Several new provisions relating to Tax Deduction at Source (TDS) have been added in the Income Tax Act in recent years, increasing the taxpayers’ burden. The latest one is a quite tedious TDS compliance in the form of section 194T, which requires a partnership firm to deduct TDS from salary, remuneration, commission, bonus, or interest paid to a partner of the firm. This section has been introduced by the Finance (no. 2) Act 2024 and is effective from 1st April 2025.

In this context, CA Prakash Hegde elaborates on the applicability of the newly inserted Section 194T, while also outlining the probable practical challenges that the taxpayers may face. He inter alia remarks that, compliance with the TDS provisions under this section, particularly in a situation where the partners' remuneration is kept flexible to maximise the deduction from the firm’s income, is too complicated. Thus, stating that the partners may need to revisit the partnership deed to ensure that the remuneration clauses are appropriately worded and do not complicate the TDS compliance, the Author concludes, “Since the TDS provisions and the increased no tax zone are effective from 1st April 2025, immediate attention is required to ensure that any amendment to the deed is made immediately, as the income tax provisions do not recognize retrospective amendments.”

“Another Tedious TDS Compliance to Kick-in for Firm-to-Partner Payments”

Amidst the claim of simplification of the income tax provisions and related compliances, the Government has been introducing several additional compliances to be done by the taxpayers.  Many new provisions of Tax Deduction at Source (‘TDS’) have been added in the Income Tax Act, 1961 (‘the Act’) in recent years, and that has increased the taxpayers’ burden.  The latest such addition is a quite tedious TDS compliance in the form of section 194T of the Act, which requires a partnership firm to deduct TDS from salary, remuneration, commission, bonus, or interest to a partner of the firm. This section has been introduced by the Finance (no. 2) Act 2024 and is effective from 1st April 2025.

Text of the new TDS Section

The section reads as under:

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Payments to partners of firms

194T. (1) Any person, being a firm, responsible for paying any sum in the nature of salary, remuneration, commission, bonus or interest to a partner of the firm, shall, at the time of credit of such sum to the account of the partner (including the capital account) or at the time of payment thereof, whichever is earlier shall, deduct income-tax thereon at the rate of ten per cent.

(2) No deduction shall be made under sub-section (1) where such sum or the aggregate of such sums credited or paid or likely to be credited or paid to the partner of the firm does not exceed twenty thousand rupees during the financial year.

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The above TDS provisions under section 194T of the Act are applicable to a ‘Firm’.  A ‘firm’ shall include[1]

1. a ‘firm’ as defined under the Indian Partnership Act, 1932, and
2. a limited liability partnership as defined in the Limited Liability Partnership Act, 2008.

Though an employer is always required to deduct TDS from the payments to be made to his employees at the time of payment of salary, bonus, commission, or remuneration, until the insertion of the above section (i.e., 194T), TDS was not required to be done by the firm from the payments to be made to its partners for salary, bonus, commission, or remuneration, as those payments to partners are not considered as salary[2].  

The Memorandum to the Finance (No. 2) Bill, 2024 explains the above amendment as under.

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TDS on payment of salary, remuneration, interest, bonus or commission by partnership firm to partners

Presently, there is no provision for deduction of tax at source (TDS) on payment of salary, remuneration, interest, bonus, or commission to partners by the partnership firm. Hence, it is proposed that a new TDS section 194T may be inserted to bring payments such as salary, remuneration, commission, bonus and interest to any account (including capital account) of the partner of the firm under the purview of TDS for aggregate amounts more than Rs 20,000 in the financial year. Applicable TDS rate will be 10%.

The provisions of section 194T of the Act will take effect from the 1st day of

April, 2025.

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Deduction of TDS and Compliances

TDS at 10% of the salary, remuneration, commission, bonus, or interest has to be done either at the time of credit of the amount to the account of the partner or at the time of payment to him, whichever is earlier.   TDS is not required if the aggregate amount credited/paid to the partner is Rs 20,000 or less during the Financial Year (‘FY’).

Provisions of this section are applicable whether the partner is a resident or a non-resident. 

If the partner does not provide his PAN or Aadhaar, the rate of TDS should be 20%.  Further, if the partner is a non-resident, surcharge and cess should be added to the rate of TDS. 

The above provisions will take effect from 1st April 2025 (i.e., FY 2025-26). Therefore, any remuneration for the earlier FYs credited to the partners’ account on or before 31^st March 2025 shall not be subjected to TDS, even if the same is paid on or after 1^st April 2025. 

The remaining compliance provisions, viz., depositing TDS to the Government Account as per Rule 30 of the Income Tax Rules, 1961 (‘the Rules’), furnishing the Certificate of TDS as per Rule 31 of the Rules, and filing a Statement of TDS in Form No. 26Q (for resident partners) or Form No. 27Q (for non-resident partners) as per Rule 31A of the Rules, will remain applicable even for TDS made under section 194T of the Act.

The Central Board of Direct Taxes (‘CBDT’) has notified the Income Tax (Seventh Amendment) Rules, 2025 on 27^th March 2025 through which Form No. 26Q and Form No. 27Q have been amended to capture the details of amounts paid to partners and  TDS made by the firm. 

It should also be noted that self-declaration by the partner for non-deduction of TDS in Form No. 15G or 15H is not applicable for TDS under section 194T of the Act. The provisions of filing an application to the income tax officer for a nil/lower deduction certificate under section 197 of the Act are also not applicable.  Therefore, the firm has to deduct the TDS if the amount of remuneration exceeds Rs 20,000 per FY. 

Practical Challenges

As with any other provision of the Act, understanding and complying with the provisions of this section presents many practical challenges for taxpayers.

1. Meaning of the terms used in the section

The first and foremost challenge is deciphering the words/terms used in the section. The TDS provisions under section 194T cover the following amounts credited/paid by the firm to its partners.

• Salary
• Remuneration
• Commission
• Bonus
• Interest

The Section and the Act do not define the terms ‘Salary’ and ‘Remuneration’.  Remuneration has to be construed in a wide manner, and it can include salary, commission, and other payments as compensation for the services rendered.  Salary is usually understood as an agreed compensation payable periodically for the services rendered.  In the context of the partnership firm, salary or remuneration may be understood to be the compensation payable to the working partners for their services/involvement in running the business of the firm.

‘Commission’ includes payment to a person for acting on behalf of another person for services rendered.  This is paid in the course of buying or selling goods or in relation to any transaction relating to any asset, valuable article, or thing, etc[3].  In the context of the partnership firm, commission may be understood to be the payment made to the partner as compensation for specific activities like purchase/sale etc.

‘Bonus’ is a premium paid in addition to what is due or expected[4]. In the context of the partnership firm, a bonus could be considered as an additional payment made to the working partners as a reward.

‘Interest’ means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim, or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised[5].  In the context of the partnership firm, interest may be paid by the firm to its partners for their capital balance or the loan lent by them. 

[For the sake of brevity, hereinafter, salary, remuneration, commission and bonus to the partners are together referred to as ‘remuneration’]

Crystallisation of the allowable amount of Remuneration under section 40(b) of the Act

Unlike payments to external parties, the amount of remuneration payable to the firm's partners may not crystallize until the end of the Financial Year (‘FY’) as the same may depend on the allowable amount determined by the other provisions of the Act.   Therefore, it is crucial to look into the other provisions of the Act that regulate the allowability of the deduction for the payments in the nature of remuneration made by the firm to its partners.  This can help us to understand the complexity involved in the determination of the amount of payment to the partners that should be subjected to TDS under section 194T of the Act. 

Section 40(b) of the Act stipulates that –

• interest should be simple and should be 12% or less and
• remuneration to a partner shall be deductible only if the conditions mentioned in that section are fulfilled viz.

• The partner should be a working partner
• The payment should be authorised and in accordance with the partnership deed
• The payment should be only for the period after the date of the partnership deed
• The total remuneration to the working partners should be equal to or less than the amount computed as under [section 40(b)(v) of the Act]: 

Explanation 3 to section 40(b) of the Act states that the "Book Profit" means the net profit, as per the Profit and Loss Account (computed in the manner laid down in Chapter IV-D i.e. from section 28 to section 44DB) before reducing the aggregate amount of the remuneration paid or payable to all the partners of the firm.

As seen above, the allowable amount of deduction for remuneration paid to the working partners is based on the firm's Book Profit for the year. To maximize the deduction, most partnership deeds contain a clause that states that the remuneration payable to the working partners for the FY shall be based on the firm's Book Profit for the concerned FY. 

For example, it is common to find the following or similar clause in a partnership deed, which determines the remuneration of the working partners:

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That each partner shall be entitled to a monthly remuneration of Rs……… subject to the limits prescribed under section 40(b)(v) of the Income Tax Act, 1961.  In the event of the surplus of income of the firm falling below such salary, the same shall be reduced proportionately, to ensure that no disallowance is made by the tax authorities

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As can be noted in the above example, each working partner is stipulated to receive a monthly amount of remuneration.  However, such remuneration may be reduced after the firm's income for the year is computed.  This gives the flexibility to ensure that the remuneration to the partners does not get disallowed in the hands of the firm for exceeding the limit (based on Book Profit) as stipulated in section 40(b)(v) of the Act. 

However, in order to ensure that the partnership deeds contain the exact quantum of remuneration to the working partners and it is not left to be determined at the end of the FY, the CBDT has issued a Circular (no. 739 dated 25^th March 1996) which provides the following conditions

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In cases where neither the amount has been quantified nor even the limit of total remuneration has been specified but the same has been left to be determined by the partners at the end of the accounting period, in such cases payment of remuneration to partners cannot be allowed as deduction in the computation of the firm's income.

It is clarified that for the assessment years subsequent to the assessment year 1996-97, no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.

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The above Circular raised a controversy regarding the flexible clause on partners’ remuneration inserted in partnership deeds. In many cases, the income tax authorities challenged the remuneration clause which allowed the flexibility to decide, or to increase or to decrease the remuneration of the working partners.  

In a few decisions of the High Courts and the Income Tax Appellate Tribunals[6][7][8] it has been viewed that even upon consideration of the CBDT Circular, the remuneration clause in the partnership deed that stipulates the maximum amount of remuneration to the working partners to be as per the limit allowed under section 40(b(v) of the Act is permissible and therefore, such remuneration is allowable to be claimed as a deduction in the firm’s hands.

Despite the challenges from the assessing authorities, it is a common practice to keep the remuneration clause flexible, as mentioned above. However, this pushes the determination of the amount of remuneration to the working partners to a date subsequent to the end of the FY when the Book Profit can be computed. 

In this context, it should be noted that in addition to the remuneration, the partners will also be eligible for a share of the firm's profit (after tax) every year.  Such profit will be credited/paid to them after the Profit and Loss Account is drawn and the tax liability is computed.  

Thus, for each FY, the partners may get the following income from their firm.

1. Remuneration (i.e., salary or remuneration or commission or bonus by whatever name called) to which TDS under section 194T of the Act is applicable;

2. Interest to which TDS under section 194T of the Act is applicable; and

3. Share of Profit which is not subject to TDS

Therefore, any lump-sum withdrawal (whether periodic or regular or ad hoc) made by the partners during the FY may consist of any or all of the above amounts. 

A Few Observations and Comments

1. Of the above 3 kinds of payments made by a firm to its partners, the amount of interest payable to the partner for the whole year can be estimated even at the beginning of the year.  Therefore, the amount of withdrawal made by the partner from the firm to the extent of the estimated amount of interest can be easily identified.  Hence, the deduction of TDS on the interest amount does not pose any challenges, and the same can be done at the time of credit/payment during the year.

For any reason, if the firm fails to deduct TDS on interest, 30% of the interest [which would have been deductible under section 36(1)(iii) of the Act] can be treated as an inadmissible expenditure [under section 40(a)(i) of the Act], and the remaining consequences of TDS default can also follow.

These consequences can be avoided if the partner does not miss to report the interest amount in his Income Tax Return (‘ITR’) filed under section 139 of the Act and a certificate of a Chartered Accountant in Form No. 26A, as stipulated under the first Proviso to section 201(1) of the Act, is furnished by the firm.   However, the firm is required to pay interest on the amount of TDS from the date it was deductible to the date the partner filed his ITR.  The Assessing Officer can still levy a penalty under section 271C of the Act which could be equal to the amount of TDS not deducted. 

2. In cases where the total remuneration to the working partners for the entire FY as per the partnership deed is fixed at Rs 3 Lakh or less (which is the minimum amount allowable under section 40(b)(v) of the Act irrespective of the amount of profit or loss of the firm), the deduction of TDS on that remuneration will also not pose any challenge since it can be done each time the amount is credited/paid to the respective partners during the year.

3. Further, in cases where the total remuneration to the working partners for the entire FY as per the partnership deed is fixed for more than Rs 3 Lakh, and TDS has been made at the time of credit/payment, and if such remuneration becomes equal to or less than the amount of remuneration arrived at as per the provisions of section 40(b)(v) of the Act (at the end of the FY), there could be no question of TDS default.   However, since the amount of remuneration arrived at under section 40(b)(v) of the Act is more, the firm loses the option to maximise the eligible deduction in its hands.

4. In all cases where, as per the partnership deed, the remuneration to the working partners is flexible being dependent on the allowable limit stipulated under section 40(b)(v) of the Act there could be challenges in determination of the amount which should be subjected to TDS at the time of payment to the partners during the FY.  Since such flexible remuneration is dependent on the Book Profit of the firm, the exact amount of remuneration to the partners will not be known at the time of payment made or to be made during the year. 

Moreover, periodic or ad hoc payments made by the firm to the partners during the FY can include both remuneration (which is subject to TDS under section 194T of the Act) and a share of the profit (which is not subject to TDS).  The exact composition of these two remains unknown until the Book Profit and the firm's tax liability are computed. This makes it challenging for the firm to bifurcate the taxable component and the non-taxable component in the payments made, to compute the appropriate amount of TDS and the timely deposit.

That is why the partnership firms are complaining that this section imposes a complicated compliance burden on them in contrast to the remaining TDS sections, which cover simple cases where the amount to be subjected to TDS  is specific as it is determined in advance by an agreement, contract, invoice, understanding, etc. with the external vendors.     

In this situation of flexible remuneration, the following two important scenarios may arise:

Scenario 1: Deduction of higher TDS than required

As per the partnership deed, the remuneration to the partners is kept flexible on the basis of eligibility under section 40(b)(v) of the Act; The Firm considers the entire amount of actual payment during the FY made to the partners as remuneration and subjects the same to TDS at 10% under section 194T of the Act; TDS amounts are regularly deposited, and eTDS returns are filed.  After the Profit and Loss Account is finalised, it is realised that the actual eligible remuneration [under section 40(b)(v)] is less than the amount on which TDS has been done.

Though there is no TDS default, the partners’ Form No. 26AS and Annual Information Statement (‘AIS’) will reflect a higher amount of remuneration than what is received, which can lead to more chaos and challenges for the partner.    To rectify this, the Firm has to revise the eTDS return(s) to reflect only the eligible amount of remuneration and claim the excess TDS as a refund or adjust the excess TDS amount against other TDS liabilities. This scenario can cause huge cash flow issues to the firm and the partners.

Also, a question may arise on the entire set of transactions since the nature of the amount, which was treated as taxable at the time of payment and therefore subjected to TDS under section 194T of the Act, has been changed to non-taxable, and the eTDS returns have been revised by the firm.

Scenario 2: Deduction of lesser TDS than required

As per the partnership deed, the remuneration to the partners is kept flexible on the basis of eligibility under section 40(b)(v) of the Act; The Firm considers the entire amount of actual payment made to the partners during the FY as remuneration and subjects the same to TDS at 10% under section 194T of the Act; TDS amounts are regularly deposited, and eTDS returns are filed.  After the Profit and Loss Account is finalised, it is realised that the actual eligible remuneration [under section 40(b)(v)] is more than the amount on which TDS has been done.

In this scenario, as per the partnership deed, the partners would be eligible for more remuneration than what they actually received during the FY.  It may not be possible for them to have that excess remuneration unless the firm has finalised its accounts for the FY within a short window, which is available till 30^th April, following the end of the FY (which is the date for deposit of TDS for March), to be fully compliant with the TDS provisions. 

In the above situation, it is pertinent to note that unless the partners claim the excess eligible remuneration, the Assessing Officer cannot treat the excess remuneration as credited or paid or due to the partners and hold the firm accountable for TDS default.  Such excess remuneration does not become mandatorily payable or due to the partners[9].   In this context, it should be noted that it is necessary to articulate the remuneration clause in the partnership deed. 

For any reason, even if the firm fails to deduct TDS on the entire or any part of the remuneration, it cannot be treated as an inadmissible expenditure under section 40(a)(i) of the Act since that section disallows only expenses referred to in sections 30 to 38 of the Act for non-deduction of TDS and does not cover partners’ remuneration.  

Further, the consequences of non-deduction of TDS on remuneration can be avoided if the partners do not miss to report the remuneration amount in their respective ITRs filed under section 139 of the Act and a certificate of a Chartered Accountant in Form No. 26A, as stipulated under the first Proviso to section 201(1) of the Act, is furnished by the firm.   However, the firm is required to pay interest on the amount of TDS from the date it was deductible to the date the partner filed his ITR.  Also, the Assessing Officer can still levy a penalty under section 271C of the Act, which could be equal to the amount of TDS not deducted. 

There could be more scenarios depending on the quantum of Book Profits, remuneration of the partners, and the remuneration clause in the partnership deed.

Conclusion

It may be relevant to mention that any payment made by the firm to the partner from his capital account is not subject to TDS.  Also, if the partnership deed provides for it, the firm may lend money to the partner.[10].  Any loan lent by the firm to the partner is also not subject to TDS.  Of course, if the firm has borrowed a loan with interest and lent to the partner without or at a lower interest, it may be questioned by the Assessing Officer. 

Further, as noted above, compliance with the TDS provisions under this section, particularly in a situation where the partners' remuneration is kept flexible to maximise the deduction from the firm’s income, is too complicated.  In such situations, it may be wiser to deduct TDS on all the payments (which may include remuneration as well as share of profit) to be made to the partners during the FY, though it may lead to overcompliance, calling for a revision of eTDS returns and claiming a refund of excess TDS once the Profit and Loss Account is finalised and the Book Profit is computed.

The partners may need to revisit the partnership deed to ensure that the remuneration clauses are appropriately worded and do not complicate the TDS compliance.  Also, on a different note, there could be some tax planning opportunities for the partners with the increase in the no tax zone to Rs 12 Lakh per annum.  Since the TDS provisions and the increased no tax zone are effective from 1^st April 2025, immediate attention is required to ensure that any amendment to the deed is made immediately, as the income tax provisions do not recognize retrospective amendments. 

[1] Section 2(23) of the Income Tax Act, 1961

[2] Explanation 2 to section 15 of the Income Tax Act, 1961

[3] Explanation to Section 194H of the Income Tax Act, 1961

[4] Black’s Law Dictionary 12th Edition

[5] Section 2(28A) of the Income Tax Act, 1961

[6] High Court of Himachal Pradesh reported in [TS-81-HC-2009(HP)]

[7] High Court of Himachal Pradesh reported in [TS-5191-HC-2011(Himachal)-O]

[8] Mumbai ITAT reported in [TS-761-ITAT-2018(Mum)]

[9] High Court of Gujarat [TS-5018-HC-2021(Gujarat)-O]

[10] Neither the Indian Partnership Act, 1932 nor the Limited Liability Partnership Act, 2008 prohibit the firm from lending loan to the partners.