Partnership Firm Taxation in India: Tax Rates, Partner Remuneration & Interest Limits

How Are Partnership Firms Taxed?

A partnership firm (registered or unregistered, governed by the Indian Partnership Act, 1932) and a Limited Liability Partnership (LLP, governed by the LLP Act, 2008) are both taxed as separate entities under the Income Tax Act, distinct from their partners. The key features of firm/LLP taxation are:

• Flat tax rate of 30% on total income - there are no slab rates and no basic exemption limit, unlike individual taxpayers.
• Surcharge: Applicable if total income exceeds the prescribed threshold (typically ₹1 crore), at the rate specified for firms.
• Health & Education Cess: 4% on the tax plus surcharge.
• No new vs old regime choice - the concept of choosing between tax regimes (as available to individuals/HUFs) does not apply to firms/LLPs; the flat 30% rate applies uniformly.

The Big Tax Planning Lever: Remuneration & Interest to Partners

While the firm itself is taxed at 30% flat, payments made by the firm to its working partners - in the form of salary, bonus, commission, or remuneration, and interest on capital - are deductible from the firm's taxable profit, subject to limits under Section 40(b). These amounts are then taxed in the hands of the individual partners as their personal income (under "Profits and Gains of Business or Profession" for remuneration, and "Income from Other Sources" or business income for interest, depending on the partner's status).

Section 40(b) Limits on Partner Remuneration

Remuneration paid to working partners only (not to non-working/sleeping partners) is deductible by the firm only if it is (a) authorized by the partnership deed, and (b) within the following limits computed on "book profit":

"Book profit" here means the net profit as per the firm's profit & loss account, adjusted as per the computation prescribed under Section 40(b) (broadly, net profit before deducting partner remuneration itself, with certain other adjustments).

Section 40(b) Limit on Interest to Partners

Interest paid by the firm to partners on their capital contributions is deductible only if:

• It is authorized by the partnership deed, and
• The rate does not exceed 12% per annum simple interest.

Any interest paid in excess of 12% per annum is disallowed in the firm's hands (added back to taxable profit) - even if the partnership deed permits a higher rate.

What Happens If Remuneration/Interest Exceeds the Limits?

Partner's Share of Profit After Remuneration/Interest

After deducting allowable remuneration and interest, the firm's remaining profit is taxed at 30% in the firm's hands. The partners' share of this post-tax profit (i.e., their share in the firm's profits as per the partnership deed, after the firm has already paid tax on it) is exempt in the hands of the partners under Section 10(2A), since it has already suffered tax at the firm level. This avoids double taxation of the same profit.

LLPs vs Traditional Partnership Firms - Any Tax Difference?

For income tax purposes, LLPs are taxed almost identically to partnership firms - flat 30% rate, same Section 40(b) limits on partner remuneration and interest, and the same exemption for partners' share of profit under Section 10(2A). The main differences between LLPs and traditional firms relate to limited liability protection and compliance requirements under the LLP Act/Companies Act framework, not the core income tax computation.