Partners' Remuneration and Salary from a Firm or LLP

2.1 The dual-layer framework

It is useful to state the framework at the outset, because the sequence matters. A payment to a partner must first be lawful and authorised under the firm's constitutional document. Only then does the tax question arise. A payment that fails the first test cannot succeed at the second; a payment that passes the first test may still fail the second in whole or in part.

2.2 Entitlement under the Indian Partnership Act, 1932

Section 4 of the Indian Partnership Act, 1932 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. The definition is built around profit sharing, not remuneration. Consistently with that, Section 13(a) provides that, subject to contract between the partners, a partner is not entitled to receive remuneration for taking part in the conduct of the business.

The default position under general partnership law is therefore that no partner is paid a salary. Remuneration arises only because the partners have contracted for it. This is not a technicality. It explains why the tax legislation has consistently conditioned deductibility on authorisation by the instrument of partnership: absent such authorisation, there is no legal foundation for the payment in the first place, and what is described as salary is in substance an unauthorised withdrawal of capital or an appropriation of profit.

Section 13(c) of the same Act provides that, where a partner is entitled under the partners’ contract to interest on capital subscribed by him, such interest is payable only out of profits. Separately, Section 13(d) provides that, subject to a contract between the partners, a partner making any payment or advance for the business beyond the capital he has agreed to subscribe is entitled to interest thereon at six per cent per annum.

2.3 Entitlement under the Limited Liability Partnership Act, 2008

The position under LLP law is structurally similar but expressed differently. Section 23 of the Limited Liability Partnership Act, 2008 provides that the mutual rights and duties of the partners of an LLP, and those of the LLP and its partners, are governed by the LLP agreement. Where the agreement is silent on a matter, the default provisions in the First Schedule apply.

The First Schedule adopts the same baseline as general partnership law: no partner is entitled to remuneration for acting in the business or management of the LLP. An LLP that intends to pay its partners must therefore make express provision in the LLP agreement, and must do so in terms that will also satisfy the requirements of tax law. Because an LLP agreement is filed with the Registrar and any change must be intimated in the prescribed form, the timing and documentation of amendments carries an additional compliance dimension that does not arise for an unregistered general partnership.

2.4 The income-tax framework and its renumbering

The Income-tax Act, 2025, come into force on 1 April 2026. It replaces the Income-tax Act, 1961 in its entirety. The substantive treatment of firms and their partners has been carried forward with limited changes, but the section numbering has been comprehensively reconstructed. The following table maps the principal provisions.

2.5 Legislative developments leading to the current position

The present regime is the product of an identifiable sequence of amendments. Understanding that sequence helps you read the older case law correctly, because several decisions turn on provisions that have since been altered.

3.1 The four conditions in outline

Reading Section 35(e) together with Sections 325 and 326, four core conditions must ordinarily be satisfied before remuneration paid to a partner survives in the firm’s computation. Failure at any one of them results in disallowance, and the consequences of failure differ in an important respect between the first condition and the remaining three. Separately, Section 325(6) operates as a procedural override: where, for a tax year, the firm has a failure referred to in Section 271, no deduction is allowed for partner interest, salary, bonus, commission or remuneration, and the corresponding payment is not chargeable in the partner’s hands under Section 26(2)(g).

3.2 Condition one: assessment as a firm

Section 325(1) provides that a firm shall be assessed as a firm if the partnership is evidenced by an instrument and the individual shares of the partners are specified in that instrument. Section 325(2) requires a certified copy of the instrument to accompany the return of income for the tax year in which assessment as a firm is first sought. Section 325(3) prescribes how that certification is to be made, namely in writing by all the partners other than minors, or, where the return is filed after dissolution, by all persons who were partners immediately before dissolution together with the legal representative of any deceased partner.

Section 325 further provides that once a firm is assessed as such for a tax year, it is to be assessed in the same capacity for every subsequent year so long as there is no change in the constitution of the firm or in the shares of the partners. Where such a change occurs, a certified copy of the revised instrument is required to accompany the return for the year in which the change took place.

The requirement that individual shares be specified is exacting and is not satisfied by a general statement that profits will be shared as mutually agreed. Nor is it satisfied by an oral understanding, however long-standing and however consistently followed in the books. The instrument must exist and must be in writing.

3.3 Condition two: the working partner requirement

Section 35(e)(i) disallows in its entirety any salary, bonus, commission or remuneration, by whatever name called, paid to a partner who is not a working partner. Section 35(e)(v)(B) defines a working partner 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.

Three elements of that definition repay attention.

• The working partner must be an individual. A body corporate, a firm or an LLP cannot itself qualify as a working partner, which is of direct practical relevance to LLP structures containing corporate partners. An individual who is a partner in a representative capacity is not automatically excluded merely because another person is beneficially represented; the statutory test remains whether that individual is actively engaged in conducting the affairs of the firm. The representative-capacity rules in Section 35(e)(iv) should therefore be distinguished from the separate working-partner test in Section 35(e)(v)(B).
• The engagement must be active. Contribution of capital, provision of guarantees, lending of name or reputation, and attendance at periodic partners’ meetings do not, without more, constitute active engagement in conducting the affairs of the business. The test looks to participation in the conduct of the business, not to the economic significance of the partner’s contribution.
• The engagement must relate to the firm’s own business. A partner actively engaged in a group entity, or in an activity that is not the business of the firm, is not thereby a working partner of the firm.

The statute does not prescribe any minimum period of engagement, any minimum time commitment, or any documentary form in which active engagement must be evidenced. In practice, however, the absence of contemporaneous evidence is where the difficulty arises. Where a partner’s active engagement is questioned, the firm is asked to demonstrate it after the event, often several years later, and the ordinary records of a small firm may not readily supply that demonstration.

3.4 Condition three: authorisation by the deed and the prospectivity rule

Section 35(e)(ii) disallows remuneration to a working partner and interest to any partner where the payment is either not authorised by the partnership deed applicable for the period in question, or is authorised by and in accordance with the terms of the deed but relates to a period before the date of that deed, or to a period in which the earlier deed did not authorise it.

The second limb is the prospectivity rule, and it is absolute. A deed executed in, say, November cannot validate remuneration referable to April to October of the same year, even where the partners had orally agreed to the arrangement from the beginning of the year and even where the deed itself purports to give retrospective effect. The provision is directed precisely at that practice.

The unsettled question is how specific the deed must be.

Section 35(e)(ii), like its predecessor, requires only that the deed authorise the payment. It does not, on its face, require the deed to quantify the remuneration or to prescribe a method of quantification. The Central Board of Direct Taxes took a different view in Circular No. 739 dated 25 March 1996, which stated that no deduction would be admissible unless the deed either specified the amount of remuneration payable to each individual working partner or laid down the manner of quantifying that remuneration. The circular was directed at deeds that provided for remuneration as allowable under the Act.

The High Courts have not spoken with one voice on the validity and effect of that circular.

There is still a difference of opinion between the High Courts, and the Supreme Court has not yet settled the issue. This difference continues to be relevant under Section 35(e)(ii) of the Income-tax Act, 2025 because the new provision substantially carries forward the language of the earlier law.

Therefore, a firm must first consider the view of the High Court with jurisdiction over it. If that High Court follows the stricter approach, the firm cannot rely on a more liberal decision of another High Court. Where the jurisdictional High Court has not decided the issue, some uncertainty remains.

More recently, in Bharat Paper Mart v. ACIT (ITA No. 5594/Mum/2025, pronounced on 9 February 2026), the Mumbai ITAT allowed deduction of partners’ remuneration even though the partnership deed contained an outdated remuneration slab. The deed had authorised payment of remuneration and also provided for incorporating subsequent statutory amendments or re-enactments. However, as this is only an ITAT decision, it does not settle the conflicting views of the High Courts.

3.5 Condition four: the quantum ceiling and the computation of book profit

Section 35(e)(iii) disallows so much of the aggregate remuneration to all working partners, as authorised by the partnership deed, as exceeds the amount computed under a two-slab formula. The formula, as it stands following the enhancement effected by the Finance (No. 2) Act, 2024 and carried into the 2025 Act, is set out below.

Three features of the formula are worth noting. The ceiling applies to the aggregate paid to all working partners taken together, not to each partner individually; a firm with several working partners does not obtain a multiple of the ceiling. The floor of ₹3,00,000 is available even where the firm has incurred a loss, so a loss-making firm is not denied a deduction altogether, although the deduction will enlarge the loss and its utility depends on the firm’s ability to carry the loss forward. And the ceiling caps deductibility, not payment: partners remain free to agree on a larger figure, with the excess simply being non-deductible.

The definition of book profit

Section 35(e)(v)(A) defines book profit as the net profit shown in the profit and loss account for the relevant tax year, computed in accordance with Chapter IV-D, as increased by the aggregate amount of the remuneration to all the partners of the firm if that amount has been deducted in computing the net profit.

The definition therefore requires two operations rather than one. The accounting net profit must first be adjusted to arrive at profit computed in accordance with the business income provisions of the Act; and partner remuneration debited to the profit and loss account must then be added back. Interest paid to partners within the 12% ceiling is not added back, because it is an allowable deduction and forms part of the computation under Chapter IV-D. Interest in excess of that ceiling is disallowed. Consequently, it increases the figure computed under Chapter IV-D, so it enters book profit through the first operation rather than the second.

A related question, on which the High Courts have differed, is whether income assessable under heads other than business or profession — house property income, or interest assessable as income from other sources — forms part of book profit. The better view, and the one consistent with the express reference in the definition to computation under Chapter IV-D, is that book profit is confined to business income. Firms with material non-business income should adopt a considered position and document the basis on which it has been taken.

Worked illustration

The following illustration draws together the interest cap, the computation of book profit and the remuneration ceiling. The figures are hypothetical and are used only to demonstrate the sequence of computation.

Illustration: Facts assumed

A partnership firm has three partners, all of whom are individuals actively engaged in conducting the affairs of the business. The deed authorises remuneration and interest, names the working partners, was executed before the commencement of the tax year, and specifies the individual profit-sharing ratios. The firm is assessed as a firm under Section 325. Aggregate partner capital is ₹50,00,000, on which the deed provides interest at 15% per annum. Remuneration of ₹24,00,000 in aggregate has been debited to the profit and loss account. The net profit after debiting both remuneration and interest is ₹6,50,000.

The result may be verified independently: book profit of ₹32,00,000 less allowable remuneration of ₹21,00,000 equals ₹11,00,000, which corresponds to the firm’s business income at Step 12. Where the two figures do not reconcile, an error has been made in the sequence of adjustments.

In the partners’ hands, ₹21,00,000 of remuneration and ₹6,00,000 of interest are chargeable under Section 26(2)(g), aggregating ₹27,00,000. The ₹3,00,000 of disallowed remuneration and the ₹1,50,000 of disallowed interest are not charged again in the partners’ hands, having already borne tax in the firm’s computation. The firm has, however, deducted tax at source on the full ₹31,50,000 credited, a mismatch addressed in Part 3.8 below.

3.6 Interest to partners

Section 35(e)(iv) disallows interest to any partner, as authorised by the partnership deed, to the extent that it exceeds 12% simple interest per annum. Four points distinguish the treatment of interest from that of remuneration.

• Interest may be paid to any partner. Unlike remuneration, interest is not confined to working partners. A partner who contributes only capital may be paid interest within the ceiling, and the firm may deduct it.
• The ceiling is a rate, not an amount. It is expressed as 12% simple interest per annum and is applied to the balance on which interest is computed. Compounding, or crediting interest to the capital account in a manner that generates interest on interest, will take the payment outside the ceiling to that extent.
• Authorisation and prospectivity apply equally. Section 35(e)(ii) applies in terms of interest as well as to remuneration. Interest paid without authorisation in the deed, or referable to a period before the date of the deed, is disallowed in full and not merely to the extent of the excess.
• Representative capacity is treated separately. Section 35(e)(iv)(A) and (B) contain detailed rules for a partner who holds the interest on behalf of or for the benefit of another person. Interest paid to such an individual otherwise than in the representative capacity is left out of account; interest paid to him in the representative capacity, and to the person represented, is taken into account. Correspondingly, where an individual is a partner otherwise than in a representative capacity, interest paid to him is excluded if he receives it on behalf of another person. These rules matter for firms in which a partner holds the interest as a karta of a Hindu undivided family or as a trustee.

3.7 Taxability in the hands of the partner

Section 26(2)(g) of the Income-tax Act, 2025 charges interest, salary, bonus, commission or remuneration, by whatever name called, received by a partner from the firm under the head profits and gains of business or profession. The characterisation is deliberate and has several consequences that are frequently misunderstood.

• The amount is business income, not salary. The standard deduction available against salary income is not available; nor are the provisions relating to perquisites or to salary withholding.
• Expenditure incurred by a partner wholly and exclusively for earning taxable remuneration, interest or other income from the firm may be deducted in computing such business income, subject to satisfaction of the applicable deduction provisions of the Act.
• The partner files the return form applicable to a person with business income, and is required to report the firm’s particulars and the partner’s share.
• The partner’s advance tax obligations are computed on the aggregate of this and other income, and tax deducted by the firm is available as credit against that liability.

The partner’s share in the profits of the firm stands on an entirely different footing. Because the firm has already been charged to tax on its total income, the partner’s share of that income is excluded from the partner’s total income, preserving the principle that the same income is not taxed twice. The 2025 Act carries this treatment forward from Section 10(2A) of the 1961 Act. The exclusion applies to the share of profit alone and does not extend to remuneration or interest, which remain chargeable under Section 26(2)(g).

The symmetry principle

For disallowances arising under Section 35(e) and the firm-assessment provisions in Sections 325 and 326, the scheme is built on symmetry: the amount allowed to the firm is charged in the partner’s hands, while the amount denied under those provisions is not charged again. The symmetry is expressed explicitly in Section 326(b) for the relevant Section 325 failures and follows from the structure of Section 26(2)(g) for a disallowance under Section 35(e).

The practical consequence is that a disallowance under Section 35(e) or the relevant Sections 325–326 provisions ought to be accompanied by a corresponding reduction in the partner’s Section 26(2)(g) income. This principle should not be extended to a separate disallowance under Section 35(b) for a withholding default: the firm’s additional or deferred deduction consequence under Section 35(b) does not, merely by itself, reduce the amount otherwise chargeable to the partner. Where the firm’s final Section 35(e) position changes after the partners have filed their returns, the partners may need to take appropriate steps to give effect to that change.

3.8 Withholding under Section 393(3)

Up to 31 March 2025, the categories now covered by the partner-payment withholding rule were outside a dedicated partner TDS provision. Section 194T of the Income-tax Act, 1961 applied to relevant payment or credit events occurring from 1 April 2025 to 31 March 2026. For events occurring on or after 1 April 2026, the corresponding obligation is contained in Section 393(3), Table Sl. No. 7 of the Income-tax Act, 2025. The governing Act is determined by the date on which the relevant payment or credit event occurs, not by the later date of TDS deposit.

Credit, not cash, is the trigger.

The point most often missed in practice is that the obligation arises on credit as much as on payment. Many firms credit remuneration and interest to partners’ accounts only at year-end, once the accounts have been drawn up, and treat the partners’ periodic withdrawals during the year as drawings. On that pattern, the deduction obligation arises on the date of the year-end credit, and the tax must be deposited by reference to that date. A firm that waits until the partner actually withdraws cash has already defaulted.

Conversely, where remuneration is credited monthly, the obligation arises monthly, and deduction on a single annual entry will be late in respect of the earlier months.

The structural mismatch

The withholding obligation and the deduction ceiling operate on different bases and the statute does not reconcile them. Tax is deducted at 10% on the sum credited. The amount the firm may deduct is capped by reference to book profit, which is ordinarily determined only after the accounts are finalised — and book profit itself depends on the remuneration figure being tested.

In the illustration in Part 3.5, the firm credited ₹31,50,000 and deducted ₹3,15,000, but only ₹27,00,000 is chargeable in the partners’ hands. The partners hold credit for tax deducted on an amount larger than the amount they are assessed on. This is not a defect in anyone’s compliance; it is a consequence of the design. Its effect is a cash-flow cost to the partners, recoverable through the return, and a reconciliation burden on the firm.

Consequences of default

The disallowance consequence depends on the payee's residence. For a sum payable to a resident partner, Section 35(b)(i) disallows 30% where tax deductible under Chapter XIX-B is not deducted during the tax year or, after deduction, is not paid up to the return-filing due-date cut-off in Section 263(1). The provision restores that 30% deduction in the tax year in which the tax is subsequently paid and also contains payee-return relief through Section 398(2). For a chargeable sum payable outside India or to a non-resident partner, Section 35(b)(ii) applies separately. It can disallow the whole relevant sum until the TDS condition is cured, subject to the statutory relief mechanism. The 30% rule should therefore not be stated as universal.

Beyond the disallowance, the ordinary consequences of a withholding default apply, including interest, late-statement consequences and possible penalty proceedings. Section 263(1) is the return-filing due-date cut-off used in Section 35(b); it is not the ordinary TDS remittance date. The actual payment timelines are prescribed in Rule 218 of the Income-tax Rules, 2026 and broadly continue the earlier Rule 30 framework (generally the seventh day of the following month, with 30 April for March deductions by non-government deductors).

3.9 Interaction with presumptive taxation

Section 58 of the Income-tax Act, 2025 consolidates the presumptive schemes formerly contained in Sections 44AD, 44ADA and 44AE. Section 58(1) provides that the ordinary computation provisions apply only to the extent that they are not contrary to Section 58, so that once a taxpayer enters the presumptive framework, the presumed income displaces the normal computation.

Two features are directly relevant to firms.

• Limited liability partnerships are excluded from the general-business and specified-profession presumptive schemes, but not from the goods-carriage scheme. For the schemes corresponding broadly to former Sections 44AD and 44ADA, the relevant definitions of eligible assessee and specified assessee exclude LLPs. By contrast, Section 58(2), Table Sl. No. 2 for the business of plying, hiring or leasing goods carriages applies to an assessee owning not more than ten goods carriages and does not contain a general LLP exclusion. A qualifying LLP may therefore fall within that goods-carriage presumptive scheme.
• Partner remuneration is not separately deductible, except for goods carriage business. The general restriction on deductions means that the presumed percentage of turnover is treated as income after all allowable business deductions, including partner remuneration and interest. The single carve-out preserves the position formerly obtaining under Section 44AE: where a firm is engaged in the business of plying, hiring or leasing goods carriages, salary and interest to partners are deducted from the presumptively computed income, subject to the conditions and limits in Section 35(e).

3.10 The Goods and Services Tax position

Whether remuneration paid to a partner represents consideration for a supply must now be analysed under Section 7 of the Central Goods and Services Tax Act, 2017 as amended, including Section 7(1)(aa), together with Section 7(2) and Schedule III. Section 7(1)(aa), inserted by the Finance Act, 2021 with retrospective effect from 1 July 2017, deems activities or transactions between a person (other than an individual) and its members or constituents, or vice versa, for cash, deferred payment or other valuable consideration to be supplies notwithstanding the doctrine of mutuality. This provision materially changes the statutory framework within which firm-partner transactions must be examined.

Entry 1 of Schedule III provides that services by an employee to the employer in the course of or in relation to employment are neither a supply of goods nor a supply of services. In Anil Kumar Agrawal (Karnataka AAR, KAR ADRG 30/2020, dated 4 May 2020), the Authority treated working-partner salary as falling outside supply on this employment-based reasoning and treated the partner’s profit share as outside GST. That ruling, however, was issued before Section 7(1)(aa) was enacted retrospectively. It should therefore not be treated as a conclusive statement of the post-amendment position. Schedule III remains relevant where a genuine employment relationship can legally and factually be established, but partnership law ordinarily does not by itself make a partner an employee of the firm. The deed, functions, control, capacity and consideration therefore require examination.

Interest on partner capital or advances should likewise not be described simply as outside the scope of supply. Financial services by way of extending deposits, loans or advances, where the consideration is represented by interest or discount, are generally exempt under the relevant entry of Notification No. 12/2017-Central Tax (Rate). However, an exempt supply may still be relevant for aggregate-turnover purposes. The Anil Kumar Agrawal ruling analysed the interest streams before it, including interest associated with partner fixed and variable capital, through that exempt-financial-service framework. The precise treatment should follow the legal character of the balance and the transaction. Where a partner supplies goods or services to the firm in a distinct capacity — for example, by letting immovable property — the ordinary GST provisions apply to that transaction on its own terms.

4.1 The partnership deed as a tax document

A partnership deed or LLP agreement is ordinarily drafted with commercial and governance considerations in mind: capital, profit sharing, admission and retirement, management, dispute resolution. The tax consequences of the drafting are frequently addressed, if at all, by a single sentence adopting the statutory maximum. Given the four cumulative conditions and the judicial divergence discussed in Part 3.4, that approach carries avoidable risk.

A deed drafted with the tax framework in view will address, at a minimum, the following.

4.2 Timing and the annual compliance cycle

Two timing points govern the year. Any amendment to the remuneration or interest arrangements must be executed before the period to which it relates, because the prospectivity rule in Section 35(e)(ii)(B) admits of no exception. And the withholding obligation attaches on credit, so the accounting entry that records remuneration determines the withholding deadline, not the date on which the partner draws the money.

These two rules are different from how firms usually operate. Firms often make deed changes at year end, after results are known, but the law requires changes at the start of the period. Remuneration is usually credited at year end, when book profit is calculated, but tax must be deducted at that time, even if the calculation is not final. Firms that follow the legal timing will find compliance easier; those that do not may face defaults.

4.3 Principal risk areas

4.4 Structuring considerations

Within the statutory limits, firms retain a degree of latitude in how partner compensation is composed between remuneration, interest on capital and share of profit. The composition is not tax-neutral, and the relevant considerations are the following.

• Remuneration and interest can be deducted by the firm up to their limits and are taxed to the partner. Profit share is not deductible by the firm and is not taxed again to the partner. The total tax result depends on the firm's tax rate and the partners' individual rates.
• Interest paid within the allowed limit lowers book profit, which also lowers the maximum allowed remuneration. These two factors are linked and should be planned together.
• Remuneration can only be paid to individuals who are actively involved, but interest can be paid to any partner. Firms with passive or non-individual partners have fewer options for structuring compensation.
• Both remuneration and interest require tax withholding under Section 393(3), but profit share does not. Focusing more on profit share can reduce the need for withholding and make reconciliation easier.