Partnership Firm: Registration, Deed, Taxation and Partner Salary Limits
- A registered partnership firm pays a flat 30% income tax on its net profit, and partner salaries are deductible only up to the limits prescribed under Section 40(b) of the Income Tax Act.
- An unregistered firm cannot sue partners or third parties and loses key tax deductions, making registration non-negotiable for any serious business.
- Partner salary and interest on capital are taxable in the partners' hands but exempt from tax at the firm level once deducted, preventing double taxation.
- Registration: Why It Is Not Optional
- The Partnership Deed: Clauses That Actually Matter for Tax
- Partnership Firm Taxation: Rates for FY 2026-27
- Section 40(b) Partner Salary Limits: The Number Everyone Gets Wrong
- Worked Example: Calculating Tax on ₹12,00,000 Partner Salary
- Key Due Dates for FY 2026-27
- Common Mistakes That Cost Firms Real Money
A partnership firm is still the fastest way for two or more people to start a business in India — no minimum capital, no board meetings, no ROC filings. But partnership firm taxation trips up most small-business owners because it sits at the intersection of the Partnership Act, the Income Tax Act, and the GST regime all at once. Here is everything you need to know for FY 2026-27, with real numbers so you can run the calculation yourself.
Registration: Why It Is Not Optional
A partnership firm is governed by the Indian Partnership Act, 1932. Registration is done with the Registrar of Firms in your state. You file an application, pay a small state-specific fee, and attach the partnership deed. The Registrar then enters the firm's name in the Register of Firms and issues a Certificate of Registration.
An unregistered firm can still operate and file taxes, but it cannot:
- File a suit against a third party to recover a debt
- File a suit against its own partners to enforce rights
- Claim a set-off in any legal proceeding
From a tax angle, the Income Tax Act does not deny deductions solely because a firm is unregistered — but practically, courts and banks treat unregistered firms as unreliable counterparties. Register before you open a bank account.
The Partnership Deed: Clauses That Actually Matter for Tax
The partnership deed is a private contract, but the Income Tax Department scrutinises three specific clauses before allowing deductions:
- Partner profit-sharing ratio — must be clearly stated; ambiguity leads to assessments where the AO decides the ratio.
- Partner salary or remuneration — the deed must authorise payment of salary to working partners and name the working partners explicitly. If the deed is silent, the deduction is disallowed entirely under Section 40(b).
- Interest on capital — the deed must specify the rate. The Income Tax Act caps the deductible rate at 12% per annum; anything above that is added back to firm income.
Always get the deed notarised and keep a dated copy. If you amend the deed mid-year, the new salary or interest terms apply only from the date of amendment, not retrospectively.
Partnership Firm Taxation: Rates for FY 2026-27
A partnership firm (and LLP) is taxed as a separate entity. The tax structure is straightforward:
| Tax Component | Rate / Limit |
|---|---|
| Income Tax on firm's net profit | 30% flat (no slab benefit) |
| Surcharge (if total income > ₹1 crore) | 12% of income tax |
| Health & Education Cess | 4% on (tax + surcharge) |
| Alternate Minimum Tax (AMT) | 18.5% of adjusted total income (+ cess) if regular tax is lower |
| Interest on partner's capital (deductible) | Maximum 12% p.a. |
| Partner salary — deductible limit (see Section 40(b)) | See table below |
Section 40(b) Partner Salary Limits: The Number Everyone Gets Wrong
Partner salary (called "remuneration" in the Act) is deductible from the firm's profit only up to prescribed limits based on the firm's book profit. Book profit is roughly: net profit as per P&L, after adding back partner remuneration and then making other adjustments specified in the Act.
| Book Profit Slab | Maximum Deductible Remuneration (all working partners combined) |
|---|---|
| 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 book profit above ₹3,00,000 | 60% of the book profit above ₹3,00,000 |
This limit applies to the total remuneration paid to all working partners combined, not per partner. How you split it among partners is your internal decision.
Worked Example: Calculating Tax on ₹12,00,000 Partner Salary
Let's say Rakesh & Priya General Traders has the following figures for FY 2026-27:
- Net profit before partner salary and interest: ₹25,00,000
- Interest on capital paid to partners (within 12% limit): ₹1,20,000
- Partner salary claimed: ₹12,00,000 (combined, both are working partners)
Step 1 — Calculate Book Profit
Book Profit = Net profit before remuneration − Interest on capital allowed
= ₹25,00,000 − ₹1,20,000 = ₹23,80,000
Step 2 — Calculate Section 40(b) Ceiling
- On first ₹3,00,000: 90% × ₹3,00,000 = ₹2,70,000
- On remaining ₹20,80,000 (i.e., ₹23,80,000 − ₹3,00,000): 60% × ₹20,80,000 = ₹12,48,000
- Total ceiling = ₹2,70,000 + ₹12,48,000 = ₹15,18,000
The firm paid ₹12,00,000, which is below the ceiling of ₹15,18,000. So the full ₹12,00,000 is deductible.
Step 3 — Firm's Taxable Income
₹25,00,000 − ₹1,20,000 (interest) − ₹12,00,000 (salary) = ₹11,80,000
Step 4 — Tax Payable by the Firm
- Income Tax @ 30%: ₹11,80,000 × 30% = ₹3,54,000
- Add Cess @ 4%: ₹3,54,000 × 4% = ₹14,160
- Total Tax = ₹3,68,160
Rakesh and Priya each receive their share of the ₹12,00,000 salary and pay tax on it under their individual slabs. Their share of remaining firm profit (₹11,80,000 − tax paid by firm) is received tax-free in their hands under Section 10(2A).
Key Due Dates for FY 2026-27
| Compliance | Due Date |
|---|---|
| Advance Tax — 1st instalment (15% of liability) | 15 June 2026 |
| Advance Tax — 2nd instalment (45% cumulative) | 15 September 2026 |
| Advance Tax — 3rd instalment (75% cumulative) | 15 December 2026 |
| Advance Tax — 4th instalment (100%) | 15 March 2027 |
| ITR filing (no audit required) | 31 July 2027 |
| ITR filing (audit required — turnover above threshold) | 31 October 2027 |
| Tax Audit Report (Form 3CB-3CD) | 30 September 2027 |
A partnership firm must file ITR-5. There is no option to file ITR-4 (Sugam). If the firm's turnover exceeds ₹1 crore (or ₹10 crore if cash transactions are within the specified ratio), a tax audit under Section 44AB is mandatory.
Common Mistakes That Cost Firms Real Money
- Deed does not name working partners explicitly. If the deed says "partners may be paid salary" without listing who qualifies as a working partner, the AO disallows the entire deduction. Name each working partner by name in the remuneration clause.
- Salary paid in excess of Section 40(b) limits. Many firms pay partners whatever is convenient and assume it will be allowed. The excess is added back to firm income and taxed at 30% — a painful and avoidable surprise.
- Interest on capital charged above 12% p.a. Some deeds specify 15% or 18% to match market rates. Only 12% is deductible; the rest is disallowed and also taxed in the partner's hands as income — double damage.
- Missing advance tax instalments. Firms often treat advance tax as a year-end exercise. Interest under Sections 234B and 234C applies from the missed instalment date, adding 1% per month to the shortfall.
- Treating partner drawings as salary. Cash drawn by partners from the firm's bank account is not automatically salary. It must be backed by a board resolution or deed clause and proper TDS deduction under Section 194T (applicable from FY 2024-25 onwards for partner remuneration above ₹20,000 per year — verify current threshold with your CA).
If you are setting up a new partnership or want to convert an existing one, Business Registration services at KyaTax can walk you through the deed drafting, state-level registration, and PAN/GST applications in one place.
Do it yourself in minutes — free to try, no login needed.
Open Business Registration →Frequently asked questions
Is a partnership firm taxed at a flat rate or slab rate?
A flat rate of 30% applies on the firm's net taxable income, regardless of how much profit it earns. There are no basic exemption limits or progressive slabs for firms — unlike individual partners who enjoy slab-rate taxation on their salary and share of profit received from the firm.
Can a sleeping (non-working) partner receive a salary that the firm deducts?
No. Section 40(b) allows remuneration deduction only for working partners — those who are actively engaged in conducting the firm's affairs. Salary paid to a sleeping or non-working partner is fully disallowed and added back to the firm's taxable income.
What ITR form does a partnership firm file?
A partnership firm must file ITR-5. This form covers firms, LLPs, AOPs, and BOIs. Individual partners file their own ITR (ITR-1, ITR-2, or ITR-3 depending on their other income) and claim their share of firm profit as exempt under Section 10(2A).
If the firm makes a loss, can partners still be paid salary and deduct it?
Yes, but only up to the statutory floor. Even in a loss situation, the firm can pay and deduct up to ₹1,50,000 (or 90% of book profit, whichever is higher) as partner remuneration. Since book profit is negative in a loss year, the floor of ₹1,50,000 applies and the resulting deduction increases the firm's carried-forward loss.
General information for FY 2026-27, not professional advice for your specific case. Rules change — verify against the latest notification or ask a KyaTax expert.
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