FDR Interest Must Be Included in Book Profit for Partners' Remuneration Under Section 40(b): ITAT Jaipur Ruling

Overview

The Income Tax Appellate Tribunal, Jaipur Bench, has delivered a significant ruling in favour of a partnership firm, holding that interest income recorded in the firm's profit and loss account cannot be stripped out of the book profit merely on account of its classification as "Income from Other Sources" when computing permissible partners' remuneration under Section 40(b) of the Income Tax Act, 1961. The Tribunal directed deletion of a disallowance of ₹1,93,183 that had been sustained by both the Assessing Officer and the CIT(A).

Case Background

Case Name: Shree Shakuntala Industries Vs ITO (ITAT Jaipur)
Appeal Number: ITA No. 1396/JPR/2025
Date of Order: 16/10/2026
Assessment Year: 2002-03

Facts of the Case

Shree Shakuntala Industries, a partnership firm, earned interest amounting to ₹8,10,553 during the relevant previous year from fixed deposit receipts (FDRs) and Kisan Vikas Patras (KVPs). This interest income was reflected in the firm's profit and loss account, and the firm included it within the book profit base while calculating deductible remuneration paid to its partners under Section 40(b) of the Income Tax Act, 1961.

The Assessing Officer, however, took the view that the said interest income was taxable under the head "Income from Other Sources" and therefore could not form part of the book profit for purposes of Section 40(b). Excluding this amount from the book profit base led to a reduction in the ceiling of permissible partners' remuneration. Initially, the resultant disallowance was computed at ₹3,24,221. However, since the assessee itself had already excluded KVP interest and returned it under "Income from Other Sources," the Assessing Officer restricted the ultimate disallowance to ₹1,93,183.

The assessee challenged this adjustment before the CIT(A), National Faceless Appeal Centre, Delhi. The CIT(A), vide order dated 10 September 2025, confirmed the Assessing Officer's position, holding that interest not attributable to eligible business activity should not enter the computation under Section 40(b). The firm then preferred an appeal before the ITAT Jaipur.

What Does Explanation 3 to Section 40(b) Say?

At the heart of this dispute lies the definition of "book profit" as prescribed in Explanation 3 to Section 40(b) of the Income Tax Act, 1961. The explanation reads as follows:

"book-profit means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit."

The critical phrase here is "net profit as shown in the profit and loss account". This anchors the computation to the firm's commercial accounts — not merely to income computed under the head "Profits and Gains of Business or Profession".

The qualifying expression "computed in the manner laid down in Chapter IV-D" has been interpreted by multiple tribunals as a directive only to exclude inadmissible or excessive claims embedded in the book profit — not as an authority to reclassify or exclude receipts that happen to be taxed under a different head of income.