Income Tax – Partnership Firms
Partners Remuneration Limit FY 2025-26 Under Section 40(b)
Section 40(b)(v) of the Income Tax Act 1961 sets the maximum remuneration that a partnership firm can deduct when computing its taxable income for payments made to working partners. For FY 2025-26 (Assessment Year 2026-27), the Finance Act 2024 enhanced these limits: the maximum aggregate deductible remuneration across all working partners is Rs 3,00,000 or 90% of book profit (whichever is more) on the first Rs 6,00,000 of book profit, and 60% on the balance. Any remuneration paid in excess of these limits is disallowed in the firm’s hands, increasing taxable income, while still being taxable in the receiving partner’s hands.
This guide covers the FY 2025-26 limits with worked calculations at common book profit levels, the definition and computation of book profit, the eligibility conditions a firm must satisfy, the distinction between remuneration and share of profit, and the tax planning implications of structuring remuneration optimally.
Contents
- What Is the Partners Remuneration Limit for FY 2025-26 Under Section 40(b)?
- What Is Book Profit and How Is It Calculated for Section 40(b)?
- Who Qualifies as a Working Partner Eligible for Remuneration?
- What Are the Section 40(b) Conditions for Remuneration to Be Deductible?
- How Much Interest Is Allowed to Partners Under Section 40(b)?
- What Are the Tax Implications of Partners Remuneration in the Partners Hands?
- How Should a Partnership Firm Optimize Remuneration for Maximum Tax Benefit?
- What Are the Most Common Questions About Partners Remuneration Under Section 40(b)?
What Is the Partners Remuneration Limit for FY 2025-26 Under Section 40(b)?
The Finance Act 2024 revised the Section 40(b)(v) limits effective from AY 2025-26 (FY 2024-25), and these enhanced limits continue to apply for FY 2025-26 (AY 2026-27). The limits prescribe the maximum AGGREGATE remuneration deductible across all working partners combined; the firm can then allocate this amount among individual working partners as per the partnership deed.
On first Rs 6,00,000 of Book Profit (or if firm has a Loss):
= Rs 3,00,000 OR 90% of Book Profit, whichever is MORE
On balance Book Profit (above Rs 6,00,000):
= 60% of such balance
Maximum Deductible Remuneration = Component 1 + Component 2
Old vs. New Limits: What Changed in Finance Act 2024
| Book Profit Slab | Old Limit (Up to AY 2024-25) | New Limit (AY 2025-26 Onwards) | Change |
|---|---|---|---|
| Loss or nil book profit | Rs 1,50,000 | Rs 3,00,000 | +Rs 1,50,000 |
| First Rs 3,00,000 of book profit | Rs 1,50,000 or 90% (higher) | Rs 3,00,000 or 90% (higher) | Minimum doubled |
| Book profit Rs 3,00,001 to Rs 6,00,000 | Max was Rs 2,70,000 (90% of Rs 3L) + 60% of excess over Rs 3L | Rs 3,00,000 or 90% of total (higher) | Higher threshold before 60% kicks in |
| Balance book profit above Rs 6,00,000 | 60% of balance above Rs 3,00,000 | 60% of balance above Rs 6,00,000 | Higher base for 60% slab |
Worked Calculations at Common Book Profit Levels
Component 1 (first slab): Rs 3,00,000 (minimum; 90% of negative profit = not applicable)
Component 2 (balance): Nil
Maximum Deductible Remuneration = Rs 3,00,000
Component 1: Rs 3,00,000 OR 90% of Rs 5,00,000 = Rs 4,50,000 → Rs 4,50,000 wins
Component 2: Nil (book profit does not exceed Rs 6,00,000)
Maximum Deductible Remuneration = Rs 4,50,000
Component 1: Rs 3,00,000 OR 90% of Rs 6,00,000 = Rs 5,40,000 → Rs 5,40,000 wins
Component 2: Nil (book profit is exactly Rs 6,00,000)
Maximum Deductible Remuneration = Rs 5,40,000
Component 1: 90% of Rs 6,00,000 = Rs 5,40,000
Component 2: 60% of (Rs 10,00,000 − Rs 6,00,000) = 60% of Rs 4,00,000 = Rs 2,40,000
Maximum Deductible Remuneration = Rs 7,80,000
Component 1: 90% of Rs 6,00,000 = Rs 5,40,000
Component 2: 60% of (Rs 20,00,000 − Rs 6,00,000) = 60% of Rs 14,00,000 = Rs 8,40,000
Maximum Deductible Remuneration = Rs 13,80,000
Component 1: 90% of Rs 6,00,000 = Rs 5,40,000
Component 2: 60% of (Rs 50,00,000 − Rs 6,00,000) = 60% of Rs 44,00,000 = Rs 26,40,000
Maximum Deductible Remuneration = Rs 31,80,000
Section 40(b) Limits: Quick Reference Table for FY 2025-26
| Book Profit | Max Deductible Remuneration | Effective Rate |
|---|---|---|
| Loss / Nil | Rs 3,00,000 | Guaranteed minimum |
| Rs 3,33,334 | Rs 3,00,000 | 90% and Rs 3L are equal at this level |
| Rs 5,00,000 | Rs 4,50,000 | 90% |
| Rs 6,00,000 | Rs 5,40,000 | 90% |
| Rs 10,00,000 | Rs 7,80,000 | 78% effective rate |
| Rs 20,00,000 | Rs 13,80,000 | 69% effective rate |
| Rs 50,00,000 | Rs 31,80,000 | 63.6% effective rate |
| Rs 1,00,00,000 | Rs 57,40,000 | 62.7% converges toward 60% |
What Is Book Profit and How Is It Calculated for Section 40(b)?
Book profit is not simply the net profit shown in the Profit and Loss Account. It is a specifically defined figure under Section 40(b) that requires adding back remuneration already debited to the P&L and making other prescribed adjustments. Computing book profit correctly is the foundation of the entire Section 40(b) calculation; errors here cascade into incorrect remuneration limits.
Step-by-Step Book Profit Computation
| Step | Item | Treatment |
|---|---|---|
| Start | Net profit as per Profit and Loss Account | Starting figure |
| Add back | Remuneration paid to working partners already debited to P&L | + (add back; we are computing pre-remuneration profit) |
| Add back | Income tax paid or payable debited to P&L | + (income tax is not an allowable business expense) |
| Add back | Interest to partners in excess of 12% p.a. already disallowed | + (excess interest disallowed under Section 40(b)(iv)) |
| Add back | Any expenditure disallowed under Section 40A(3) or other provisions | + (to the extent debited and disallowed) |
| Deduct | Income from other heads (house property, capital gains, other sources) included in P&L profit | − (these are taxable under other heads, not business) |
| Deduct | Unabsorbed depreciation brought forward (to the extent set off against book profit) | − (reduces book profit for remuneration purposes) |
| Result | Book Profit for Section 40(b)(v) | Apply the 90%/60% formula to this figure |
Warning: Remuneration Must Be Added Back Before Applying the Formula
The most common error in computing book profit is forgetting to add back the remuneration already debited to the Profit and Loss Account. The Section 40(b)(v) formula is designed to compute the maximum allowable remuneration based on the pre-remuneration book profit. If the firm debits Rs 5 lakh as remuneration to P&L and does not add it back, it starts the book profit calculation at Rs 5 lakh less than the correct figure, resulting in a lower (and incorrect) remuneration limit. The Assessing Officer will compute book profit independently during a scrutiny assessment under Section 143(2) and may disallow excess remuneration if the firm’s computation is wrong.
Who Qualifies as a Working Partner Eligible for Remuneration?
Section 40(b) allows remuneration deduction only for remuneration paid to working partners. The term working partner is defined in the Explanation to Section 40(b) as an individual who is actively engaged in conducting the affairs of the business or profession of the firm.
Working Partner: Remuneration Deductible
- An individual (natural person) who is a partner in the firm
- Actively engaged in conducting the firm’s business operations, management, or professional practice
- Must be identified by name in the partnership deed as a working partner
- Can be a full-time or part-time working partner, provided actual engagement is demonstrable
- Must be an individual; companies, LLPs, or trusts as partners cannot receive deductible remuneration
Sleeping Partner: Remuneration NOT Deductible
- A partner who has contributed capital but is not involved in running the business
- Any non-individual partner (corporate partner, trust, etc.) cannot be a working partner
- A partner nominally described as working in the deed but not actually working
- Remuneration paid to a sleeping partner is disallowed in full under Section 40(b)
- Interest on capital (up to 12% p.a.) is allowed to all partners including sleeping partners under Section 40(b)(iv)
What Are the Section 40(b) Conditions for Remuneration to Be Deductible?
Section 40(b) imposes 5 conditions, all of which must be satisfied simultaneously for the remuneration to be deductible. Failure of any single condition results in full disallowance.
Section 40(b) applies only to firms that are assessed under the Income Tax Act 1961 as a “firm” within the meaning of Section 2(23). If the firm is treated as an Association of Persons (AOP) or Body of Individuals (BOI) for tax purposes, Section 40(b) does not apply and no deduction for remuneration is available.
Remuneration is deductible only when paid to a working partner who is an individual (natural person) actively engaged in the business. Companies or LLPs as partners cannot receive deductible remuneration. The working status of the partner must be genuine and verifiable; a partner added to the deed for tax purposes without actual working involvement will not qualify.
The partnership deed must explicitly authorize the payment of remuneration to the working partners and specify the amount, basis, or formula of remuneration. The authorization must be in the deed effective for the period during which remuneration is paid; retrospective amendments to the deed that authorize remuneration for a past period already closed do not make the remuneration deductible for that past period.
The actual remuneration paid must not exceed the limit computed under Section 40(b)(v) for the year. The excess is disallowed. If the remuneration paid is less than the ceiling, only the amount actually paid is deductible; firms cannot notionally claim the ceiling amount without actual payment.
Remuneration is deductible from the date of effectiveness of the partnership deed that authorizes it. A deed executed on 1 October 2025 can authorize remuneration only from 1 October 2025 onwards; remuneration for the period April 2025 to September 2025 cannot be deducted even if the same deed is filed with the ITR. Firms that change remuneration structures must amend the deed before the new structure takes effect.
How Much Interest Is Allowed to Partners Under Section 40(b)?
In addition to remuneration, partners can receive interest on their capital accounts and loan accounts from the firm. Section 40(b)(iv) governs the deductibility of such interest. Unlike remuneration (which is limited by the book profit slab formula), interest deductibility has a simple percentage cap.
| Item | Section 40(b) Provision | FY 2025-26 Limit | Who Can Receive |
|---|---|---|---|
| Interest on capital / loan to the firm | Section 40(b)(iv) | 12% per annum simple interest | All partners (working and sleeping) |
| Remuneration (salary, commission, bonus, fees) | Section 40(b)(v) | As per book profit slab (90%/60% formula) | Working partners only |
| Share of profit | Section 10(2A) read with Section 40(b) | Not a deduction; firm pays tax on profit; partner receives tax-free | All partners |
Interest at rates exceeding 12% p.a. is disallowed to the extent of the excess. For example, if a firm pays a partner 18% interest on their capital, only 12% is deductible; the remaining 6% is added back to the firm’s taxable income. The 12% limit applies to the simple rate; compound interest is not recognized for this purpose.
Interest Deductible Even in a Loss Year
Unlike remuneration (where the minimum Rs 3,00,000 floor applies only when there is book profit or a loss), interest under Section 40(b)(iv) is deductible up to 12% p.a. regardless of whether the firm has profit or loss. A firm making a loss can still deduct partner interest (at up to 12% p.a.) and carry forward the increased loss under Section 70/72. This makes interest a more stable deduction than remuneration in loss years, and firms sometimes structure partner contributions as loans (rather than capital) to maximize the interest deduction when book profits are low.
What Are the Tax Implications of Partners Remuneration in the Partners Hands?
The tax treatment of remuneration in the partner’s hands is fundamentally different from salary income, even though the amounts may look the same on paper. This distinction affects which ITR form to use, which deductions are available, and how advance tax is computed.
| Income Type | Tax Head in Partner’s ITR | Deductions Available | TDS Applicable |
|---|---|---|---|
| Remuneration (salary / commission / bonus) | Profits and Gains of Business or Profession (Section 28(v)) | Business expenses incurred to earn the remuneration; no standard deduction as under salary | TDS may apply; depends on nature and treatment by firm |
| Interest from firm on capital / loan | Profits and Gains of Business or Profession (Section 28(v)) | No deduction; gross interest is taxable | TDS under Section 194T at 10% if total payments to partner exceed Rs 20,000 in FY (effective April 1, 2024) |
| Share of profit | Exempt under Section 10(2A) | Fully exempt; no tax | No TDS |
Which ITR Form Must the Partner File?
Because remuneration from a partnership firm is taxable under the head Profits and Gains of Business or Profession, a partner receiving remuneration cannot file ITR-1 (Sahaj) or ITR-2 (which covers only capital gains, salary, and other sources). The partner must file ITR-3 (for individuals having income from PGBP and other sources) or ITR-4 if they have presumptive income under Section 44AD/44ADA in addition. Filing the wrong ITR form (for example, an ITR-2 for a partner receiving remuneration) is a Section 143(1) defective return trigger.
How Should a Partnership Firm Optimize Remuneration for Maximum Tax Benefit?
The tax planning opportunity in a partnership firm arises from the rate differential between the firm’s tax rate and the partners’ individual tax rates. The firm is taxed at 30% (plus surcharge and cess) on its taxable income, while individual partners are taxed at progressive slab rates that can be as low as 5% or zero (below the exemption threshold under the new regime). Remuneration paid to working partners reduces the firm’s taxable income at the 30% rate and creates income in the partners’ hands at their personal slab rate.
Tax Arbitrage Calculation
WITHOUT REMUNERATION:
Firm taxable income: Rs 10,00,000
Firm tax @ 30%: Rs 3,00,000
Net after-tax profit: Rs 7,00,000
WITH FULL REMUNERATION (Rs 7,80,000 total, Rs 3,90,000 each partner):
Firm taxable income: Rs 10,00,000 − Rs 7,80,000 = Rs 2,20,000
Firm tax @ 30%: Rs 66,000
Tax in partners hands*: Approximately Rs 24,000-Rs 60,000 (new regime slabs)
Total tax: Approximately Rs 90,000-Rs 1,26,000
Tax saving vs. no remuneration: Rs 1,74,000 to Rs 2,10,000 approximately
*Depends on partners’ total income; consult a tax advisor for exact computation
5 Key Planning Points for Partnership Firms
- Execute and register the partnership deed before the start of the financial year (or at least before the first remuneration payment) so that the authorization covers the full year. A deed executed on 15 April 2025 loses April 1-14 remuneration deductibility.
- Pay remuneration up to the computed ceiling, not above it. Paying excess remuneration creates double taxation: the excess is taxed in the firm’s hands and also in the partner’s hands. Run the Section 40(b)(v) calculation before finalizing the remuneration figure.
- Partners with income below the taxable threshold or in the 5% slab create the most tax arbitrage. Directing maximum remuneration to partners with the lowest personal income minimizes the total tax outflow on the firm’s income.
- Combine remuneration with 12% interest on capital for maximum deductible outflow from the firm. Interest (up to 12% p.a.) and remuneration (up to the book profit ceiling) are both independently deductible and can be used simultaneously.
- Partners must pay advance tax on their estimated remuneration income. Since firms may not always deduct TDS on remuneration, each partner must factor remuneration into their advance tax computation and pay by 15 June, 15 September, 15 December, and 15 March to avoid interest under Sections 234B and 234C.
Warning: Retrospective Deed Amendments Are Ineffective for Claiming Deductions
A common error is to draft a new partnership deed in March (or after the year-end) backdating the authorization of remuneration to cover the entire financial year. The courts and the Assessing Officer have consistently held that remuneration is deductible only for the period after the deed takes effect; the authorization cannot be effective retrospectively for a period already past. If your firm has not paid remuneration in FY 2025-26 due to an outdated deed, you cannot cure this by amending the deed after 31 March 2026. Address deed authorization before the financial year begins or before the first remuneration payment.
What Are the Most Common Questions About Partners Remuneration Under Section 40(b)?
What is the partners remuneration limit for FY 2025-26 under Section 40(b)?
For FY 2025-26 (AY 2026-27), the maximum aggregate remuneration deductible across all working partners is: on the first Rs 6,00,000 of book profit (or if there is a loss), Rs 3,00,000 or 90% of book profit, whichever is higher; and on book profit above Rs 6,00,000, 60% of such balance. These limits were enhanced by the Finance Act 2024 effective from AY 2025-26. For a firm with Rs 10 lakh book profit, the maximum deductible remuneration is Rs 5,40,000 + Rs 2,40,000 = Rs 7,80,000 in aggregate across all working partners.
What is the difference between partners remuneration and share of profit?
Partners remuneration (salary, commission, bonus, fees paid under Section 40(b)) is deductible by the firm within the Section 40(b)(v) ceiling and is taxable in the partner’s hands as Profits and Gains of Business or Profession under Section 28(v). Share of profit is not deductible by the firm (the firm pays tax on it as part of taxable income) but is fully exempt in the partner’s hands under Section 10(2A) of the Income Tax Act 1961. Remuneration transfers tax liability from the firm (at 30%) to the partner (at their slab rate); share of profit results in the firm bearing the full 30% tax and the partner receiving a tax-free amount.
Can a partnership firm pay remuneration to a sleeping partner?
No. Section 40(b) allows deduction for remuneration paid only to working partners (individuals actively engaged in conducting the firm’s business). Remuneration paid to a sleeping partner is disallowed in full. The disallowed amount is added to the firm’s taxable income; however, the sleeping partner still pays tax on the remuneration received. This creates economic double taxation on the disallowed amount. Sleeping partners can receive interest (up to 12% p.a.) on their capital or loans under Section 40(b)(iv), which is deductible regardless of working or sleeping status.
What happens if partners remuneration exceeds the Section 40(b) limit?
Remuneration in excess of the Section 40(b)(v) ceiling is disallowed as a deduction in the firm’s hands and added back to taxable income. The firm pays income tax at 30% on the disallowed excess. Simultaneously, the full remuneration amount (including the disallowed excess) remains taxable in the partner’s hands as PGBP income. This results in double taxation on the excess.
Is partners remuneration subject to TDS under the Income Tax Act 1961?
Partner remuneration is taxable in the partner’s hands as Profits and Gains of Business or Profession under Section 28(v), not as salary. Effective April 1, 2024, Section 194T requires the firm to deduct TDS at 10% on salary, remuneration, commission, bonus, or interest paid to a partner when total payments to that partner in a financial year exceed Rs. 20,000. The firm deposits this TDS with the government and the partner receives credit in Form 26AS. Partners must also pay advance tax on their estimated income (remuneration plus share of profit) by the prescribed due dates to avoid interest under Sections 234B and 234C.
CA Madhusmita Padal is a Practicing Chartered Accountant with firms based in Odisha and Chennai. She specializes in taxation, company law, and auditing. She is passionate about simplifying complex concepts and making knowledge accessible to all.