The Finance Act 2024 introduced important changes to the rules governing remuneration paid to working partners of partnership firms and LLPs under Section 40(b) of the Income-tax Act. These changes increase the allowable deduction that firms can claim for partner remuneration while calculating taxable income.
With the revised provisions becoming effective from Financial Year 2024–25 (Assessment Year 2025–26), partnership firms should review their existing partnership deeds to ensure that remuneration and interest clauses comply with the updated tax limits. If the deed does not clearly authorize remuneration or specify the calculation method, the Income Tax Department may disallow the deduction, even if the firm actually pays the remuneration.
Therefore, firms are advised to execute a supplementary deed or addendum to update the relevant clauses and align them with the new tax provisions.
Revised Deduction Limits and Need to Update the Partnership Deed
Under the amended provisions of Section 40(b), the limits for deducting remuneration paid to working partners have been increased based on the book profit of the firm.
The revised limits are:
- On the first ₹6,00,000 of book profit or in case of loss – ₹3,00,000 or 90% of book profit, whichever is higher
- On the remaining book profit – 60% of the balance amount
This change effectively doubles the earlier limits, allowing partnership firms to claim higher deductions for remuneration paid to working partners. However, the deduction will only be allowed if the partnership deed clearly authorizes such remuneration and specifies the method of calculation.
Apart from remuneration, firms often provide interest on capital contributed by partners. Under the Income-tax provisions, interest on partner capital is allowed as a deduction only when it is specifically mentioned in the partnership deed, and the maximum allowable rate is 12% per annum.
Another important compliance aspect comes from CBDT Circular No. 739 (1996). The circular clarifies that the partnership deed must either specify the exact remuneration amount or clearly define the method of calculating it. Vague wording such as “remuneration will be decided at the end of the year” may lead to complete disallowance during tax assessments or tax audits.
To ensure proper compliance, partnership firms should review their existing deeds and include clear provisions that:
- Authorize remuneration only to working partners
- Specify a clear formula for remuneration calculation based on Section 40(b)
- Mention the interest rate on partner capital
- Clearly identify the working partners eligible for remuneration
Conclusion
The amendment introduced by the Finance Act 2024 provides partnership firms with an opportunity to claim higher deductions for remuneration paid to working partners, thereby improving tax efficiency. However, these benefits can only be utilized when the partnership deed properly authorizes remuneration and clearly defines the calculation method in accordance with Section 40(b).
Therefore, partnership firms should review and update their partnership deeds through a supplementary deed or addendum to reflect the revised limits and comply with CBDT guidelines. Proper drafting and timely amendment of the deed will help firms avoid deduction disallowance during tax audits and ensure smooth tax compliance.