Key Takeaways
- Section 40(b) caps how much partner remuneration and interest a firm can deduct when computing its business income. Anything in excess is disallowed and added back.
- From FY 2024-25 (AY 2025-26), the remuneration limit is higher of Rs 3,00,000 or 90% of book profit on the first Rs 6,00,000 of book profit (or in a loss), and 60% on the balance. The earlier limits (Rs 1,50,000 / Rs 3,00,000 slab) applied only up to FY 2023-24.
- Interest to partners is deductible up to a maximum of 12% per annum simple interest on capital; excess is disallowed.
- Remuneration is deductible only to working partners and only if authorised by the partnership deed. Remuneration not authorised by the deed is 100% disallowed.
- Section 40(b) applies to LLPs too, because the definition of "firm" includes an LLP.
- From FY 2025-26, Section 194T requires the firm to deduct 10% TDS on partner remuneration, interest, and similar payments above Rs 20,000 in a year.
What is the maximum partner remuneration deductible under Section 40(b)? For FY 2024-25 (AY 2025-26) onward, deductible remuneration to working partners is the higher of Rs 3,00,000 or 90% of book profit on the first Rs 6,00,000 of book profit (or where there is a loss), plus 60% of the balance book profit. The remuneration must be authorised by the partnership deed and paid to working partners. Interest to partners is separately deductible up to 12% per annum. Amounts above these limits are disallowed when computing the firm's taxable income.
A partnership firm pays its partners in two main ways: remuneration (salary, bonus, commission to working partners) and interest on the capital they contribute. Both reduce the firm's profit, so the Income Tax Act limits how much the firm can deduct. Section 40(b) is that limit. Get it wrong and the Assessing Officer disallows the excess, raising the firm's taxable income and creating demand, interest, and sometimes penalty. This guide walks through the current limits, the book profit formula, and a full worked example for CAs filing ITR-5 and for partners who want to know what they can actually take out tax-efficiently.
What Section 40(b) controls
Section 40(b) sits in the chapter on computing business income and disallows certain payments to partners. It deals with two distinct items:
- Interest paid to any partner on capital or loans, and
- Remuneration (salary, bonus, commission, or other payment) to working partners.
For each, the section sets conditions and a ceiling. Anything paid beyond the ceiling, or paid without meeting the conditions, is not deductible for the firm, even though it is still taxed in the partner's hands as business income.
Section 40(b) is a disallowance provision, not a payment cap. A firm can pay a partner more than the limit, but the excess is not deductible. The firm pays tax on the disallowed amount, and the partner is still taxed on the full receipt, so over-paying creates double taxation. The goal is to keep payments within the limit.
Interest to partners: the 12% ceiling
Interest paid to a partner is deductible only if:
- It is authorised by the partnership deed, and
- It does not exceed 12% per annum, simple interest.
If the deed allows, say, 15%, only interest up to 12% is deductible and the rest is disallowed. If the deed is silent on interest, no interest is deductible. Interest must also relate to a period on or after the date of the deed that authorises it.
Remuneration to working partners: the revised limits
Remuneration is deductible only when two gate conditions are met first:
- It is paid to a working partner (a partner actively engaged in conducting the firm's business), and
- It is authorised by, and quantified in or determinable from, the partnership deed.
If remuneration is not authorised by the deed, it is 100% disallowed, regardless of amount. Once both gates are cleared, the quantum ceiling under Section 40(b)(v) applies.
The limits were revised by the Finance (No. 2) Act, 2024, effective from AY 2025-26 (FY 2024-25). The table below shows the change, which roughly doubled the deductible room for small and mid-sized firms.
Comparison
Section 40(b)(v) Remuneration Limits: Old vs Revised
The revised slab applies from FY 2024-25 (AY 2025-26) onward
| Parameter | Up to FY 2023-24 | FY 2024-25 onward |
|---|---|---|
| First slab of book profit | First Rs 3,00,000 | First Rs 6,00,000 |
| Limit on first slab (or loss) | Higher of Rs 1,50,000 or 90% | Higher of Rs 3,00,000 or 90% |
| Limit on balance book profit | 60% | 60% |
| Interest to partners | Max 12% p.a. | Max 12% p.a. |
| Deed authorisation needed | Yes | Yes |
Takeaway: From FY 2024-25, firms can deduct more remuneration before hitting the 60% slab. Use the revised limits for any return for AY 2025-26 onward.
Source: Section 40(b)(v), as amended by the Finance (No. 2) Act 2024
So, for FY 2024-25 onward, the maximum deductible remuneration is:
- On the first Rs 6,00,000 of book profit, or in case of a loss: Rs 3,00,000 or 90% of book profit, whichever is higher.
- On the balance of book profit: 60%.
How to compute "book profit" for Section 40(b)
"Book profit" has a specific meaning here. It is not simply the net profit in the profit and loss account. Compute it as follows:
Step-by-Step Guide
Computing Book Profit for Section 40(b)
Get this base right, or the whole remuneration limit is wrong
Start with net profit as per the P&L
Take the firm's net profit as shown in the profit and loss account.
Step 1Compute income under business head
Make the normal adjustments to arrive at income under 'Profits and gains of business or profession', before partner remuneration. Interest to partners within the 12% limit is allowed and not added back.
Step 2Add back partner remuneration already debited
Add back any partner salary, bonus, or commission that was debited to the P&L, so the base is profit before remuneration.
Step 3Apply the slab formula
Apply higher of Rs 3,00,000 or 90% on the first Rs 6,00,000, plus 60% on the balance, to find the maximum deductible remuneration.
Step 4Allow the lower of actual or limit
Deduct the lower of the remuneration actually paid (and authorised by deed) or the computed limit. Disallow the excess.
Step 5Source: Explanation 3 to Section 40(b), Income Tax Act 1961
The key point: interest to partners within 12% is a normal deduction and is not added back to compute book profit, but remuneration is added back because the slab formula is applied on profit before remuneration.
Worked example: book profit of Rs 10,00,000
A firm's profit and loss account shows a net profit of Rs 2,00,000 after debiting partner remuneration of Rs 8,00,000 and partner interest of Rs 1,00,000 (interest is within the 12% limit and authorised by the deed).
Step 1 to 3, compute book profit:
- Net profit per P&L: Rs 2,00,000
- Add back partner remuneration debited: Rs 8,00,000
- Interest to partners (within 12%): not added back
- Book profit = Rs 10,00,000
Step 4, apply the slab (FY 2024-25 limits):
- On first Rs 6,00,000: higher of Rs 3,00,000 or 90% of Rs 6,00,000 (= Rs 5,40,000) → Rs 5,40,000
- On balance Rs 4,00,000: 60% → Rs 2,40,000
- Maximum deductible remuneration = Rs 7,80,000
Step 5, allow the lower:
- Actual remuneration paid: Rs 8,00,000
- Maximum allowed: Rs 7,80,000
- Disallowed (added back to income): Rs 20,000
The firm's taxable business income increases by the Rs 20,000 of disallowed remuneration. Had the deed-authorised remuneration been kept at Rs 7,80,000, the entire amount would have been deductible.
The loss scenario
If the firm has nil or negative book profit, the deductible remuneration is not 90% of the loss; it is the fixed floor of Rs 3,00,000 (FY 2024-25 onward). So even a loss-making firm can deduct up to Rs 3,00,000 of authorised remuneration to working partners, which increases the firm's loss available to carry forward.
In a loss year, the limit is a flat Rs 3,00,000, not a percentage. This is a deliberate floor so that small firms always get some deduction for partner effort, even when the business loses money.
Section 40(b) applies to LLPs as well
A common misconception is that Section 40(b) is only for traditional partnership firms. It applies to Limited Liability Partnerships (LLPs) too. Under Section 2(23) of the Income Tax Act, the expressions "firm", "partner", and "partnership" include an LLP and its partners as understood under the LLP Act, 2008. So an LLP computing its business income applies the same 12% interest ceiling and the same remuneration slab, with the same deed-authorisation requirement (here, the LLP agreement). For the wider compliance picture, see our LLP annual compliance guide.
New from FY 2025-26: Section 194T TDS on partner payments
A separate change affects the same payments. From FY 2025-26 (1 April 2025), Section 194T requires a firm or LLP to deduct TDS at 10% on remuneration, interest, commission, bonus, or salary paid to a partner where the aggregate exceeds Rs 20,000 in a financial year. This is a withholding obligation and is separate from the Section 40(b) deductibility limit, but the two now operate together: the firm must both keep payments within the 40(b) limit and deduct TDS under 194T on what it pays. We cover the mechanics in our guide on Section 194T TDS on partner payments.
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Common tax audit and assessment issues
- Remuneration not authorised in the deed. The single most common disallowance. If the deed does not authorise remuneration, or does not quantify it or give a method to quantify it, the full amount is disallowed. The deed clause must be precise.
- Remuneration for a period before the deed. Remuneration relating to a period before the date of the relevant deed clause is disallowed.
- Partner drawings treated as salary. Drawings against capital are not remuneration. Only payments that are genuinely salary, bonus, or commission to a working partner, authorised by the deed, qualify.
- Interest above 12% or without deed authority. Excess interest, or interest where the deed is silent, is disallowed.
- Remuneration to a non-working (sleeping) partner. Only working partners can be paid deductible remuneration.
Partnership deed checklist for Section 40(b) compliance
To keep remuneration and interest fully deductible, the deed should:
- Name the working partners entitled to remuneration,
- Quantify the remuneration or give a formula to compute it (commonly by referring to the Section 40(b)(v) limits themselves),
- State the rate of interest on capital, not exceeding 12%,
- Be in force for the period to which the payments relate.
A frequently used drafting approach is to set remuneration "as per the limits specified under Section 40(b)(v) of the Income Tax Act, as amended from time to time", so the firm automatically tracks the maximum without re-executing the deed each time the law changes.
When the firm converts to a company
Section 40(b) is specific to firms and LLPs. If a partnership converts into a company, the partners become directors and shareholders, and Section 40(b) stops applying. Director remuneration is then governed by the Companies Act and the company's own tax rules rather than the 40(b) slab. This is one factor partners weigh when comparing structures; see our proprietorship vs partnership vs LLP vs company comparison.
Frequently Asked Questions
What are the Section 40(b) remuneration limits for FY 2024-25 and later?
On the first Rs 6,00,000 of book profit, or in case of a loss, the limit is the higher of Rs 3,00,000 or 90% of book profit. On the balance of book profit, the limit is 60%. These revised limits, set by the Finance (No. 2) Act 2024, apply from AY 2025-26 onward. The earlier Rs 1,50,000 / Rs 3,00,000 slab applied only up to FY 2023-24.
How much interest can a partnership firm pay a partner?
Interest on a partner's capital is deductible up to a maximum of 12% per annum simple interest, and only if the partnership deed authorises it. Interest above 12%, or interest where the deed is silent, is disallowed under Section 40(b).
What is book profit for Section 40(b)?
Book profit is the firm's income under the head 'Profits and gains of business or profession', computed before deducting partner remuneration but after allowing partner interest within the 12% limit. In practice, you start from net profit per the P&L and add back the partner remuneration that was debited.
Is remuneration deductible if there is a loss?
Yes. In a year of nil or negative book profit, the deductible remuneration to working partners is a flat Rs 3,00,000 (FY 2024-25 onward), not a percentage of the loss. This increases the firm's carry-forward loss.
Does Section 40(b) apply to LLPs?
Yes. Under Section 2(23) of the Income Tax Act, the terms firm, partner, and partnership include an LLP and its partners. So an LLP applies the same 12% interest ceiling and remuneration slab, with the LLP agreement serving as the authorising deed.
What happens if remuneration is not authorised in the partnership deed?
It is disallowed in full, regardless of the amount or whether it is within the slab limit. The deed must authorise remuneration to working partners and quantify it or provide a method to compute it. Remuneration for a period before the deed is also disallowed.
Section 40(b) is one of the most routinely misapplied provisions in firm taxation, usually because of a loose deed clause or because the old slab limits were used after they changed. The discipline is simple: authorise remuneration and interest properly in the deed, compute book profit before remuneration, apply the revised FY 2024-25 slab, cap interest at 12%, and now also deduct 194T TDS on partner payments. Done correctly, every rupee of legitimate partner pay is deductible and the assessment passes without a disallowance.
This guide is based on Section 40(b) of the Income Tax Act, 1961 (including Explanation 3 and the limits in Section 40(b)(v) as amended by the Finance (No. 2) Act 2024, effective AY 2025-26), Section 2(23) defining firm and partner to include LLPs, and Section 194T effective FY 2025-26. It is general information for educational purposes and not a substitute for professional advice. Verify the current limits against the latest bare Act and consult a qualified professional for your firm's computation.