Question 4 OR (a)

Section 40(b): remuneration and interest paid by a firm to its partners (as set, 1961 Act, AY 2022-23)

5.5 marks

Time to write: About 11 minutes

From an older CBCS paper

Question

Question 4 OR (a) · 5.5 marks

What are the provisions of section 40(b) relating to remuneration and to interest paid to partners?

Paper note: The as-set version: set and answered under the Income-tax Act, 1961 for assessment year 2022-23 (previous year 2021-22), with the dates as printed. No marks are printed for this part; 5.5 inferred (11 for the OR, two parts of 5.5).

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

11 minfor 5½ marks

Read from the question

section 40(b)The section is named: open with what it says, then explain or apply it.

Write it in this order

Read; underline the asks; jot your points 1 min
1 The five conditions, interest at 12% 2 marks 3 min
2 The remuneration limit 1½ marks 2 min
3 Book profit and working partner 1 mark 2 min
4 Example and the partner's side 1 mark 2 min
Check: every ask answered, key terms underlined 1 min

1234

Short on time? Trim steps 1 and 2 evenly rather than skip one: each is capped at its own marks. End with step 4 in a line or two.

Try it first. About 11 minutes for 5.5 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

The conditions of section 40(b)

A firm assessed as a firm may deduct salary, bonus, commission or other remuneration, and interest, paid to its partners only within section 40(b). An amount is disallowed if:

remuneration is paid to a partner who is not a working partner (section 40(b)(i));
remuneration to a working partner, or interest to any partner, is not authorised by the partnership deed or not in line with it (section 40(b)(ii));
it is authorised by the deed but relates to a period before the date of the deed, when no earlier deed authorised it (section 40(b)(iii));
interest authorised by the deed exceeds 12% simple interest a year; only the excess is disallowed (section 40(b)(iv));
remuneration to working partners, authorised by the deed, exceeds in total for all partners the limit below; only the excess is disallowed (section 40(b)(v)).

The limit on remuneration

Book profit	Maximum remuneration for all partners together
On the first ₹3,00,000, or in case of a loss	₹1,50,000 or 90% of the book profit, whichever is more
On the balance	60%

Book profit and working partner

Book profit is the net profit in the profit and loss account, computed as Chapter IV-D lays down (sections 28 to 44D), plus the remuneration to partners if it was deducted (Explanation 3 to section 40(b)). Interest to partners allowed within 12% is deducted before arriving at it.
Working partner is an individual actively engaged in conducting the business or profession of the firm (Explanation 4).
Partner in a representative capacity: where an individual is a partner on behalf of another person, only the interest paid to him in that capacity, and to the person he represents, counts for this clause; interest paid to him otherwise is left out (Explanation 1). Where he is a partner in his own right, interest he receives on behalf of someone else is left out (Explanation 2).

Example

Example (our own): a firm with two working partners has a book profit of ₹8,00,000 and pays them remuneration of ₹6,00,000. Limit: 90% of ₹3,00,000 = ₹2,70,000, plus 60% of ₹5,00,000 = ₹3,00,000; total ₹5,70,000. ₹30,000 is disallowed and added to the firm's income.

In the partner's hands

The partner is taxed on the interest and remuneration as business income, adjusted for any part not allowed to the firm under section 40(b) (section 28(v) and its proviso); his share of the firm's profit is exempt (section 10(2A)).

Where the 5.5 marks sit

#	Component	Marks
1	The five conditions, interest at 12%	2
2	The remuneration limit	1.5
3	Book profit and working partner	1
4	Example and the partner's side	1
	Total	5.5

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