Legal Reference
Section 2(31) (firm definition), Section 40(b) equivalent (partner salary/interest limits), Section 86 (partner share of profit exempt), ITA 2025 | Flat 30% on firm income | Partner salary within limits deductible | Corresponds to Sections 184-189 of ITA 1961
1. How Firms Are Taxed
Partnership firms (both registered and unregistered) are taxed as separate entities under ITA 2025 at a flat rate of 30% (plus 4% cess = 31.2%). This is different from LLPs (also 30%) and companies (22-25%). The firm files ITR-5 separately from partners. Partners then receive their share of profit — which is exempt in their hands (to avoid double taxation).
2. Partner Salary: Deductible with Limits
A registered partnership firm can pay remuneration (salary, bonus, commission) to working partners — deductible from firm income subject to limits:
| Book Profit Slab | Maximum Deductible Partner Salary |
|---|
| First Rs 3,00,000 of book profit (or loss) | Rs 1,50,000 or 90% of book profit — whichever is higher |
| Balance book profit above Rs 3,00,000 | 60% of remaining book profit |
3. Partner Interest: Maximum 12% per Annum
Interest paid to partners on their capital contributions is deductible from firm income — but only up to 12% per annum. Any excess interest is disallowed and not deductible. Partners include the interest received in their individual income (as "income from firm").
4. Partners Taxation
- Share of firm profits: FULLY EXEMPT in partner hands under Section 86 — no double taxation
- Salary from firm: Taxable as salary in partner hands — but deductible for the firm
- Interest from firm: Taxable as business income in partner hands — but deductible (up to 12%) for firm
- Capital gains on sale of firm interest: Taxable as capital gains in partner hands
5. Registered vs Unregistered Firm
| Feature | Registered Firm | Unregistered Firm |
|---|
| Partner salary deduction | Allowed (within limits) | NOT allowed — full disallowance |
| Tax rate | 30% | 30% |
| Ability to sue partners/third parties | Yes | Limited |
6. LLP vs Partnership Firm
LLPs (Limited Liability Partnerships) are taxed similarly to partnership firms at 30%. However, LLP partners have limited liability — personal assets are not at risk for LLP debts. LLP partner remuneration limits are the same as for firms. LLPs are often preferred over traditional partnership firms for professional services due to the liability protection.
7. Why TaxClue
Partner salary within prescribed limits, firm ITR-5 filing, and partner individual ITR coordination require precision. TaxClue handles firm taxation and partner ITR filing together. Contact us under ITA 2025.
Disclaimer
This article is for general informational and educational purposes only. It does not constitute legal, financial, or professional tax advice. Readers are advised to consult a qualified Chartered Accountant or tax professional before making any decisions. TaxClue Consultech Pvt Ltd accepts no liability. All case studies and examples in this article are illustrative only and do not represent actual persons or transactions.
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❓ Frequently Asked Questions
How is a partnership firm taxed?
A partnership firm is taxed as a separate entity at a flat 30% plus 4% cess on its total income under ITA 2025. The firm files ITR-5. Partner remuneration (salary/bonus) to working partners is deductible within prescribed limits. Interest to partners on capital is deductible up to 12% p.a. The net taxable profit after these deductions is taxed at 30%. Partners receive their share of profits — which is exempt in their individual hands under Section 86.
What are the partner salary limits?
A registered firm can deduct partner remuneration from firm income within limits: on the first Rs 3 lakh of book profit (or if there is a book loss), Rs 1,50,000 or 90% of book profit — whichever is higher; on balance book profit above Rs 3 lakh, 60% of the remaining book profit. Unregistered firms cannot deduct partner salary at all — the disallowance is complete. Excess salary paid beyond limits is disallowed even for registered firms.
Is a partner share of profit taxable?
No. A partner share of profit from a registered firm is fully exempt from tax in the partner hands under Section 86 of ITA 2025. This prevents double taxation — the firm has already paid 30% on its profits before distribution. However, salary received from the firm and interest on capital are taxable in the partner hands (as salary and business income respectively). Capital gains on sale of firm interest are also taxable as capital gains.
What is the maximum interest a firm can pay partners?
Under ITA 2025, interest paid to partners on their capital and loan accounts is deductible from firm income only up to 12% per annum. Any interest paid above 12% is disallowed. Partners must include the interest received in their individual income. The 12% limit applies per the deed — if the partnership deed specifies interest above 12%, only 12% is deductible. Interest is computed on the opening balance of the partner capital account.
What is the difference between a registered and unregistered firm for tax?
The key tax difference: a registered firm (registered with the Registrar of Firms) can deduct partner remuneration within prescribed limits. An unregistered firm cannot deduct any partner remuneration — the entire salary/bonus paid to partners is disallowed as a deduction. Both pay tax at 30%. For this reason, virtually all partnership firms dealing with significant business should be registered to claim the partner salary deduction.
