How Partnership Firms Are Taxed

A firm pays flat 30% regardless of income, none of the slab-based reliefs built for individuals apply. What partners take home depends entirely on Section 40(b), a limit that trips up more firms than it should.

Business Taxation

How Partnership Firms Are Taxed

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Tax Exemption for Trusts and NGOs

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Presumptive Taxation Scheme

TDS, Basics for Individuals

A note on the law: section numbers here are from the Income tax Act, 1961, the operative law for the current filing cycle. The Income tax Act, 2025 renumbers these provisions from returns filed for Tax Year 2026-27 onward.

A partnership firm, unlike an individual, pays tax at a flat rate regardless of how much it earns, and none of the slab-based reliefs built for individuals apply to it.

The basics

Flat 30% tax rate on total income, plus applicable surcharge and 4% cess
No Section 87A rebate, no basic exemption slab, the flat rate applies from the first rupee of profit
Everything below assumes a partnership firm governed by a written partnership deed; an LLP follows the same Section 40(b) rules since the definition of “firm” for this purpose includes LLPs, covered separately in LLP Taxation for LLP-specific points like AMT and conversion

Partner remuneration: what the firm can deduct

Remuneration (salary, bonus, commission) paid to partners is deductible to the firm only within limits set by Section 40(b), and only for working partners, those actively engaged in running the business. A firm that pays a non-working partner a “salary” gets zero deduction for that payment.

For FY 2025-26 (AY 2026-27), the limit works off the firm’s book profit:

Book profit slab	Maximum deductible remuneration
First 6,00,000 rupees (or a loss)	Higher of 3,00,000 rupees or 90% of book profit
Balance above 6,00,000 rupees	60% of the balance

This limit covers the partners’ remuneration in aggregate, not per partner, the firm and its partners then agree how to split it.

Two conditions matter as much as the numbers: the deed must specifically authorise remuneration, vague language like “as decided by the partners” gets challenged on scrutiny, and if the deed is later amended to revise the amount, the new limit applies only from the date of that amendment, not retroactively for the full year.

Worked example

Two working partners, firm pays each 4,50,000 rupees (9,00,000 rupees total).

Net profit per P&L, after deducting that remuneration: 3,00,000 rupees
Add back the 9,00,000 rupees remuneration to arrive at book profit: 12,00,000 rupees
First 6,00,000 rupees of book profit: 90% = 5,40,000 rupees
Balance 6,00,000 rupees: 60% = 3,60,000 rupees
Maximum deductible: 9,00,000 rupees

The firm paid exactly what it’s allowed to deduct, so the full 9,00,000 rupees is deductible to the firm and taxable to the two partners.

Interest to partners

Interest on partner capital is deductible up to 12% per annum simple interest, whether the partner is working or not. Anything paid above 12% is disallowed to the firm, in full, not just the excess treated loosely.

How this is taxed in the partner’s hands

Remuneration and interest that the firm is allowed to deduct is taxable to the receiving partner as business income (Profits and Gains of Business or Profession), not salary
Amounts disallowed to the firm, because they exceeded the 40(b) limit, went to a non-working partner, or weren’t authorised by the deed, are correspondingly not taxable to the partner either. That money is simply paid out with no deduction for the firm and no tax anywhere, a pure inefficiency worth avoiding rather than a double-tax risk
The partner’s share of the firm’s profit, separate from remuneration and interest, is fully exempt under Section 10(2A), since the firm has already paid 30% tax on its total income before that profit is distributed

TDS on partner payments: Section 194T

Since 1 April 2025, the firm must deduct 10% TDS on salary, remuneration, bonus, commission, or interest paid to a partner once the aggregate for that partner crosses 20,000 rupees in the year. One reconciliation trap worth watching: TDS applies to the amount actually paid or credited, which can be larger than the amount ultimately allowed as a deduction under Section 40(b). A partner’s Form 26AS can show TDS on an amount that isn’t fully taxable to them, worth checking every year rather than assuming the two figures will always match.

FAQs: How Partnership Firms Are Taxed

Is a partner’s salary taxed twice, once at the firm level and again in their hands?

No. The remuneration is deducted from the firm’s income before the firm’s 30% tax is computed, then taxed once, in the partner’s hands. The firm’s profit share, by contrast, is taxed once at the firm level and then received tax-free by the partner. Neither path taxes the same rupee twice.

What happens if remuneration paid exceeds the Section 40(b) limit?

The excess is disallowed to the firm, added back to its taxable income, and correspondingly exempt in the partner’s hands. The firm still gets taxed as if it had never paid that excess out, while the partner who received it owes no tax on it either, it’s simply money that generated no deduction anywhere.

Does interest to partners need to be authorised by the deed too?

Yes, and it must relate to a period after the date of that deed. A renewed or amended deed’s terms apply only to the period it covers.

Do LLPs follow the same remuneration and interest rules?

Yes, Section 40(b) applies to LLPs as well, the definition of “firm” for this section includes them.

Can a partnership firm use presumptive taxation like individuals do?

Yes, under Section 44AD, a resident partnership firm running an eligible business can declare profit at the deemed rate (8% of turnover, 6% for digital receipts) and skip full books and audit, the same mechanism covered in our Presumptive Taxation Scheme article. Section 44ADA, the professional equivalent, is not available to firms, only individuals and HUFs.

When does a partnership firm need a tax audit?

When turnover crosses the Section 44AB threshold, 1 crore rupees normally, 10 crore rupees if cash transactions stay at 5% or less. A firm on presumptive taxation that declares profit below the deemed 6%/8% rate, while its income exceeds the basic exemption limit, also triggers a mandatory audit even below the turnover threshold.

Can a firm carry forward its losses if a partner retires or the firm is reconstituted?

Mostly yes, but with one restriction: Section 78 blocks the firm from carrying forward the retiring or deceased partner’s share of a loss. The remaining continuing partners can still carry forward their own share.

What happens if the firm doesn’t have a proper written partnership deed?

The firm risks being assessed as an Association of Persons instead of a partnership firm, which can mean losing Section 40(b) deductions for remuneration and interest altogether. A signed deed authorising these payments isn’t optional paperwork, it’s what makes the deduction available in the first place.

Does a partnership firm need its own PAN, separate from the partners?

Yes, the firm is a distinct assessee and needs its own PAN, filed under ITR-5 as covered in Which ITR Form for Your Business.

Can a firm pay salary to a partner’s spouse or family member and deduct it?

Yes, if that person is a genuine employee, not a partner, doing real work at a reasonable market salary. This has nothing to do with the Section 40(b) limits above, which apply only to partners, it’s an ordinary business expense under Section 37. It does draw scrutiny attention if the salary looks inflated relative to the actual role.

Last updated on 30 July 2026