The Finance Act 1992 has made the firm as a separate entity for income tax purposes and as such following new sub-section 40(b) has been inserted with effect from assessment year 1993-94
In the case of firm assessable as firm (i.e. PFAF)
(a) any payment of salary, bonus, commission or remuneration by whatsoever name called, to any partner who is not a working partner shall be disallowed;
(b) any payment of remuneration to a working partner shall also be disallowed if such payment is not authorised by or is not in accordance with the terms of partnership deed;
(c) any payment of interest to a partner which is not authorised by or is not in accordance with the terms of partnership deed shall also be disallowed;
(d) any payment of remuneration to any working partner or of interest to any partner relating to the period (prior to the date of such partnership deed) for which such payment was not authorised or is not in accordance with, any earlier partnership deed, shall also be disallowed. However, the period of authorisation for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier deed.
(e) any payment of interest to any partner which is authorised by and is in accordance with the terms of partnership deed and relates to the period falling after the date of such partnership is allowed if rate of interest does not exceed 12% p.a. If it exceeds 12% p.a. excess is disallowed;
(f) any payment of remuneration to all working partner which is in accordance with the terms of and is authorised by the partnership deed is allowed upto limits as laid down below :
W.e.f. assessment year 2010-11 the prescribed limit on remuneration to working partners of firms shall be uniform in case of both professional and non-professional firm, i.e., there will be no distinction between professional and business firm.
The revised limits for all types of firms are as under :
(i) on the first ‘ 3,00,000 of book profit or in case of a loss— 1,50,000 or @ 90% of book profit, w.e. is more.
(ii) on the balance of book profit—60% of book profit.
(g) In case a person is represented by another individual, in a firm such person is called “person so represented” and the individual who is so representing is called “partner in representative capacity.”
(i) any interest paid to such individual (otherwise than as partner in representative capacity) shall not be taken into consideration for the purposes of this section;
(ii) any interest paid to such individual as partner in representative capacity and interest paid by the firm to the person so represented shall be taken into consideration for the purposes of this section.
(h) where an individual is a partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf of or for the benefit of any other person.
(i) the term Book Profit means the net profit as shown in the profit and loss account for the relevant previous year computed in accordance with provisions of this chapter and after adding the aggregate amount of remuneration paid to partners if already debited to the Profit & Loss account or any other account prepared to calculate income.
(J) the term working partner means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner.