with clear remuneration clauses
• Monthly partner account statements
• Board resolutions for remuneration approvals
• TDS certificates and payment receipts

Compliance Calendar

Monthly: Update partner accounts and calculate running remuneration totals
Quarterly: File TDS returns and issue certificates
Annually: Review Section 40(b) limits and partnership deed compliance

Section 40(b) Planning Strategies

Strategic planning can help optimize Section 40(b) benefits while maintaining full compliance.

Remuneration Distribution Planning

• Analyze book profit projections early in the financial year
• Distribute remuneration strategically among eligible partners
• Coordinate timing of payments for optimal tax efficiency
• Plan profit vs remuneration mix for overall tax optimization

Partnership Structure Optimization

• Review partner roles for working partner qualification
• Update partnership deeds to reflect current Section 40(b) limits
• Consider profit-sharing alternatives for excess amounts
• Implement digital systems for accurate tracking

Section 40(b) vs Other Partnership Provisions

Understanding how Section 40(b) interacts with other tax provisions is essential.

Section 40(b) and Presumptive Taxation

Important Restriction: Firms opting for presumptive taxation under Section 44AD/44ADA cannot claim Section 40(b) deductions. This creates a strategic choice between simplified taxation and partner remuneration benefits.

Section 40(b) and LLP Distinction

Limited Liability Partnerships (LLPs) are not subject to Section 40(b) restrictions. However, Section 194T (TDS provisions) applies to both partnership firms and LLPs.

Recent Amendments: Finance Act 2024 Impact on Section 40(b)

The Finance Act 2024 brought the most significant changes to Section 40(b) in recent years.

Key Changes Effective FY 2024-25

Enhanced Monetary Limits:

• First slab doubled from ₹3 lakh to ₹6 lakh
• Minimum threshold increased from ₹1.5 lakh to ₹3 lakh
• Better alignment with contemporary business profit levels

New Compliance Framework:

• Section 194T introduction with 10% TDS requirement
• Additional documentation needs for firms
• Enhanced audit scrutiny for Section 40(b) claims

Official Section 40(b) Calculator: How to Use

The Income Tax Department provides an official Section 40(b) calculator for accurate computations.

Calculator Access and Features

URL: https://incometaxindia.gov.in/Pages/tools/partners-remuneration.aspx

Key Features:

• Assessment year selection (2020-21 to 2026-27)
• Automatic book profit calculation
• Partner-wise interest computation
• Remuneration breakdown (salary, bonus, commission)
• Instant disallowance calculation

Step-by-Step Calculator Usage

1. Select appropriate Assessment Year for your calculation
2. Enter Net Profit/Loss from your P&L account
3. Add partner details with interest rates and amounts
4. Input remuneration components for accurate computation
5. Review calculated results and plan accordingly

Section 40(b) Frequently Asked Questions

Q1: Can sleeping partners receive remuneration under Section 40(b)?

Answer: No, only working partners actively engaged in business affairs can receive deductible remuneration under Section 40(b).

Q2: How does Section 194T affect Section 40(b) compliance?

Answer: Section 194T requires 10% TDS on partner remuneration exceeding ₹20,000 per year, adding compliance requirements to Section 40(b) planning.

Q3: What happens if we exceed Section 40(b) limits?

Answer: Excess amounts are disallowed as deductions for the firm but remain tax-free in partners' hands, creating potential tax optimization opportunities.

Q4: Can firms under presumptive taxation claim Section 40(b) benefits?

Answer: No, firms under Section 44AD/44ADA cannot claim Section 40(b) partner remuneration deductions.

Q5: How do Section 40(b) limits apply to multiple partners?

Answer: Section 40(b) limits apply to the aggregate remuneration of all partners combined, not individual partner maximums.

Conclusion: Mastering Section 40(b) for Optimal Tax Efficiency

Section 40(b) of the Income Tax Act 1961 continues to be one of the most important provisions for partnership taxation in India. The Finance Act 2024 amendments have made it even more relevant, offering enhanced opportunities for legitimate tax optimization while introducing new compliance challenges.

Key Takeaways for Partnership Firms

Immediate Action Items:

• Update partnership deeds to reflect enhanced Section 40(b) limits
• Implement TDS systems for Section 194T compliance
• Use official IT calculator for accurate Section 40(b) computations
• Document all transactions meticulously for audit readiness

Strategic Planning Points:

• Plan remuneration distribution early in the financial year
• Coordinate individual partner tax planning with firm decisions
• Consider partnership vs LLP structure based on Section 40(b) impact
• Stay updated with evolving jurisprudence and amendments

The enhanced Section 40(b) framework effective from FY 2024-25 offers substantial opportunities for tax optimization when combined with proper planning and compliance. By understanding the intricacies of Section 40(b), maintaining accurate documentation, and leveraging professional guidance, partnership firms can achieve optimal tax efficiency while staying fully compliant with the law.

Remember, Section 40(b) is not just about staying compliant—it's about maximizing legitimate tax benefits while building a sustainable, transparent partnership structure that stands the test of time and regulatory scrutiny.