Key answer: calculate the firm-wide ceiling, then test actual authorised remuneration
For FY 2025-26/AY 2026-27, Section 40(b) of the Income-tax Act, 1961 allows only the qualifying working-partner remuneration within its aggregate ceiling. For the first ₹6,00,000 of book profit, or a loss, the ceiling is ₹3,00,000 or 90% of the relevant book profit, whichever is higher; the balance above ₹6,00,000 carries 60%. The ceiling does not create a deduction for remuneration never incurred or not authorised by the deed. The ₹6 lakh/₹3 lakh substitution was enacted by the Finance (No. 2) Act, 2024 with effect from 1 April 2025 and therefore applies to this stated assessment year; it is not merely a Budget proposal.
This is a period-specific computation guide, checked against the Income Tax Department's Section 40 text and its amendment footnotes on 22 October 2026. It concerns FY 2025-26, not an automatic mapping of the section number, forms or reporting framework to a later tax year. Presumptive-tax cases and other special regimes require separate analysis. The illustrations assume a firm assessable as such and exclude separate withholding disallowance questions unless expressly mentioned.
Build book profit before applying the percentage
Explanation 3 defines book profit by reference to the P&L net profit computed under Chapter IV-D, adding back remuneration paid/payable to all partners where deducted in arriving at that net profit. Start from a tax-adjusted working rather than turnover or a remembered accounting profit. Explain each adjustment and avoid adding the same remuneration back twice. Partner interest has its own deed and rate test; it is not automatically added back merely because remuneration is.
Keep remuneration, interest, profit share and drawings separately identified. The statutory working-partner definition concerns an individual actively engaged in conducting the firm's affairs. A high book-profit limit does not cure payment to a non-working partner or a deed that does not authorise the payment for the relevant period. CBDT Circular No. 739 dated 25 March 1996 states that the deed must specify the remuneration payable to each individual working partner or the method of quantifying it; leaving the amount entirely for agreement at year-end is insufficient under that guidance. Read the actual deed, its allocation method and any applicable binding judicial interpretation.
A compact ceiling function
| Book-profit position | Aggregate statutory remuneration ceiling |
|---|---|
| Loss or zero book profit | ₹3,00,000, subject to the other conditions and actual expenditure |
| Positive book profit up to ₹6,00,000 | Higher of ₹3,00,000 and 90% of that book profit |
| Book profit above ₹6,00,000 | ₹5,40,000 plus 60% of the excess over ₹6,00,000 |
The table gives the statutory upper limit, not an instruction to book that amount. Compare it with actual qualifying expenditure and the deed's operative authorisation. Where the deed specifies a lower entitlement, the tax ceiling does not enlarge that entitlement. Keep a partner-wise allocation and a firm-wide cap reconciliation.
Partner interest is a separate calculation
Section 40(b)(iv) restricts otherwise qualifying partner interest to 12% simple interest per annum. Consider the authorised rate, capital movements, relevant period and the representative-capacity explanations where applicable. A fixed closing capital balance should not be used for the whole year when the underlying capital changed. Do not treat a profit-share withdrawal as interest simply because it is posted to a partner account.
Section 40(b) eligibility and partner-payment withholding are different reviews. A correct ceiling does not establish that all TDS obligations have been met. Conversely, deduction of tax does not make an unauthorised or excessive payment deductible under Section 40(b).
Worked illustrations
The following cases use fictional figures and stated assumptions. Amounts are Indian rupees unless a different unit is expressly shown. They illustrate preparation controls and do not represent real client results.
Illustrative example 1: loss does not create an automatic ₹3 lakh expense
The properly computed book-profit figure is a loss of ₹1,00,000. Qualifying deed-authorised remuneration actually incurred is ₹2,40,000. The statutory ceiling is ₹3,00,000, but the deduction in this simplified case is ₹2,40,000, not ₹3,00,000. No extra ₹60,000 is created by the ceiling.
Illustrative example 2: small positive book profit uses the higher alternative
Book profit is ₹2,00,000. Ninety per cent is ₹1,80,000, so the ceiling is the higher amount of ₹3,00,000. Actual qualifying authorised remuneration of ₹2,50,000 is within that cap. The difference between the cap and actual expenditure is not an additional deduction.
Illustrative example 3: the exact ₹6 lakh boundary
Book profit is ₹6,00,000. The ceiling is 90% × ₹6,00,000 = ₹5,40,000, higher than ₹3,00,000. If actual otherwise qualifying remuneration is ₹6,00,000, the Section 40(b) excess is ₹60,000. The 60% band has not started at this exact boundary.
Illustrative example 4: a higher profit uses both bands
Book profit is ₹10,00,000. The first band gives ₹5,40,000 and the remaining ₹4,00,000 gives ₹2,40,000. Total ceiling is ₹7,80,000. Actual otherwise qualifying remuneration ₹9,00,000 produces an excess of ₹1,20,000. Applying 90% to the entire ₹10,00,000 would incorrectly give ₹9,00,000.
Illustrative example 5: book profit is not the P&L balance after remuneration
Assume P&L net profit ₹6,00,000 after partner remuneration ₹4,00,000. A separately supported Chapter IV-D adjustment increases profit by ₹50,000, with no other adjustments. Book profit is ₹6,00,000 + ₹4,00,000 + ₹50,000 = ₹10,50,000. The ceiling is ₹5,40,000 + 60% × ₹4,50,000 = ₹8,10,000. Actual qualifying remuneration remains ₹4,00,000; the ceiling is not the expenditure.
Illustrative example 6: the deed authorises less than the tax ceiling
Book profit is ₹20,00,000, giving a statutory ceiling of ₹5,40,000 + 60% × ₹14,00,000 = ₹13,80,000. Assume the operative deed authorises only ₹6,00,000 and the firm books ₹8,00,000. On those stated facts, ₹2,00,000 fails the deed-authorisation test even though the booked amount is below the numerical statutory ceiling.
Illustrative example 7: 15% deed interest still faces the 12% simple-interest limit
Assume qualifying partner capital of ₹10,00,000 remains unchanged for exactly one full year. The deed authorises 15% simple interest and the firm incurs ₹1,50,000. The Section 40(b) rate limit gives ₹1,20,000, leaving ₹30,000 excess. This simplified case assumes no representative-capacity exception, capital movement or shorter interest period.
Ten-step verification table
| Step | Verification | Evidence to retain |
|---|---|---|
| 1 | Fix FY 2025-26 and AY 2026-27. | Period-specific governing-law record. |
| 2 | Confirm firm status and any special computation regime. | Entity and tax-regime assessment. |
| 3 | Read the operative deed and amendments. | Authorised terms and effective dates. |
| 4 | Establish actual working-partner eligibility. | Evidence of active individual participation. |
| 5 | Separate remuneration, interest, profit share and drawings. | Partner-wise ledger classification. |
| 6 | Reconcile P&L profit to Chapter IV-D book profit. | Tax adjustments and remuneration add-back once. |
| 7 | Apply the aggregate two-band ceiling. | Recomputed ₹6 lakh-band working. |
| 8 | Compare ceiling with actual deed-authorised expenditure. | Partner allocation and disallowance reconciliation. |
| 9 | Test interest separately at the eligible simple-interest rate. | Capital/period and rate schedule. |
| 10 | Reconcile the computation and separate withholding review. | Final tax working and independent TDS conclusion. |
Sixteen practitioner FAQs
1. Is the ₹3 lakh amount a compulsory deduction?
No. It is part of the statutory ceiling. Actual expenditure, deed authorisation and other conditions still govern eligibility.
2. Is the ceiling available separately to each partner?
No. The numerical cap is for aggregate remuneration to all working partners. Reconcile allocations within that firm-wide limit.
3. Can turnover be used as book profit?
No. Use the statutory definition and the tax-adjusted P&L working, with the required remuneration add-back.
4. Should remuneration already added back be added again?
No. Trace the starting profit and adjustment register to avoid double counting.
5. Does every partner count as a working partner?
No. Apply the statutory definition concerning an individual actively engaged in the firm's affairs.
6. Can the tax ceiling override a lower deed entitlement?
No. A numerical maximum does not itself authorise a payment beyond the operative deed.
7. Does a later deed automatically authorise an earlier period?
No. Review the deed dates and the statutory restriction on periods before authorisation. Do not assume retrospective entitlement.
8. Is the ceiling 90% of all profits?
No. Apply the first ₹6 lakh band and then 60% of the excess, using the stated period's law.
9. What happens at exactly ₹6 lakh book profit?
The first-band ceiling is ₹5.40 lakh. There is no excess profit to which the 60% rate applies.
10. Is interest included within the remuneration percentage cap?
It is tested separately under the partner-interest provisions. Preserve separate amounts and conclusions.
11. Can the firm deduct 15% interest because the deed allows it?
The stated-year Section 40(b) simple-interest limit is 12% per annum for otherwise qualifying interest, subject to its specific explanations and conditions.
12. Can closing capital be used for the entire year?
Only if the facts support that unchanged balance for the whole relevant period. Otherwise use the actual capital and time working.
13. Does TDS make an excessive payment deductible?
No. Withholding and deduction eligibility are separate reviews.
14. Does this calculator determine the partner's personal tax?
No. It computes the firm's Section 40(b) restriction under stated assumptions. The partner's return and any corresponding treatment require separate assessment.
15. Does this apply unchanged to presumptive taxation?
Do not assume so. Establish the applicable special-regime rules before seeking a separate partner-payment deduction.
16. Can this section number be copied into every later tax year?
No. This article is deliberately scoped to FY 2025-26/AY 2026-27. Check the legislation and reporting framework applicable to another period.
Organising the supporting working
Keep the underlying records, calculation and conclusion linked to the same entity and period. When organising work with assureTax and the assureOffice tools, retain these supporting schedules alongside the final output and use only the features confirmed for the version available to you.
Conclusion
Prepare the book-profit working before applying the bands, then reconcile the actual deed-authorised payments. Keep the firm-wide remuneration cap, partner-interest restriction and withholding assessment as distinct conclusions.