Partnership Firm · Chapter 5
Tax, compliance and closing a Partnership Firm
In short
A Partnership Firm pays income tax at 30% plus surcharge and cess, can deduct partners' interest and remuneration within limits, files ITR-5, and is closed by a dissolution deed and settling accounts.
A Partnership Firm pays income tax at a flat 30% of its total income, plus 12% surcharge above ₹1 crore and 4% cess. It can deduct interest and remuneration paid to partners within the limits of section 40(b), files its return in ITR-5 (or ITR-4 if on the presumptive scheme), and is closed by dissolving it, settling accounts and cancelling its Registrations.
A note on the new Income-tax Act
The Income-tax Act, 2025 replaced the Income-tax Act, 1961 from 1 April 2026. Returns filed in 2026 for FY 2025-26 follow the 1961 Act; income from 1 April 2026 (tax year 2026-27) follows the new Act. Section numbers have changed — for example, TDS on partner payments (old section 194T) is now in section 393, and the presumptive schemes are in section 58 — but the rules described below carry over. This chapter uses the familiar old section numbers where they help.
How is a Partnership Firm taxed?
| Item | Rule |
|---|---|
| Tax rate | 30% of total income |
| Surcharge | 12% of tax, if total income exceeds ₹1 crore |
| Cess | 4% health and education cess on tax plus surcharge |
| Basic exemption | None — tax from the first rupee |
| Partner's share of profit | Exempt in the partner's hands (old section 10(2A)) |
| Interest and remuneration | Deductible for the firm within limits; taxable for the partner |
How much interest and remuneration can partners get? (Section 40(b))
The firm can deduct payments to partners only if all these conditions are met:
- The payment is authorised by the partnership deed and the amount or method is specified.
- It relates to the period after the deed was made (it cannot be backdated).
- Remuneration is paid only to working partners who are individuals.
- Interest does not exceed 12% simple interest a year.
Deductible remuneration to all working partners together is capped by "book profit":
| Book profit | Maximum deductible remuneration |
|---|---|
| First ₹6 lakh, or a loss | ₹3 lakh or 90% of book profit, whichever is higher |
| Balance above ₹6 lakh | 60% of book profit |
These limits apply from FY 2024-25, following the Finance (No. 2) Act, 2024, and continue under the new Act. Anything paid above the limit is not deductible for the firm, but the partner is taxed only on the amount the firm was allowed.
Is TDS required on payments to partners?
Yes. From 1 April 2025, a firm must deduct 10% TDS on salary, remuneration, commission, bonus or interest paid or credited to a partner, if the total for the year exceeds ₹20,000. TDS applies at the time of credit (including to the partner's capital account) or payment, whichever is earlier. The firm needs a TAN and must file TDS returns.
Can a Partnership Firm use presumptive taxation?
Yes — unlike an LLP. A resident firm can opt for the presumptive scheme for business (up to ₹2 crore turnover, or ₹3 crore if cash receipts are within 5%; 8% of turnover or 6% of digital receipts) or for specified professions (up to ₹50 lakh, or ₹75 lakh with limited cash; 50% of receipts). Under the business scheme, no separate deduction is allowed for partners' interest or remuneration. Check the conditions carefully before opting in.
What are the annual compliances?
| Compliance | When |
|---|---|
| Income tax return (ITR-5; ITR-4 if presumptive and eligible) | Every year; audit cases have a later due date |
| Tax audit | If turnover exceeds ₹1 crore (₹10 crore if cash transactions are within 5%), or professional receipts exceed ₹50 lakh, or as required under the presumptive rules |
| Advance tax | In instalments during the year if tax payable is ₹10,000 or more |
| TDS returns | Quarterly, if the firm deducts TDS |
| GST returns | Monthly or quarterly, if GST-registered |
| Registrar of Firms | No annual return; notify changes in partners, name, address or places of business |
Due dates are notified on the Income-tax e-filing portal and can be extended, so check them each year.
How is a Partnership Firm closed?
Closing a firm is called dissolution. The Indian Partnership Act, 1932 allows dissolution:
- By agreement of all partners (section 40).
- Compulsorily, if all but one partner become insolvent or the business becomes unlawful (section 41).
- On certain events, such as expiry of a fixed term, completion of the venture, or death or insolvency of a partner, unless the deed says otherwise (section 42).
- By notice, in a partnership at will (section 43).
- By the court, on grounds such as misconduct or persistent breach (section 44).
Steps to dissolve a firm
- Sign a dissolution deed on stamp paper (duty varies by state; in Maharashtra it is ₹500 unless property is distributed, when conveyance rates can apply).
- Settle accounts (section 48): pay outside creditors first, then partners' advances, then partners' capital, and share any surplus in the profit ratio.
- Notify the Registrar of Firms if the firm is registered, and give public notice so partners are not liable for later acts done in the firm's name.
- Cancel GST Registration by filing Form GST REG-16 and the final return.
- File the final income tax return and TDS returns; close the bank account.
Capital gains tax can arise for the firm when assets are distributed to partners on dissolution or reconstitution, so review the tax effect before transferring assets.
Key takeaways
- A firm pays 30% tax plus 12% surcharge above ₹1 crore and 4% cess, with no basic exemption.
- Partners' interest (up to 12%) and remuneration are deductible only within section 40(b) limits and if the deed authorises them.
- TDS at 10% applies to partner payments above ₹20,000 a year from 1 April 2025.
- Dissolution needs a deed, settlement of accounts, notice to the Registrar and cancellation of GST and other Registrations.
Frequently asked questions
What is the income tax rate for a Partnership Firm in India?
A Partnership Firm, including an LLP, pays income tax at a flat 30% of its total income. A surcharge of 12% of the tax applies if total income exceeds ₹1 crore, and 4% health and education cess is added on top. Unlike individuals, a firm has no basic exemption limit, so tax is payable from the first rupee of taxable income.
How much remuneration can a firm pay its partners under section 40(b)?
Remuneration is deductible only if paid to working partners who are individuals and authorised by the deed. The deductible amount is capped: on the first ₹6 lakh of book profit, or in case of a loss, the higher of ₹3 lakh or 90% of book profit; on book profit above ₹6 lakh, 60%. These limits apply from FY 2024-25 and continue under the Income-tax Act, 2025.
Is a partner's share of profit taxable?
No. A partner's share in the total income of the firm is exempt in the partner's hands, because the firm has already paid tax on it. This was section 10(2A) of the Income-tax Act, 1961. However, interest on capital and remuneration received from the firm are taxable in the partner's hands as business income, to the extent the firm was allowed to deduct them.
Is TDS applicable on salary or interest paid to partners?
Yes. From 1 April 2025, a firm must deduct TDS at 10% on salary, remuneration, commission, bonus or interest paid or credited to a partner, when the total for the year exceeds ₹20,000. This was introduced as section 194T of the Income-tax Act, 1961 and continues under section 393 of the Income-tax Act, 2025. TDS applies when the amount is credited, including to the capital account, or paid, whichever is earlier.
How do you dissolve a Partnership Firm?
Partners usually sign a dissolution deed on stamp paper, settle the firm's accounts by paying outside debts first and then partners' advances and capital, and distribute any surplus. A registered firm must inform the Registrar of Firms, and a public notice is advisable to end partners' liability for later acts. The firm then cancels its GST Registration, files its final income tax return and closes its bank account.
