Starting April 1, 2025, significant income tax changes will apply to partnership firms and Limited Liability Partnerships (LLPs) due to amendments introduced in the Finance Act. These changes focus on two key areas:
- Increased Limits for Partner Remuneration
- Introduction of Section 194T - TDS on Payments to Partners
With the financial year 2024-25 coming to an end, it is crucial for firms and partners to understand these updates and ensure compliance. Let's look at these changes in detail.
1. Increased Limits for Partner Remuneration
Until March 31, 2025 (Assessment Year 2025-26), the maximum allowable remuneration for working partners was:
- On the first ₹3,00,000 of book profit (or in case of a loss): ₹1,50,000 or 90% of book profit, whichever is higher.
- On the remaining book profit: 60% of the book profit.
Revised Limits from April 1, 2025 (AY 2026-27 Onwards)
The Finance (No. 2) Act, 2024, has doubled the limits:
- On the first ₹6,00,000 of book profit (or in case of a loss): ₹3,00,000 or 90% of book profit, whichever is higher.
- On the remaining book profit: 60% of the book profit.
Impact on Partnership Firms
- Firms can now pay higher remuneration to partners while keeping it tax-deductible.
- Partnership agreements should be updated to align with the new limits.
- Accurate bookkeeping and tax calculations are necessary to ensure compliance.
2. Introduction of Section 194T - TDS on Payments to Partners
One of the most important changes is the introduction of Section 194T, which mandates Tax Deducted at Source (TDS) on payments to partners.
Applicability of Section 194T
- Applies to all partnership firms and LLPs, irrespective of their turnover.
- TDS is required if total payments to a partner exceed ₹20,000 in a financial year.
- 10% TDS will be deducted on the entire payment amount once this threshold is crossed.
Payments Covered Under Section 194T
| Transaction Type | TDS Applicability |
|---|---|
| Commission | Yes |
| Salary/Remuneration | Yes |
| Bonus | Yes |
| Interest on Capital/Loan | Yes |
| Drawings/Capital Repayment | No |
For example, if a firm pays a partner a salary of ₹10,00,000, a 10% TDS will be deducted on the full amount, meaning ₹1,00,000 will be deducted as tax at source.
When to Deduct TDS?
TDS must be deducted at the time of crediting the amount in the partner's account or at the time of payment-whichever is earlier.
What Happens If Firms Fail to Deduct TDS?
Non-compliance can lead to severe financial and legal consequences, including:
- Disallowance of 30% of the expense (salary/remuneration/commission/bonus/interest on capital).
- Interest Penalty: 1% per month for non-deduction, 1.5% per month for non-payment of deducted TDS.
- Late Filing Penalty: ₹200 per day for non-filing of TDS returns.
No Exemption or Lower TDS Rate Allowed
- Partners cannot submit Form 15G or 15H to avoid TDS.
- No provision for lower TDS deduction under Section 197.
Impact on Partners' Tax Liability
- TDS deducted will be available as a credit when partners file their Income Tax Return (ITR).
- Excess TDS can be claimed as a refund.
- TDS can be adjusted against advance tax liability, helping partners plan their taxes better.
Annual vs. Monthly TDS Deduction - What Firms Need to Do
- Monthly Salary Payments: TDS should be deducted every month.
- Interest on Capital: TDS should be deducted annually at the end of the financial year (usually in March).
- Firms must review their payment structure to ensure timely and accurate TDS deductions.
Steps Firms Should Take Before April 1, 2025
To ensure compliance with these new tax provisions, partnership firms should:
- Update Remuneration Agreements - Modify partnership deeds to reflect the revised remuneration limits.
- Obtain a TAN (Tax Deduction and Collection Account Number) - If not already obtained, firms must apply for a TAN before April 1, 2025.
- Set Up a TDS Deduction and Filing System - Ensure proper monthly deductions and timely TDS return filing.
- Communicate Changes to Partners - Inform partners that TDS will be deducted on their payments, and they need to claim it while filing their ITR.
- Consult a Tax Expert - Seek professional tax advice to ensure compliance and avoid legal complications.
Final Thoughts
The Finance (No. 2) Act, 2024, brings two major tax changes impacting partnership firms and LLPs from April 1, 2025:
- Higher remuneration limits for partners - allowing increased compensation while maintaining tax benefits.
- Mandatory TDS on payments to partners under Section 194T - requiring strict compliance with tax deduction rules.
With penalties for non-compliance being significant, firms must act immediately to update their financial and taxation practices. By making the necessary changes now, partnership firms can avoid disruptions and legal issues when the new rules take effect.
CAclubindia
