How Partnership firms are taxed in India – All you need to know

A partnership firm is owned by several individuals who have signed an agreement, known as partnership deed and have invested in the business.

A partnership deed or agreement should be prepared when you start the Partnership. The agreement is a contract signed by the partners in partnership to clarify lots of things including:

  • the details of partners, who is the managing partner among them and their roles and responsibilities,
  • share of profits or losses,
  • salary, bonus, commission or remuneration to be paid to partners,
  • Interest to be paid on capital, and
  • tenure of the Partnership and what will happen on the death or resignation or retirement of partners.

You can take help of a professional to draft it for you as it requires lot of compliance and based on it expenses can be allowed or disallowed to calculate taxable business income.

In India, many chartered accountants, cost accountants, company secretaries, lawyers, architect, contractors, Information Technology professionals, retail businesses, wholesalers and other professionals are running their business or professions in partnership form.

You can also opt for Limited Liability Partnership firm or LLP.

When a firm is assessed to tax as a partnership firm

A business will be assessed to tax as a partnership firm if following conditions are satisfied;

  • Partners have signed a partnership deed in accordance to the Partnership act 1932, and
  • Such deed or instrument has specified the share of partners.

If a partnership firm doesn’t fulfill the conditions of section 184, then no deduction is allowed in respect of any payment of interest, salary, bonus, commission or remuneration made to partners.

It doesn’t mean that the entity will not be assessed to tax as a partnership firm.

It will be considered and assessed to tax as a partnership firm, but interest, salary, bonus, commission or remuneration paid to partners will be disallowed under section 40(b) of income tax act, 1961.

If it’s disallowed, then it will not be taxed in the hand of partners.

Basic exemption limit for Partnership firm

We do not have any basic exemption limit for a partnership firm. Basic exemption limit is the amount up to which the person is not liable to pay tax. Income in excess of basic exemption limit will be taxed.

For instance in case of an individual who is less than 60 years of age, basic exemption limit has been set to Rs. 2,50,000 for the financial year 2018-19 and 2019-20. Up to Rs. 2,50,000 an individual is not required to pay any tax.

In case of firm, income will be taxable if its in profit during the financial year. In case of loss, it can be carried forward to next year.

Maximum permissible remuneration to partners

While calculating profit for the financial year, the firm has to calculate maximum permissible limit for allowing salary, bonus, commission or remuneration paid to partners as tax deductions under section 40(b) of income tax act, 1961.

If the actual amount paid is more than the maximum permissible amount as calculated under section 40(b), then the excess amount will not be allowed as a business expenditure while calculating taxable business income.

If amount paid is less than the permissible limit, then the entire amount paid will be allowed as business expenditure.

However, entire amount paid can be disallowed if certain conditions as mentioned in section 40(b) is not satisfied.

In simpler terms, salary, bonus, commission or any remuneration paid to partner by a partnership firm is allowable as tax deduction only if its mentioned in the partnership deed and paid to working partners. Its allowed as deduction to the extent of least of the following;

  • Amount mentioned in the partnership deed, or
  • Maximum permissible limit as calculated under section 40(b)

Is Interest on partner’s capital tax deductible

Similar to salary, bonus, commission or remuneration to partners, interest on capital is allowed as business expenditure only if conditions to Section 40(b) is satisfied.

As per section 40(b), interest on partner’s capital is allowed up to a maximum limit of 12%. Interest in this case is calculated at simple rate of interest.

If your Partnership deed specify rate of interest on partner’s capital as 15%, then extra 3% paid will be disallowed, only 12% will be allowed as business expenditure. Where interest payment to partners is less than 12%, the entire amount so paid will be tax deductible.

However, entire amount paid towards interest on partner’s capital will be disallowed if certain conditions as stated under section 40(b) is not satisfied.

This means interest, salary, bonus, commission or remuneration of partners are allowed as tax deduction only when conditions of section 184 and 40(b) are satisfied.

In simpler terms, interest on partner’s capital is allowed only if its mentioned in the partnership deed. Its allowed as deduction to the extent of least of the following;

  • Percentage of interest mentioned in the partnership deed, or
  • 12% per annum

Applicability of Rate of tax, surcharge, Health and education cess on Partnership Firm

First you need to find out gross total income under different heads of income excluding incomes that are exempted.

From gross total income, you need to deduct deductions if any applicable to the firm under section 80G, 80GGA, 80GGC, 80-IA / IAB / IAC / IB / IBA / IC / ID/ IE, 80JJA and 80JJA. The resultant figure will be total income

Income from the business of partnership firm is taxable at the rate of 30%. Apart from this rate following rates are also applicable;

  • For short term capital gain under section 111A – 15%
  • Long term capital gain – 20%
  • Winning from lottery – 30%

Certain other incomes are also taxed at special rate.

In addition to the tax calculated on total income by applying above rate of tax as the case may be, health and education cess at the rate of 4% is to be charged.

If you only have business income from your partnership firm, then health and education cess at the rate of 4% has to be calculated on 30% of basic tax liability calculated on such income. In total, tax to be paid on business income from Partnership firm is calculated at the rate of 31.2% (I.e. 30%+ 4% on 30%).

If partnership firm’s income is more than Rs. 1 Crore, then surcharge at the rate of 12% will be charged to the tax liability calculated before charging health and education cess.

If the income is less than or equal to Rs. 1 crore, then no surcharge will be charged on income tax liability.

Income Tax return form to be filed and Due date of filing

A partnership firm is compulsorily required to file their return of income in form ITR -5 irrespective of profit or loss.

Income Tax return has to be filed after getting firm’s permanent account number.

Due date of filing firm’s return of income is 30th July of the assessment year relevant to the previous year for which return of income is filed.

If firm’s books of account is required to be audited under section 44AB of income tax act 1961, then due date of filing is 30th September of the assessment year relevant to the previous year for which return of income is to be filed.

If the Partnership firm has opted for presumptive taxation scheme, return of income has to be filed in ITR-4.

Applicability of Presumptive taxation scheme

Partnership firm can take benefits of presumptive taxation scheme under section 44AE or 44AD or 44ADA of Income Tax Act,1961.

If your firm runs a goods transport agency, then business income can be claimed under section 44AE. However, conditions as specified in section 44AE must be satisfied to avail benefits.

A partnership firm running business can take benefits of section 44AD. Similarly, a Professional Partnership firm can take benefits of section 44ADA. As per these sections, you need to declare business income at the rate of 8% and 50% on the turnover or gross receipt under section 44AD and 44ADA respectively.

Applicability of section 44AB – Tax audit

A partnership firm is liable to tax audit when its turnover crossed Rs. 1 Crore during the financial year. If the Partnership firm is rendering professional services, then the limit is Rs. 50 Lakhs.

Tax audit has to be done on the basis of turnover or gross receipt of the firm irrespective of its profit. This means, if the Partnership firm is selling goods has a turnover of Rs. 3 crore, then it has to compulsorily do tax audit.

Tax audit has to be done by a chartered accountant in practice. After tax audit, report along with form 3CD, balance sheet and profit and loss account has to be submitted online.

TDS provisions are also applicable to a partnership firm. If any transaction is required to be tax deducted as per the provisions of Income Tax Act 1961, then it has to be compulsorily deducted and deposited with the government on or before the due date. Failure in doing so may attract interest and penalties as per income tax laws.

In addition to above provisions, you may require to comply with additional tax laws and other legal provisions based on your type of business. We suggest you to always consult a finance professional or tax expert before taking any decision.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.