Taxation of Partnership Firms in India: Liabilities, Calculation & Case Study
Partnership firms are a popular business structure in India, especially among small and medium enterprises (SMEs). Compared to companies, they are simpler to form and operate. However, understanding the tax implications is crucial for compliance and optimization.
In this detailed, guide tailored for cmaknowledge.in, we cover everything you need to know about the taxation of partnership firms in India—focusing on the retail sector. You’ll learn:
- Key tax rates and surcharge/cess applicable for FY 2025–26
- Deduction rules, especially under Section 40(b)
- Computation steps for taxable income
- Filing requirements, TDS & advance tax obligations
- Penalties for non‑compliance
- A comprehensive retail case study with full calculations
- Practical FAQs and planning tips
1. Introduction to Partnership Firm Taxation
A partnership firm is a business entity where two or more persons agree to share profits. Governed by the Indian Partnership Act, 1932, a partnership firm must have a Partnership Deed that outlines the terms, profit-sharing ratio, and partner roles.
Unlike companies, a partnership firm is not a separate legal person for civil law, but for tax purposes, it is considered a distinct entity. It must file its own tax return and compute tax on its profits under the Income Tax Act, 1961.
2. Applicable Tax Rates for FY 2025–26
For the financial year 2025–26 (Assessment Year 2026–27), domestic partnership firms (including LLPs) are taxed at a flat 30% on their taxable income. Additionally:
- Surcharge: 12% on tax if total income > ₹1 crore
- Health & Education Cess: 4% on (tax + surcharge)
Example: If a firm’s tax before surcharge is ₹10 lakh, and its income exceeds ₹1 crore, surcharge = ₹1.2 lakh (12% of ₹10 lakh) and cess = 4% of (₹10 lakh + ₹1.2 lakh) = ₹44,800. Total = ₹11,44,800.
3. Exempt Income and Alternate Minimum Tax (AMT)
Partnership firms enjoy the following:
- Profit Share Exemption: Profit distributed to partners is exempt in their hands (Section 10(2A)).
- AMT: If firm’s normal tax liability (after deductions) falls below 18.5% of its book profit, it must pay Alternate Minimum Tax at 18.5% of book profit.
4. Deductions under Section 40(b)
Section 40(b) permits deduction for payments to partners—remuneration, commission, bonus, and interest on capital—subject to strict limits and deed authorization.
4.1 Partner Remuneration
Remuneration to working partners is deductible only if:
- Authorized by the partnership deed
- Within limits prescribed by Section 40(b)
| Book Profit Slab | Max Deductible Remuneration |
|---|---|
| First ₹6,00,000 | 90% of slab or ₹3,00,000 (whichever higher) |
| Balance | 60% of balance profit |
4.2 Interest on Capital
Interest to partners (working or non‑working) is deductible up to 12% per annum on agreed capital, if authorized by deed. Any excess is disallowed.
4.3 Other Deductions
Standard business expenses (rent, utilities, salaries) are deductible under general business expenditure provisions.
5. Presumptive Taxation Scheme (Section 44AD)
Firms with turnover ≤ ₹3 crore can opt for presumptive taxation under Section 44AD:
- Presumptive Income: 8% of turnover (6% if digital receipts)
- No Book Keeping: No detailed books required
- No 40(b) Deductions: Partner payments are ignored
While compliance is simpler, firms cannot claim partner remuneration or interest deductions.
6. Step‑by‑Step Computation of Taxable Income
- Determine Book Profit: Add back disallowed partner payments to net profit.
- Calculate Max 40(b) Deduction: Based on book profit and slab rules.
- Deduct Actual Partner Payments: Up to allowed limits.
- Deduct Interest on Capital: Up to 12% per partner.
- Compute Taxable Income: Book profit minus deductions.
- Apply Tax Rate: 30% + surcharge + cess.
- Check AMT: If applicable, compute at 18.5% of book profit.
7. Filing Requirements & Compliance
Partnership firms must file:
- ITR‑5: Partnership & LLP return form
- Due Dates: 31st July (no audit) / 31st October (audit)
7.1 Tax Audit
Audit under Section 44AB if:
- Turnover > ₹1.5 crore
- Gross receipts > ₹50 lakh (professionals)
- Firm opts out of presumptive scheme and income > basic exemption
7.2 Advance Tax & TDS
Advance tax due if liability > ₹10,000:
| Due Date | % of Advance Tax |
|---|---|
| 15th June | 15% |
| 15th September | 45% |
| 15th December | 75% |
| 15th March | 100% |
TDS on:
- Salaries (u/s 192)
- Rent (u/s 194I)
- Contractor payment (u/s 194C)
- Professional fees (u/s 194J)
- Interest (u/s 194A)
8. Penalties for Non‑Compliance
| Default | Penalty/Interest |
|---|---|
| Late return filing (sec 234A) | 1% per month on unpaid tax |
| Shortfall advance tax (sec 234B) | 1% per month on shortfall |
| Deferred instalment (sec 234C) | Interest on deferred instalment |
| Late filing (sec 234F) | ₹1,000–₹5,000 (before Dec 31), ₹10,000 (after) |
| No audit (sec 271B) | 0.5% of turnover or ₹1,50,000 (whichever less) |
9. Case Study: “ABC Retail Partners”
Background: “ABC Retail Partners” is a retail partnership firm operating a chain of grocery stores in Bengaluru. It has two working partners, Mr. Arun and Ms. Bhavana. The partnership deed authorizes partner remuneration and interest on capital at up to 12%.
9.1 Financials Overview for FY 2025–26
| Description | Amount (₹) |
|---|---|
| Sales Revenue | 1,20,00,000 |
| Cost of Goods Sold | 65,00,000 |
| Gross Profit | 55,00,000 |
| Operating Expenses (rent, utilities, salaries) | 12,50,000 |
| Depreciation | 2,00,000 |
| Profit before Partner Payments | 40,50,000 |
| Partner Mr. Arun – Salary | 7,00,000 |
| Partner Ms. Bhavana – Salary | 5,00,000 |
| Interest: Arun (₹6,00,000 @12%) | 72,000 |
| Interest: Bhavana (₹4,00,000 @12%) | 48,000 |
| Net Profit after Partner Payments | 27,30,000 |
9.2 Computation of Book Profit
- Net Profit after partner payments: ₹27,30,000
- Add: Actual partner salaries (₹12,00,000) + interest (₹1,20,000) = ₹13,20,000
- Book Profit: ₹40,50,000
9.3 40(b) Deduction Calculation
For book profit ₹40,50,000:
- First ₹6,00,000: 90% = ₹5,40,000
- Balance ₹34,50,000: 60% = ₹20,70,000
- Total allowable remuneration: ₹26,10,000
Actual salaries ₹12,00,000 < allowable ₹26,10,000 ⇒ full ₹12,00,000 deductible.
9.4 Interest Deduction
Interest paid ₹1,20,000 (within 12% cap) ⇒ fully deductible.
9.5 Taxable Income and Tax Computation
- Profit before partner payments: ₹40,50,000
- Less: Salaries ₹12,00,000
- Less: Interest ₹1,20,000
- Taxable Income: ₹27,30,000
Tax @30% = ₹8,19,000; Cess @4% = ₹32,760; Total Tax = ₹8,51,760.
10. Frequently Asked Questions (FAQs)
Q1. Can LLPs claim 40(b) deductions?
Yes, LLPs follow the same Section 40(b) provisions as partnership firms for partner payments.
Q2. Is new tax regime available?
No, partnership firms cannot opt for the new concessional tax regime under Section 115BAC.
Q3. What if the deed is silent on partner remuneration?
Payments not authorized by the deed are disallowed and added back to income.
Q4. How to switch to presumptive scheme?
Opt via Section 44AD while filing ITR‑5; maintain prescribed conditions.
Q5. Are partners individually taxed on profit share?
No. Profit share is exempt in partners’ hands under Section 10(2A). However, salary and interest received by partners is taxed as business income in their personal returns.
11. Conclusion & Tips
Taxation of partnership firms involves precise computation of allowable deductions and timely compliance. Key takeaways:
- Maintain a clear, deed‑authorized schedule of partner payments.
- Leverage Section 40(b) fully but within limits.
- Consider presumptive scheme for small retail firms to reduce compliance.
- Plan advance tax and TDS to avoid interest and penalties.
- Engage a qualified tax professional (CMA/CA) for audit and planning.
By following these steps and understanding the underlying provisions, retail partnership firms can optimize their tax liability, ensure compliance, and focus on business growth.