Partnership Deed Tax Rules in India (2026): Partner Remuneration, TDS & Section 35(e) Explained

Sandeep Singla & Associates | Chartered Accountants

1. Executive Summary

A partnership deed or LLP agreement typically governs the relationship between partners. Under the Income-tax Act, it also serves as the basis for determining the deductibility of payments made by the firm to its partners. If the deed is silent, unclear, or outdated, this can result in disallowance rather than a mere drafting issue.

Three recent developments make it important for firms and LLPs to review their deeds this year:

• A new governing statute. The Income-tax Act, 2025 came into force on 1 April 2026 and governs Tax Year 2026–27. The Income-tax Act, 1961 continues to govern earlier years that remain open to assessment, appeal or rectification. Deeds that cite only the 1961 Act by section number now refer to a repealed provision.
• A revised statutory ceiling. The ceiling on deductible remuneration to working partners was raised with effect from Assessment Year 2025–26 and has been carried into the 2025 Act. Deeds drafted before that change, which reproduce the earlier slab figures, cap the firm's own deduction below the amount the statute now permits.
• A withholding obligation on partner payments. Tax is deductible at source on salary, remuneration, commission, bonus and interest paid or credited to a partner. The obligation attaches to the credit entry, not to the deductibility of the payment, and operates independently of the remuneration ceiling.

The practical exposure is cumulative rather than isolated. A single payment to a partner can be tested against the deed, against the statutory ceiling, and against the withholding provisions, with a separate disallowance available under each. This update sets out the clauses that carry that exposure and the drafting positions that address them.

2. Legal and Regulatory Background

2.1 The General Law of Partnership

Under the Indian Partnership Act, 1932, a partner is not entitled to remuneration for taking part in the conduct of the business of the firm in the absence of a contract to that effect. Entitlement is therefore contractual in origin, and the deed is the contract.

For limited liability partnerships, the contractual position requires particular attention. Under section 23(4) of the Limited Liability Partnership Act 2008, where the LLP agreement does not provide for a particular matter, the mutual rights and duties of the partners in relation to that matter are governed by the First Schedule. The First Schedule provides that no partner is entitled to remuneration for acting in the business or management of the LLP. Accordingly, where there is no agreement authorising remuneration, or the agreement is silent on that entitlement, the default position does not itself support a remuneration payment. Separately, the LLP agreement and subsequent changes are required to be filed with the Registrar in the prescribed manner and within the applicable timelines. The contractual authority, the executed instrument and the ROC filing record should therefore remain consistent.

2.2 The Income-tax Framework

For income-tax purposes, a firm includes an LLP, and the same provisions apply to both. The provisions relevant to a deed review, and their predecessors under the repealed statute, are set out below.

The administrative guidance that shaped assessment practice under the earlier statute continues to be instructive, because the substantive conditions have been carried forward without material change. In particular, CBDT Circular No. 739 dated 25 March 1996 addressed deeds that neither specify the amount of remuneration payable to each working partner nor lay down the manner of quantifying it. It stated that a deduction is not admissible where the quantum is left to be determined by the partners at the end of the accounting period. The reasoning of that circular applies with equal force to the corresponding conditions in section 35(e) of the 2025 Act.

3. Key Provisions and Professional Analysis

The following clauses are set out in the sequence in which they ordinarily appear in a deed. Each is examined for the income-tax condition it is required to satisfy and the exposure that arises where it does not.

3.1 Constitution and Profit-Sharing Clause (Sections 325 and 326 of the Income-tax Act, 2025)

An entity is assessed as a firm only where the partnership is evidenced by an instrument and the individual shares of the partners are specified in that instrument. A certified copy accompanies the return for the year in which assessment as a firm is first sought, and a fresh instrument is required where the constitution or the shares change.

Where these conditions are not met, section 326 operates with unusual severity. No deduction is allowed to the firm for any payment of interest, salary, bonus, commission or remuneration to any partner, not merely the excess over a ceiling, but the entirety. Correspondingly, those amounts are not chargeable in the partners' hands under section 26(2)(g). The symmetry is of limited comfort, since the firm is taxed at the rate applicable to firms on income it has in fact paid away.

A common issue is a profit-sharing clause that uses vague terms, such as profits to be shared "as may be mutually agreed" or in a ratio decided at year-end. Such clauses do not specify individual partner shares and put the firm's entire deduction at risk. The loss-sharing ratio should also be clearly stated, especially if a minor is admitted to the partnership, as minors cannot be held liable for losses.

Review point: Ensure that profit and loss sharing ratios are numerically specified for each partner, the deed reflects the current partnership structure, and all changes are documented by supplementary deeds.

3.2 Designation of Working Partners (Section 35(e)(i) and 35(e)(v)(B))

Remuneration is deductible only where it is paid to a working partner, defined as an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner. Two consequences follow, and both are structural rather than procedural.

First, only an individual can be a working partner. A body corporate admitted as a partner in an LLP, or a company or firm holding a partnership interest, cannot receive deductible remuneration in that capacity, however substantial its contribution to the management of the business. Payments of that character require a different commercial and tax analysis.

Second, the deed should identify which partners are working partners. Where the deed is silent, and remuneration is nonetheless paid, the burden of establishing active engagement rests on the firm at assessment, on evidence assembled after the event. Where a partner is admitted, retires, or ceases to be actively engaged during the year, the change should be recorded contemporaneously.

Partners holding an interest in a representative capacity require separate attention. Section 35(e)(iv) contains specific rules distinguishing amounts paid to an individual as a representative partner from amounts paid to that individual otherwise, and the deed should record the capacity in which each such partner holds the interest.

Review point: Verify that the deed identifies the working partners, confirms each is an individual, and that any admissions, retirements, or role changes during the year are documented by supplementary instruments.

3.3 Quantification and Allocation of Remuneration (Section 35(e)(iii); CBDT Circular No. 739 dated 25 March 1996)

This is the clause on which most disputes turn. The deduction available to the firm is the lower of two amounts: the aggregate remuneration to all working partners as authorised by the deed, and the statutory ceiling computed on book profit. The deed therefore operates as an independent cap. A deed that authorises less than the statute permits limits the firm to the lower figure; the statutory ceiling does not supply an entitlement the deed has not created.

The statutory ceiling is computed as follows:

The practical significance of the deed acting as a cap is best shown by comparison. Consider a firm with book profit of ₹40,00,000 whose deed reproduces the slab figures that applied before the ceiling was revised.

The shortfall of ₹90,000 is modest in isolation. It is, however, permanent, recurs in every year the deed remains unamended, and cannot be recovered by a later instrument, for the reasons set out at 3.4 below.

The opposite defect carries a larger exposure. Where the deed leaves the quantum to be settled at the year end, or expresses it as "such sum as the partners may determine", the position taken in Circular No. 739 is that no deduction is admissible at all. A deed of that kind fails the requirement that the partnership deed authorise the aggregate remuneration, and the firm loses the whole of its remuneration deduction rather than an excess.

The drafting response is a clause that either specifies a fixed amount for each working partner or lays down a determinate formula, together with the ratio in which the aggregate is to be allocated among them. A formula expressed by reference to the maximum permissible under the applicable law, rather than by reproducing the slab figures, avoids both defects at once: it neither leaves the amount to later negotiation nor freezes it at figures that a subsequent amendment supersedes.

Review point: Confirm that the deed specifies a clear amount or formula for remuneration, details the allocation among working partners, and authorises an aggregate amount up to the current statutory ceiling.

3.4 Effective Date and Supplementary Deeds (Section 35(e)(ii)(A) and (B))

Remuneration or interest is disallowed where it is not authorised by the partnership deed applicable for the period to which it relates, and equally where it is authorised by the current deed but relates to a period before the date of that deed or was not authorised by the earlier one. The statute forecloses retrospective authorisation.

The operative consequence is one of timing. Where a supplementary deed revising the remuneration clause is executed part-way through the year, the revised entitlement runs from the date of execution. The period preceding it continues to be governed by the earlier instrument, and the deduction for that period is confined to what the earlier instrument authorised. A recital that the amendment takes effect from the first day of the year does not alter this. Where a firm identifies a defective clause mid-year, the correct approach is to execute the supplementary deed at once and apportion the annual entitlement across the two periods, rather than to rely on a retrospective recital.

Review point: Ensure supplementary deeds are executed with required stamping before the revised entitlement takes effect, and that remuneration is apportioned according to the operative dates of each deed.

3.5 Interest on Partners' Capital and Current Accounts (Section 35(e)(ii) and 35(e)(iv))

Interest to a partner is deductible where it is authorised by the deed and does not exceed 12% simple interest per annum. Four points warrant attention in drafting.

• Interest is not confined to working partners. Interest compensates the commitment of capital rather than the rendering of services, and is deductible where paid to a non-working partner, subject to the same conditions. This is a common and avoidable misconception.
• The ceiling is expressed as simple interest. Where interest is credited to the capital account, and interest is then computed on the enhanced balance, the effective rate compounds. Firms crediting interest annually should satisfy themselves that the computation remains within the simple-interest ceiling.
• Capital accounts and current accounts should both be addressed. Where the deed authorises interest on capital and the firm in fact pays interest on current account balances or on loans from partners, the payment lacks authority under the deed. The clause should identify the balances on which interest is payable.
• A ceiling formulation is preferable to a fixed rate. A clause providing for interest at a rate not exceeding the maximum permissible under the applicable law, as the partners may determine, preserves flexibility without exceeding the statutory limit. A deed hard-coding a rate above 12% guarantees an annual disallowance of the excess.

Review point: Reconcile the interest rate and balances in the deed with the amounts credited in the books, and confirm that interest is calculated on a simple-interest basis.

3.6 Book Profit — The Computational Base (Section 35(e)(v)(A))

Book profit is defined as the net profit shown in the profit and loss account for the tax year, computed in accordance with the provisions governing the computation of business income, as increased by the aggregate remuneration to partners to the extent it has been deducted in arriving at that net profit.

Two errors recur in practice. The first is computing the ceiling on the accounting net profit rather than on business income as computed under the Act. Book profit is arrived at after every other adjustment required in computing business income — depreciation at the rates prescribed by the statute rather than as charged in the accounts, disallowances for expenditure not deductible, and any disallowance for failure to deduct or deposit tax at source. Each of those adjustments moves the base on which the ceiling is computed.

The second issue is the treatment of income chargeable under other heads. CBDT Circular No. 12/2019 directs that, while computing book profit for partner-remuneration purposes, income such as capital gains, interest, rental income and income from other sources that does not fall under the head profits and gains of business or profession should be excluded. Judicial authority has not, however, been entirely uniform on the breadth of this exclusion, particularly where such receipts are credited to the profit and loss account. The safer compliance position is to follow the statutory definition read with the CBDT guidance, while evaluating any material non-business receipt in light of the nature of the income and the judicial position applicable in the relevant jurisdiction.

Where book profit is a loss, the ceiling is ₹3,00,000. A firm in a loss year is therefore not precluded from paying deductible remuneration, but the amount is confined.

Firms computing income on a presumptive basis require separate analysis, since the presumptive provisions do not permit a further deduction for partner remuneration. A deed formula expressed by reference to book profit does not sit naturally with presumptive computation, and the interaction should be considered before the basis of assessment is chosen.

Review point: Recompute book profit as per section 35(e)(v)(A) and relevant CBDT guidance. Identify material income under other heads and consider jurisdiction-specific judicial positions before finalising the ceiling.

3.7 Characterisation of Receipts in the Partners' Hands (Section 26(2)(g))

The deed frequently describes remuneration as "salary". The description is of no consequence for the partner's assessment. Remuneration and interest received from the firm are chargeable under the head profits and gains of business or profession, not under the head salaries. There is no employer-employee relationship between a firm and its partner, and the deductions and reliefs available against salary income are not available.

The partner's share of the firm's profits stands on a different footing. Because the firm has been assessed on that income, the share is not taxed again in the partner's hands. The distinction between the two receipts is therefore of direct consequence, and the deed should keep them separate rather than describing a single composite entitlement.

Under section 26(2)(g), interest, salary, bonus, commission or remuneration due to or received by a partner from the firm is chargeable as business income only to the extent allowed as a deduction to the firm under section 35(e). The firm's computation and the partner's return should therefore be prepared consistently. Where part of a payment is not allowable to the firm under section 35(e), the corresponding amount does not form part of the partner's charge under section 26(2)(g) to that extent.

Review point: Confirm that the deed distinguishes remuneration, interest and profit share as separate entitlements, and that the partners' returns disclose each in its correct character.

3.8 Withholding on Payments to Partners (Section 393(3), Table Sl. No. 7; Section 35(b))

A firm is required to deduct tax at 10% on any sum in the nature of salary, remuneration, commission, bonus or interest paid to a partner or credited to the partner's account, including the capital account, where the aggregate of such sums for the partner for the tax year exceeds ₹20,000. The obligation applies at the earlier of credit or payment. It applies irrespective of the firm's turnover, and it requires the firm to hold a tax deduction account number.

Three features of this provision interact directly with the deed and with the firm's accounting practice.

• The trigger is the credit entry. Where the deed provides for remuneration to be quantified and credited at the year-end, the withholding obligation crystallises on that credit even though no amount has been withdrawn. Firms that credit partners' capital accounts on 31 March should ensure the deduction and its deposit are addressed within the applicable timelines.
• Withholding is independent of deductibility. Section 393(3) attaches to the payment or credit, not to the amount ultimately allowed under section 35(e). Tax is therefore deductible on the whole of the amount credited, including any portion later disallowed as exceeding the ceiling.
• Failure to comply with withholding requirements can produce a separate disallowance under section 35(b). Broadly, where tax required to be deducted from a payment to a resident has not been deducted, or after deduction has not been paid within the statutory time, 30% of the relevant sum may be disallowed; for specified payments to a non-resident, the corresponding rule can apply to the whole relevant sum. This test operates independently of section 35(e). The computation should, however, avoid a duplicate addition of the same expenditure merely because more than one disallowance provision is technically attracted. Further, a withholding-related disallowance may become deductible in a later tax year upon satisfaction of the statutory conditions, whereas an amount that was never validly authorised by the operative deed cannot ordinarily be cured retrospectively for the earlier period.

Payments outside the scope of the provision include the partner's share of profit, withdrawal of capital, repayment of a loan, and genuine reimbursement of expenditure incurred on behalf of the firm. The accounting treatment should keep these distinct from remuneration and interest, since the distinction determines whether tax is deductible on the entry.

Firms should also note that with effect from Tax Year 2026–27, the statutory reference, the section code used in tax deduction statements, and the prescribed forms follow the 2025 Act and the rules made under it. Continuing to report under the section code of the repealed provision is liable to cause validation failures in the return of tax deducted.

Review point: Trace each entry in partners' capital and current accounts to its nature, confirm when the withholding obligation arose, and reconcile credited amounts with the tax deduction statements filed for the year.

3.9 Statutory References and Reconstitution — Drafting and Transition

Deeds executed before the current year commonly refer to "section 40(b) of the Income-tax Act, 1961" in the remuneration and interest clauses. That section has been repealed. While a reference to a repealed enactment would ordinarily be construed as a reference to the corresponding provision of the replacing statute, a deed is not improved by requiring that construction to be argued at assessment. The preferable formulation refers to the maximum permissible under the income-tax law applicable to the relevant tax year, together with any statutory modification or re-enactment, so that the clause survives future amendment without further supplementation.

Separately, clauses dealing with retirement, admission, revaluation of assets, treatment of goodwill and dissolution carry income-tax consequences of their own, including on the receipt of money or a capital asset by a partner on reconstitution or dissolution. Those provisions operate independently of the remuneration framework and merit a distinct review; they are outside the scope of this update.

Review point: Replace fixed statutory references and slab figures with language tied to the law applicable for each tax year, and identify reconstitution clauses that need separate analysis.

4. Business Implications

Deduction capacity is set by the deed, not by the statute. Firms frequently assume that the statutory ceiling defines what may be claimed. It defines only the upper limit. Where the deed authorises less, the shortfall is a permanent loss of deduction that recurs annually and cannot be remedied retrospectively. Firms whose deeds predate the revision of the ceiling should quantify the shortfall for the current year and amend before the year closes.

Exposures arise under independent statutory tests. A failure to satisfy the conditions for assessment as a firm under section 325 can trigger the consequences in section 326 for payments to partners. Separately, section 35(e) tests the authority, timing, status of the working partner and statutory limits applicable to remuneration and interest, while section 35(b) addresses withholding-related defaults. Each test should be applied independently, but the tax computation should avoid adding back the identical expenditure twice merely because more than one provision is attracted.

Working-capital and cash-flow effects. Withholding on partner payments advances the collection of tax that was previously discharged through the partners' advance tax and self-assessment. Firms crediting remuneration at the year-end face a concentrated deduction and deposit obligation at that point. Partners should revisit their advance tax estimates to reflect credit for tax deducted, so that instalments are neither overpaid nor short-paid.

Documentation is the evidentiary base at assessment. The matters that determine the outcome are established by contemporaneous record: a properly stamped and executed instrument, supplementary deeds bearing dates preceding the periods they govern, minutes recording the annual determination of remuneration where the deed provides a formula, ledger entries that distinguish remuneration and interest from drawings and reimbursements, and tax deduction statements reconciled to those entries. Deficiencies in these records are ordinarily identified during tax audit reporting, at which point the year is closed, and the position cannot be corrected.

The transition requires a two-statute approach. For the current tax year, compliance follows the 2025 Act. Earlier years that remain under assessment, appeal or rectification continue to be governed by the 1961 Act, and positions taken for those years should be defended by reference to the provisions then in force. Firms should ensure that internal computation templates, accounting software and tax deduction workflows have been updated for the change in statutory references, and that historical working papers retain the citations applicable to their respective years.

Governance beyond tax. For an LLP, the agreement and its amendments must be filed with the Registrar of Companies and become part of the public record. Consistency among the filed agreement, accounts, tax computation, and tax deduction statements is important for both assessment and regulatory integrity. If the LLP relies on the First Schedule's default provisions, ensure authority to pay remuneration is established before making any payments.

5. Conclusion

The provisions governing payments by a firm to its partners have been carried into the Income-tax Act, 2025 with their substance intact. The conditions that have generated disputes for three decades — authorisation by the instrument, determinate quantification, prospective operation, the working-partner requirement and the ceiling on interest — continue to apply in the same terms. What has changed is the statutory framework in which they sit, the numbering by which they are cited, and the addition of a withholding obligation that operates on the same payments by a different mechanism.

The required review is focused and time-sensitive. It involves a few key clauses in one document, tested against established statutory conditions. Since retrospective authorisation is not permitted, defects found after year-end cannot be corrected for that year. Firms and LLPs should review the deed, accounting treatment, computation, and withholding position together, well before the tax year closes.