Section 40(b)

Section 40(b) — the law in short

What the courts have decided on section 40(b), in one screen. Read this first; open an entry when you need the facts, the reasoning and the source.

• Munjal Sales Corporation v CIT Supreme CourtHelps taxpayerValidity unconfirmed
  My firm pays interest on partners' capital. Is the s.40(b)(iv) ceiling the only test the AO can apply?
  No — both tests apply, in that order. A firm must first bring the interest within s.36(1)(iii) and then keep within the ceiling in s.40(b)(iv), because ss.30 to 38 grant the deduction while s.40 operates as a limitation on them. Whether the partners' capital was in the nature of a loan makes no difference to that analysis.
• Keshavji Ravji & Co v CIT Supreme CourtHelps taxpayerSuperseded by amendment
  A Board circular supports my reading of the section. Can I hold the Tribunal or the High Court to it, and can a circular settle what a provision means?
  No. The Supreme Court held that the Board cannot pre-empt a judicial interpretation of a provision by issuing a circular, that a circular cannot impose on the taxpayer a burden higher than the Act on its true construction, and that the task of interpreting the law belongs exclusively to the courts, which circulars do not bind. Circulars issued under section 119 that are beneficial to assessees and tone down the rigour of the law do bind the authorities administering the Act, and their benefit is available even where they depart from the strict statute - but the Tribunal and the High Court are not such authorities.
• CIT v R.M. Chidambaram Pillai Supreme CourtHelps taxpayerSuperseded by amendment
  I draw a salary from my firm, which grows and manufactures tea. Only 40 per cent of the firm's income is taxable as business income - is my whole salary taxable, or only 40 per cent of it?
  Only the taxable proportion. The Supreme Court held that a firm is not a legal person, and since a contract of service needs two distinct persons there can be no contract of employment between a firm and its own partner. A salary agreed to a partner is therefore a special share of profits - profits under another name - and takes the character of the firm's income. Where the composite income from tea is apportioned so that 60 per cent is agricultural and beyond the Union's reach, 60 per cent of the partner's salary shares that character too. The position is different for a stranger who is not a partner.
• Mr. Anandkumar v ACIT High CourtHelps department
  I am a partner. Can I take the salary and interest my firm pays me, call it my turnover, and offer 8 per cent of it under s.44AD?
  No. The High Court held that a partner receiving remuneration and interest from his firm is not himself carrying on a business, so those receipts cannot be termed a turnover, and they do not qualify as gross receipts either. Section 44AD applies only to an eligible assessee engaged in an eligible business having a total turnover or gross receipts, and the assessee here had neither effected sales nor rendered services; the sums had already been debited in the firms' own profit and loss accounts. The appeal was dismissed and both questions of law were answered against the assessee and in favour of the Revenue. This is the answer to a scheme that is still marketed to partners, and it is a High Court answer, not a Tribunal one.
• Pr CIT, Kota v Modern Motors — a deed that fixes the METHOD of computing partners' salary is enough High CourtHelps taxpayerValidity unconfirmed
  Our deed does not name a rupee figure; it gives slabs of book profit and percentages. The officer says the amount is not specified and has disallowed the salary. Is he right?
  No. The Rajasthan High Court upheld the Tribunal's view that where the deed provides the manner of quantifying the remuneration — here as slabs of percentages of book profit determinable only at the year end, shared equally among the partners, with no salary in a year of loss — the exact quantum need not be stated, and the deduction under s.40(b)(v) is allowable. Circular No. 739 of 1996 itself requires either the quantum OR the manner of quantification, and on these facts it supported the assessee rather than the Revenue.
• CIT v S.R. Batliboi & Associates High CourtHelps taxpayerHigh Courts differ
  The revised partnership deed was not filed with the return but was produced during the assessment. Does s.185 still disallow the partners' remuneration?
  No, on this judgment. The Calcutta High Court held that s.185 read with s.184, although worded in emphatic terms, is not intended to be mandatory. The Assessing Officer had refused to treat the return as defective under s.139(9); having refused that, he could not simultaneously hold the return to be in derogation of s.184(4) and disallow the deduction. The disallowance of Rs. 4,49,60,000 of partners' remuneration was deleted.
• Sood Brij & Associates v CIT High CourtHelps departmentValidity unconfirmed
  Our deed says the partners will be paid such remuneration as they mutually agree, up to the statutory ceiling. Is that enough for s.40(b)(v)?
  No. The Delhi High Court held that the words 'in accordance with the terms of the partnership deed' require the deed either to quantify the remuneration or to lay down the manner of computing it. A clause that leaves the amount to be settled by mutual agreement in future does not do that, and a clause that merely reproduces the statutory maximum fixes a ceiling rather than a quantum. The deduction of Rs. 21,40,000 was disallowed.
• CIT v Jagdish Medical Agencies High CourtHelps taxpayerValidity unconfirmed
  My firm pays interest on a deposit standing in the name of an AOP, and one of my partners is a member of that AOP. Is the interest disallowed as interest to a partner?
  No. An association of persons is a separate person under s.2(31)(v) and a separate assessable entity, different from the firm, so interest paid by a firm to an AOP is not interest paid to a partner and is outside s.40(b). The Allahabad High Court applied the Supreme Court's reasoning in Brij Mohan Das Laxman Das, which held that interest paid to a partner who represents his Hindu undivided family, on the deposit of his own individual funds, does not fall within s.40(b).
• Indwell Constructions v CIT High CourtHelps taxpayer
  The officer rejected my firm's books and estimated the profit. Can he then also add back the interest and remuneration the firm paid its partners?
  No. Once the books are rejected and the profit is estimated, the estimate stands in substitution for a computation under s.29, and every deduction that s.29 brings in is deemed to have been taken into account in arriving at it. The Court added that the embargo in s.40 is taken into account in the same way. To add back one specific item out of the profit and loss account is to rely on the very books that have been rejected, which the officer cannot do. The separate addition of Rs 63,859 for interest and remuneration paid to partners was held not permissible, and the reference was answered in the negative and in favour of the assessee. Read the reasoning carefully before relying on it, because it cuts both ways: the same sentence that stops the Revenue adding an item back is the sentence the Revenue uses to resist a further deduction claimed on top of an estimate.
• GRK Agencies v ITO — a deed saying salary 'as may be mutually agreed' will not carry a section 40(b)(v) claim ITATHelps departmentValidity unconfirmed
  Our partnership deed says partners' salary will be as mutually agreed from time to time, and we passed a resolution fixing the amounts. The officer has disallowed the whole remuneration. Can he?
  Yes, on those facts. The Tribunal held that a clause providing that salary 'be paid every month/year as may be mutually agreed between the partners from time to time' neither fixes a sum, fixed or variable by reference to profits, nor identifies which partners are working partners, and is therefore at best an authorisation to pay salary and nothing more. Because s.40(b)(ii) requires the payment to be both 'authorised by' AND 'in accordance with' the terms of the deed, identification of the partner and quantification of the remuneration are prerequisites to the deduction, and a later resolution on the firm's letterhead — unstamped, unregistered, undated by the signatories and produced only when the officer asked — could not be treated as a valid amendment of the deed.
• C. Eswara Reddy & Co v ACIT ITATCuts both waysSuperseded by amendment
  The officer rejected my firm's books and estimated the profit at a percentage of receipts. Can the firm still deduct salary and interest paid to its partners from that estimated figure?
  For the years this order governs, yes. The Tribunal held that s.44AD(2) deems only the deductions under ss.30 to 38 to have been given full effect; s.40 is not deemed to have been allowed, and the proviso to s.44AD(2) as it then stood said in terms that salary and interest paid to a partner shall be deducted from the income computed under s.44AD(1), subject to the ceiling in s.40(b). Taking a clue from that scheme, the Tribunal directed the officer to allow partner salary and interest from the estimated income. On depreciation it went the other way: because depreciation is allowable under s.32, which falls inside ss.30 to 38, no separate deduction for depreciation was permitted from the estimate. The order concerns assessment years 2003-04 and 2004-05 and rests squarely on a proviso Parliament has since deleted.
• Statutory position — section 194T: from 1 April 2025 a firm must deduct 10 per cent on what it pays its own partners CBDT Circulars & InstructionsCuts both ways
  We credit partners' remuneration and interest to their capital accounts once a year when the accounts are finalised. Do we now have to deduct TDS on that?
  Yes, from 1 April 2025. Section 194T, inserted by the Finance (No. 2) Act 2024, requires a firm paying any sum in the nature of salary, remuneration, commission, bonus or interest to a partner to deduct income-tax at 10 per cent at the time of credit to the partner's account — expressly INCLUDING his capital account — or at the time of payment, whichever is earlier. No deduction is required where the sum, or the aggregate of such sums credited or paid or likely to be credited or paid to that partner, does not exceed Rs 20,000 in the financial year.
• Statutory position — section 40(b)(v): the working-partner remuneration ceiling, raised from AY 2025-26 CBDT Circulars & InstructionsCuts both ways
  What is the maximum remuneration my firm can deduct for its working partners for the year I am filing now, and does the old professional / non-professional split still exist?
  For assessment year 2025-26 onwards the ceiling is Rs 3,00,000 or 90 per cent of the book profit, whichever is more, on the first Rs 6,00,000 of book profit or in case of a loss, and 60 per cent of the balance of the book profit. Those figures were substituted by the Finance (No. 2) Act 2024 (Act No. 15 of 2024) with effect from 1 April 2025. For assessment years 2010-11 to 2024-25 the same two-band table applied but with Rs 1,50,000 and Rs 3,00,000 in place of Rs 3,00,000 and Rs 6,00,000. The separate table for professional firms disappeared from AY 2010-11 and there is now one table for all firms.
• Statutory position — sections 184 and 185: what a firm loses when it is not assessed as a firm CBDT Circulars & InstructionsCuts both ways
  The AO has invoked section 185 because of a defect in the partnership deed filed with our return. What exactly do we lose, and does the partner get any relief?
  The firm loses every rupee it paid its partners. Section 185 provides that where a firm does not comply with section 184 for any assessment year, it is so assessed that no deduction by way of interest, salary, bonus, commission or remuneration to any partner is allowed in computing its business income. Section 184(5) imposes the same consequence where there is a section 144 failure. The partner is not taxed on the same amounts, because both provisions end by saying those sums are not chargeable under clause (v) of section 28.
• CBDT Circular No. 739 dated 25 March 1996 — a deed that neither fixes the remuneration nor fixes the way of working it out carries no section 40(b)(v) claim CBDT Circulars & InstructionsHelps departmentValidity unconfirmed
  Our partnership deed says the partners will be paid such salary as they may decide at the end of the year. The AO has disallowed the whole remuneration relying on a 1996 circular. What does that circular actually say?
  It says that for assessment years after assessment year 1996-97 no deduction under section 40(b)(v) is admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration. And it says that where neither the amount has been quantified nor even the limit of total remuneration has been specified, but the figure has been left to be determined by the partners at the end of the accounting period, the remuneration cannot be allowed as a deduction in computing the firm's income.
• Statutory position — sections 10(2A) and 28(v): the share of profit is exempt, the remuneration and interest are not CBDT Circulars & InstructionsCuts both ways
  The AO says the whole of what I received from my firm is taxable. Which part of a partner's receipts from his firm is actually exempt, and how is the exempt share computed?
  Only the partner's share in the total income of the firm is exempt, and only where the firm is separately assessed as such — that is section 10(2A). Interest, salary, bonus, commission and remuneration due to or received by a partner from the firm are not covered by the exemption at all; they are charged in the partner's hands as business income under section 28(v). The proviso to section 28(v) then works the other way, reducing the partner's income to the extent the firm was denied the deduction under section 40(b).

Listed strongest first: Supreme Court, then High Court, then Tribunal, then CBDT. Nothing here has yet been read in full by a chartered accountant — open an entry to see where it came from.