Separate the contract, deduction, withholding and presentation
For a firm or LLP assessed as a firm, first establish what is payable under the applicable written instrument. Then compute the business deduction, any withholding, and the treatment in the partner’s own return. Keep the tax calculation separate from presentation under the applicable accounting guidance. A statutory ceiling does not create a payment entitlement.
| Period | Aggregate ceiling for authorised working partner remuneration |
|---|---|
| Legacy section 40(b), AY 2010–11 through AY 2024–25 | On the first ₹3 lakh of book profit or in a loss case: ₹1.50 lakh or 90% of that book profit, whichever is higher; 60% of the balance. |
| Section 40(b), AY 2025–26 and AY 2026–27 | On the first ₹6 lakh of book profit or in a loss case: ₹3 lakh or 90% of that book profit, whichever is higher; 60% of the balance. |
| Section 35(e), tax year 2026–27 onward under the Income-tax Act, 2025 | The ₹6 lakh first band, ₹3 lakh amount, and 90%/60% structure continue. Check the rules and legislation for the relevant year. |
Only remuneration of an individual actively engaged in conducting the firm’s business or profession qualifies as working partner remuneration. Remuneration and interest must be authorised by and in accordance with the applicable deed. A later deed does not create a deduction for an earlier unauthorised period; check whether an earlier applicable deed already authorised it. Interest to any partner is separately capped at 12% simple per annum, subject to the applicable provisions, including rules for representative capacity.
Compute book profit under the statutory definition. Reconcile accounting profit to business profit under the relevant chapter, add back remuneration to all partners to the extent already deducted, and document depreciation and disallowances. Do not add a charge back twice if it was shown below the starting line or already adjusted. Analyse income classification on the facts, particularly interest; the examples state their assumed treatment. Keep the brought-forward loss and depreciation schedules separate from the current book-profit working and evaluate applicable law for disputed items.
CBDT Circular 739 explains the need for an amount or a manner of quantification in the deed. In Sood Brij & Associates, the Delhi High Court rejected a clause that left actual remuneration to future agreement despite referring to the statutory ceiling. Great City Manufacturing Co. addressed an Assessing Officer’s separate disallowance on its own facts; it does not validate every deed. Name the working partners, specify a payable amount or an ascertainable formula and allocation, and preserve evidence of their work and actual credits.
Seven worked cases
1. Book profit and the ceiling
Assume FY 2024–25, a partnership with two eligible working partners, valid deed authorisation, and tax treatment as stated below. Amounts are ₹ lakh.
| Line | Amount |
|---|---|
| Accounting net profit | 18.50 |
| Add remuneration already debited | 12.00 |
| Add excess interest: 15% less 12% on ₹32 lakh | 0.96 |
| Add accounting depreciation | 3.20 |
| Add donation assumed inadmissible as a business expense | 0.50 |
| Deduct tax depreciation | −4.50 |
| Remove FD interest assumed separately classified on these facts | −1.40 |
| Book profit for the illustration | 29.26 |
Interest booked at ₹4.80 lakh exceeds the ₹3.84 lakh simple cap by ₹0.96 lakh. Apply the AY 2025–26 ceiling: ₹5.40 lakh on the first ₹6 lakh plus 60% of ₹23.26 lakh, or ₹19,35,600 in total. The ₹12 lakh actually payable (₹6 lakh each) is within the ceiling. On the same assumed book profit the older ceiling would have been ₹18,45,600, which does not govern this example.
2. Retrospective authorisation
A partner joins on 15 November 2024. The deed is signed on 20 November and attempts to award ₹50,000 a month from 1 April. No earlier instrument authorised the amount. Assume the valid prospective entitlement begins 21 November, a full month is ₹50,000 and November is prorated by actual days. The prospective calculation is 10/30 of ₹50,000 plus four full months, or ₹2,16,666.67. Of a ₹6 lakh claim, ₹3,83,333.33 relates to the unauthorised period. The prospective amount remains subject to the other deduction tests. If the adjustment were fully taxable at 30% plus 4% cess with no surcharge, illustrative incremental tax before statutory rounding would be about ₹1,19,600. The marginal effect can differ with the actual computation.
3. Passive partner
Three partners are each credited ₹10 lakh. Assume two actually work in the firm and one is a passive investor. ₹10 lakh paid to the non-working partner is disallowed regardless of their description in the deed; assess the other ₹20 lakh under the authorisation and aggregate ceiling tests. Being abroad does not itself make someone non-working. Apply the recipient tax, withholding and treaty rules separately where relevant.
4. Compounding and current accounts
Assume combined eligible partner balances of ₹60 lakh are constant before any interest credit, the deed covers the relevant balances, and 12% nominal annual interest is compounded quarterly at 3%. That produces ₹7,53,052.86 compared with ₹7,20,000 at 12% simple. On those facts ₹33,052.86 exceeds the cap. Recalculate each partner’s changing balances where necessary; a current account is not automatically excluded or deductible simply because of its caption.
5. A clause with a determinable amount
For an illustrative deed, identify A and B as working partners and state that the amount payable for the relevant year equals the aggregate ceiling computed under the provision governing that year, with A and B each receiving 50%, subject to clearly stated commencement or cessation terms. Define how the calculation and credits are made. Tailor it to the firm’s intended payment and avoid contradictory language that leaves the actual amount to future discretion. This is a drafting example and does not guarantee deductibility.
6. Loss year
In FY 2024–25 an LLP has a ₹4 lakh tax book loss before remuneration and a valid deed under which it credits ₹1.50 lakh to working partners. The loss-case ceiling is ₹3 lakh, but the deduction considered is the ₹1.50 lakh actually authorised and credited. Assuming the other conditions are met, the illustrated business loss becomes ₹5.50 lakh. Check the rules on filing and carry-forward; under the legacy section 72, eligible ordinary business loss can generally be carried forward for eight assessment years, subject to statutory conditions. No conclusion on individual partners’ tax follows from these figures alone.
7. Financial statements and partner balances
A non-corporate firm’s turnover is ₹14 crore in FY 2025–26. It is above ICAI’s ₹5 crore Phase I threshold. For accounting periods beginning on or after 1 April 2026, Phase II covers all entities within the scope of the respective guidance notes. Apply the relevant non-corporate or LLP format. On assumed earnings of ₹32 lakh before partner amounts, ₹18 lakh remuneration and ₹4 lakh interest leave ₹10 lakh available for allocation. Do not present the same amount as both an expense and a separate appropriation. Reconcile each partner’s opening capital and current balances, contributions, credited amounts, profit allocation, drawings and closing balances. Use a separate tax bridge for deductibility and withholding.
Practical checks
Partner income. For legacy years section 28(v) governs the partner’s interest and remuneration, with adjustment for an amount disallowed under section 40(b) in the firm’s computation. Check the evidence and the relevant year. A partner’s share of assessed firm profit is distinct from salary or interest. For an individual representing another person, identify the legal partner, actual work and capacity in which interest or remuneration is received; do not treat the HUF itself as an individual working partner or assume the same treatment for every payment.
Withholding. From 1 April 2025, legacy section 194T requires 10% deduction at the earlier of credit (including to the capital account) or payment of covered salary, remuneration, commission, bonus or interest to a partner, subject to the ₹20,000 aggregate threshold per partner for the financial year. Under the 2025 Act, use the corresponding section 393 rule from tax year 2026–27. Test the threshold and timing on the covered payments or credits, independently of the firm’s final deduction.
Evidence. Retain the operative deed, partner authorisations and role records, book-profit reconciliation, interest schedules, credits and withholding trail. A payment exceeding the tax interest ceiling does not necessarily breach the deed; an orally agreed payment does not satisfy the tax requirement for deed authorisation. Use the ledger and the tax working to document the difference.
Sources
- Income Tax Department: Income-tax Act, 1961, sections 28(v), 40(b), 72 and 194T
- Gazette: Finance (No. 2) Act, 2024, revised limits and partner withholding
- Income Tax Department: Income-tax Act, 2025, sections 35(e), 393 and 536
- CBDT Circular 739 of 25 March 1996
- Delhi High Court: Sood Brij & Associates, ITA 1154/2011
- Allahabad High Court: CIT v. Great City Manufacturing Co.
- ICAI: 31 March 2026 applicability announcement for non-corporate entities and LLPs
- ICAI: Guidance Note on Financial Statements of Non-Corporate Entities