I. Introduction
Section 40(b) of the Income Tax Act, 1961, lays down conditions and limits for the deduction of partner remuneration in computing the taxable income of a partnership firm. It ensures that only working partners’ remuneration, duly authorized by the partnership deed and within specified limits, is eligible for deduction. The Finance Act 2024 has amended these provisions to align with contemporary business profitability levels. Additionally, Section 194T has been introduced to mandate tax deduction at source (TDS) on partner remuneration, enhancing tax transparency but posing reconciliation challenges.
II. Comparative Analysis of Amendments in Section 40(b)
| Provision | Pre-Amendment Limits | Post-Amendment Limits (Effective April 2025) |
|---|---|---|
| Deductible Remuneration | Rs. 1,50,000 or 90% of first Rs. 3,00,000 of book profits, whichever is higher | Rs. 3,00,000 or 90% of first Rs. 6,00,000 of book profits, whichever is higher |
| Remaining Book Profits | 60% of remaining book profits | 60% of remaining book profits |
| Eligible Partners | Only working partners with remuneration authorized by the deed | No change |
| Disallowed Remuneration | If not authorized by the deed or paid for a period before authorization | No change |
Impact:
Increased Deduction Limits: The revised thresholds reflect the increased scale of business operations and provide greater flexibility in structuring partner remuneration.
No Change in Eligibility Criteria: Only working partners remain eligible, ensuring that remuneration does not become a tool for tax evasion.
Enhanced Compliance Requirements: Firms must carefully document remuneration payments to ensure eligibility under the revised limits.
Illustration: A partnership firm with book profits of Rs. 10,00,000 in FY 2024-25 can claim the following remuneration deduction:
Pre-Amendment: Rs. 1,50,000 (fixed) + 60% of Rs. 7,00,000 = Rs. 5,70,000
Post-Amendment: Rs. 3,00,000 (fixed) + 60% of Rs. 4,00,000 = Rs. 5,40,000
While the revised structure benefits firms with lower profits (Rs. 6,00,000 or below), those with higher profits see minimal impact.
III. Introduction of Section 194T – TDS on Partner Remuneration
1. Key Features of Section 194T
Applicability: Firms paying salary, remuneration, commission, bonus, or interest to partners must deduct TDS.
Threshold: TDS at 10% applies if payments exceed Rs. 20,000 annually.
Timing: Deduction occurs at the earlier of:
Credit of the amount to the partner’s account (including the capital account), or
Actual payment.
2. Rationale and Implications
| Aspect | Pre-Amendment | Post-Amendment (With Section 194T) |
| TDS on Partner Remuneration | No specific provision | TDS @10% on amounts exceeding Rs. 20,000 p.a. |
| Tax Transparency | No direct tracking | Enhanced traceability and reporting |
| Impact on Partners | No automatic TDS deduction | TDS deduction may lead to reconciliation issues |
Challenges and Considerations:
Reconciliation Issues: If a portion of remuneration is disallowed under Section 40(b), but TDS is deducted on the full amount, discrepancies may arise in Form 26AS.
Compliance Burden: Firms must ensure correct computation of allowable and taxable remuneration to avoid tax credit mismatches for partners.
Tax Liability Distribution: If a firm is taxed on disallowed remuneration while partners have TDS credits, adjustments will be necessary.
Illustration: Consider ABC Firm with three partners. The firm pays Rs. 2,50,000 to each partner as remuneration.
Total Payment: Rs. 7,50,000 (Rs. 2,50,000 x 3)
TDS Deducted: 10% of Rs. 2,50,000 = Rs. 25,000 per partner
Allowed Remuneration under Section 40(b): Rs. 6,00,000
Excess Remuneration Disallowed: Rs. 1,50,000 (taxable in firm’s hands)
Despite disallowance, Form 26AS of partners will reflect full TDS credit, leading to reconciliation challenges.
IV. Consideration of Cash Basis Accounting for Firms and Partners
Firm Follows Cash Basis, Partners Follow Accrual Basis:
If the firm follows cash accounting but partners report on an accrual basis, a timing mismatch may arise.
TDS under Section 194T will be deducted when the firm pays the remuneration, but partners may recognize income when it is credited in their books.
This can lead to a situation where TDS is deducted in one financial year but the partner recognizes income in the next, affecting tax computation.
Firm Follows Accrual Basis, Partners Follow Cash Basis:
If the firm recognizes remuneration on an accrual basis while partners recognize it on a cash basis, a disallowance under Section 40(b) may occur due to a mismatch in timing.
Partners may not be able to claim the TDS credit in the year of deduction if income is not reported simultaneously.
Both Follow Cash Basis:
This ensures consistency but can create a delay in recognizing deductions and credits, impacting advance tax planning.
Both Follow Accrual Basis:
This leads to the least reconciliation issues, ensuring that TDS and income recognition align.
Illustration: If XYZ Firm follows cash accounting and pays Rs. 3,00,000 to a partner in April 2025 for work done in FY 2024-25:
If the partner follows accrual accounting, they will report this income in FY 2024-25, while TDS will be deducted in FY 2025-26, leading to a tax credit mismatch.
If the partner also follows cash accounting, they will report the income in FY 2025-26, aligning with the TDS deduction.
V. Conclusion
The Finance Act 2024 amendments to Section 40(b) and the introduction of Section 194T signify a balanced approach between increasing deductible limits and ensuring tax transparency.
Positive Impacts: Firms benefit from increased allowable remuneration deductions, reducing their taxable income.
Challenges: The introduction of TDS on partner remuneration could lead to reconciliation difficulties, requiring clarity from tax authorities on handling discrepancies between firm and partner tax liabilities.
Strategic Implications: Firms must revise partnership deeds and remuneration structures to maximize benefits while ensuring compliance with TDS provisions.
Accounting Method Considerations: Firms and partners should align accounting methods to avoid timing mismatches and ensure smooth tax compliance.
While the amendments encourage fair taxation and revenue traceability, their practical application demands careful tax planning and compliance adjustments to avoid unintended tax mismatches.
