A partnership firm has to pay tax on the profit earned by that firm. There is however, some exemptions subject to a limit that the firm can avail. One such parameter is the amount of interest the firm pays towards interest on the amount that any of the partner has contributed for the working of the firm.
The interest paid to partners component of the balance sheet may be exempted from the taxable income of the firm subject to fulfillment of the following conditions, as laid down under section 40(b) of Income Tax Act, 1961.
- The partner should be a working partner.
- The interest or the remuneration payable has to be mentioned in the partnership deed.
- The method that will be adopted for calculating the interest or remuneration should be clearly articulated in the partnership deed.
- Any interest paid before the date of authorizing the remuneration in the partnership deed will not qualify for exemptions.
- The interest rate should be below 12%, even if higher interest rate is quoted in the partnership deed.
It is understood that the interest income earned by the partner will be added to his total income and he is liable to pay tax on it. Also, the cap of 12% ensures that this facility is not misutilised by firms and partners to reduce their tax liability as a whole.
