In view of expanding scope of TDS provisions, Finance Act 2024 introduced the TDS liability on payments made to the Partners of a Firm which includes limited liability Partnerships. TDS provisions merely aid the tax collection mechanism and are not charging sections in themselves, and since TDS is made applicable on the payments made by the firm, the recipient Partners have to adjust their advance tax/self-assessment tax obligations accordingly.

Mr. Sharath Rao (Partner, BBSR & Associates LLP) and Mr. Rajat Nahata (Director) in this article, analyse the amendment vide Finance Act, 2024 introducing Section 194T requiring tax to be deducted from on payments made to the Partners of a Firm (including Limited Liability Partnership). Section 194T requires TDS on the payment made by a “Firm” to its partners towards salary, remuneration, commission, bonus or Interest on any account and since the definition of “firm”, includes an LLP as well, this TDS rule will therefore also apply to LLPs paying their Partners. The authors underscore that while the introduction of section 194T increases the compliance burden of partnership firms, the same would help in bringing in enhanced transparency and accountability under the partnership form of business and would ultimately contribute to an efficient tax administration in India.

They opine that, “Firms should establish robust systems and mechanism to ensure timely deduction and payment of taxes for complying with these newly introduced provisions. While the intent with which the section has been introduced is in the right spirit, however, the section has some inherent challenges… which would have to be ironed out by the CBDT.,”.

“Payments to Partners of a Firm – New TDS Rule from April 1, 2025”

Background

The Finance (No. 2) Act, 2024 introduced a new section, section194T, to the Income‑tax Act, 1961 (“the Act”) which requires tax to be deducted at source on payments made to the Partners of a Firm (including Limited Liability Partnership). The new TDS rule is effective from 01-April-2025.

In the last few years, the Government has been expanding the scope of TDS provisions and section 194T is one more addition to this.  It is a well-known fact that TDS provisions merely aid the tax collection mechanism and are not charging sections in themselves. Certain streams of income of the partners like interest, salary, bonus, commission, remuneration etc, received from a firm, are taxable under the head ‘Profits and gains of business or profession’, provided, such payments from the firm are not subject to disallowance under section 40(b) of the Act. However, up until the introduction of section 194T, such income was not subject to TDS and partners had to pay tax on such income on their own, either by way of advance tax or as self-assessment tax. With effect from April 1, 2025, since TDS is applicable on these payments, the recipient Partners have to adjust their advance tax/self-assessment tax obligations accordingly.

Coverage

Section 194T requires TDS on the following payments made by a “Firm” to its Partners:

• Salary

• Remuneration

• Commission

• Bonus or

• Interest on any account.

Since the definition of “firm”, includes an LLP as well, this TDS rule will therefore also apply to LLPs paying their Partners.  Profit distributions and capital repayments by a firm are not covered within the TDS rule. 

Mechanism

As per section 194T of the Act, tax is to be deducted at the rate of 10 percent on certain specified payments made to the Partners of the firm provided such sum credited or paid or likely to be credited or paid to the partner exceeds the threshold of Rs 20,000 during the financial year.

The liability to deduct tax would arise 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.

Interplay between section 194T and 192/194A

Section 192 deals with tax deduction at source on income chargeable under the head salary. Further, explanation 2 to section 15 of the Act specifically states that any salary, bonus, commission, or remuneration, by whatever name called, due to, or received by, a partner of a firm from the firm shall not be regarded as salary.

Likewise, section 194A which deals with tax deduction at source on income by way of interest other than income by way of interest on securities, specifically excludes interest income which is credited or paid by a firm to a partner of the firm.

Thus, salary and interest paid/ payable to a partner which were never covered within the ambit of section 192 and section 194A respectively, have now been brought within the ambit of TDS under the new section 194T.

Some practical issues that arise

1. If any payment to the partners of the firm has been disallowed under section 40(b) in the income computation of the firm, the same is then exempt in the hands of the partner as per proviso to section 28(v) (this is to avoid double taxation).  Therefore, where a sum is exempt from tax, the same may ideally not warrant TDS as TDS is merely a tax collection mechanism.  However, no such exclusion has been provided under section 194T, which may lead to unnecessary cash flow issues to the firm and the partners. 

2. For Partners whose effective tax rate may be low (or no tax liability), 10% TDS rate may be high.  Such Partners may therefore have to seek of refund of the TDS by filing their ITRs after the end of the year.  This impacts their cash flows.  Section 197, which allows an assessee to seek a lower TDS rate from the tax office, unfortunately does not include TDS u/s 194T.  However, the good news here is that section 395 of the proposed Income-tax Bill, 2025 (proposed applicability from FY 2026-27) has removed the reference to specific sections that are eligible for lower TDS and all TDS sections seem to be eligible for lower TDS.  Hence, the absence of a mechanism for seeking lower TDS could be an issue only for one year, viz, FY 2025-26. 

3. What if the recipient partner is a non-resident – will section 195 apply or section 194T? As per the plain language of section 194T, it applies to all Partners, irrespective of their residential status (ie, resident or non-resident).  However, section 195 is a special TDS section that applies to all payments made to a non-resident.  Also, unlike some other TDS sections, where it clearly specifies that it applies only to payments to residents (for example, section 194R, 194O, etc), section 194T is silent about this aspect.  Therefore, this ambiguity arises, for example, when an LLP in India is paying remuneration to its partner who is a non-resident, which TDS section should the LLP apply? A better position would be to say that section 195 will apply, since section 195 is more specific to non-resident recipients and section 194T is a more generic section.  Also, if the position is otherwise (ie, that section 194T applies), then the benefit of applying the taxation under relevant Double Tax Avoidance Agreement (DTAA) for the purposes of TDS may not be available under section 194T, since this is available only under section 195 (DTAA can be accessed only for TDS under section 195, since the definition of “rates in force” used in section 195, includes DTAA rates).  This also allows the recipient to then seek a lower TDS rate under section 197 (if required), since section 195 is covered under section 197, but not section 194T as aforesaid. 

While in the case of PILCOM Vs CIT 425 ITR 313 (2020) (SC) : [TS-5032-SC-2020-O], the Supreme Court upheld the position that section 194E applies (as opposed to section 195) in relation to payments to non-resident sports associations and as such, DTAA cannot be taken into account at the stage of TDS under section 194E, it may be noted that section 194E is a specific TDS rule applicable only for payments to non-resident associations, whereas section 195 is a general rule applicable for all payments to all other non-residents.  It could be for this reason that in the PILCOM case, the Supreme Court upheld the applicability of section 194E Vs section 195.   Subsequently, the Supreme Court in the case of Engineering Analysis Vs CIT 432 ITR 471 (2021) (SC) : [TS-5014-SC-2021-O] distinguished its judgment in the PILCOM case to say that section 195 will apply for payments to non-residents in the context of payment made towards purchase of software and as such, DTAA provisions have to be taken into account.

Currently, there is some ambiguity around this aspect (viz, section 194E Vs section 195 for payment to non-resident partners by an Indian firm/LLP).  It is better that the CBDT clarifies this aspect, to avoid any disputes around this.  This ambiguity is likely to continue in the Income-tax Bill, 2025 as well, hence a clarification will help. 

Concluding thoughts:

One would agree that while the introduction of section 194T increases the compliance burden of partnership firms, the same would help in bringing in enhanced transparency and accountability under the partnership form of business and would ultimately contribute to an efficient tax administration in India. 

Firms should establish robust systems and mechanism to ensure timely deduction and payment of taxes for complying with these newly introduced provisions. While the intent with which the section has been introduced is in the right spirit, however, the section has some inherent challenges, some of which have been discussed above, which would have to be ironed out by the CBDT. Since the section comes into effect from 01-April-2025, sooner it is clarified, it is better for business, since it avoids unnecessary litigation.