Taxation of partnership firms and LLPs in FY 2026-27: 30% rate, Section 40(b) remuneration, interest on capital, partner taxation and ITR-5 filing.
Taxation of Partnership Firms
Partnership firms and LLPs pay a flat 30% income tax at the entity level for FY 2026-27. The critical design principle is this: profit retained in the firm is taxed at 30%, but income shifted to partners as authorised remuneration or interest is taxed at each partner's individual rate ā which is often substantially lower. Section 40(b) sets the outer boundary of what can be shifted, and a well-drafted partnership deed is the non-negotiable precondition for any of it to work. Here is how every element fits together, with worked numbers throughout.
Who This Covers: Firms and LLPs Under Indian Tax Law
For income-tax purposes, the term "firm" includes:
- Traditional firms registered under the Indian Partnership Act, 1932
- Limited Liability Partnerships (LLPs) incorporated under the LLP Act, 2008
- Unregistered firms ā taxed at the same rate, but they forfeit important procedural rights, including the ability to sue third parties to enforce contracts; deductions can also be challenged more easily by the Assessing Officer (AO)
Both are taxed as separate taxable entities under the Income-tax Act, 1961. This is not a pass-through structure. The firm computes and pays tax on its own net income. What reaches partners as their share of profit is then exempt from tax ā but what reaches them as remuneration or interest is taxable again in their personal returns. Understanding this layered structure is the starting point for any tax planning.
One significant carve-out: Section 44AD (presumptive taxation at 8%/6% of turnover up to ā¹3 crore for 95%+ digital businesses) is available to eligible firms but not to LLPs. Firms considering Section 44AD should note that the Section 40(b) remuneration deduction is still computed, but on the presumptive book profit ā which can produce unexpected results. Always compare the presumptive route against normal computation before opting in.
The 30% Flat Rate: What Firms Actually Pay
The tax rate applicable to partnership firms and LLPs for AY 2027-28 is:
| Component | Rate |
|---|---|
| Base income tax | 30% of total income |
| Surcharge (where total income exceeds ā¹1 crore) | 12% of tax |
| Health and education cess | 4% of (tax + surcharge) |
Firms are not eligible for the concessional 22% rate under Section 115BAA or the 15% rate under Section 115BAB ā both of which are available only to domestic companies. There is no equivalent new tax regime for firms.
Effective rate illustration ā two scenarios:
Scenario A ā Income of ā¹50,00,000 (no surcharge):
- Tax: 30% Ć ā¹50,00,000 = ā¹15,00,000
- Cess: 4% Ć ā¹15,00,000 = ā¹60,000
- Total: ā¹15,60,000 | Effective rate: 31.2%
Scenario B ā Income of ā¹1,20,00,000 (surcharge applies):
- Tax: 30% Ć ā¹1,20,00,000 = ā¹36,00,000
- Surcharge: 12% Ć ā¹36,00,000 = ā¹4,32,000
- Cess: 4% Ć ā¹40,32,000 = ā¹1,61,280
- Total: ā¹41,93,280 | Effective rate: ~34.9%
Alternate Minimum Tax (AMT) Under Section 115JC
Section 115JC applies where the firm's regular income tax is less than 18.5% of its adjusted total income. Adjusted total income adds back deductions claimed under Chapter VI-A (other than Section 80P) and Section 10AA, among other items. If AMT is triggered, the firm pays the higher of regular tax or AMT. Any AMT credit paid can be carried forward and set off against regular tax liability for up to 15 subsequent assessment years.
Section 40(b) Remuneration to Working Partners: The Most Powerful Lever
Section 40(b) is the centrepiece of partnership tax planning. It permits the firm to deduct remuneration paid to working partners, subject to caps tied to the firm's book profit. Used correctly, it legally shifts taxable income from the firm's 30% bracket into the partners' personal tax brackets, which can be considerably lower.
Who Qualifies as a Working Partner?
A working partner is one who is actively engaged in conducting the affairs of the business or profession. Holding a capital interest is not sufficient. If the matter goes to scrutiny, the AO will look for evidence of actual involvement ā day-to-day decision-making, client meetings, correspondence under the partner's name. Sleeping partners and retired partners who have retained a profit share cannot qualify.
How Book Profit Is Calculated
Book profit is the net profit shown in the profit and loss account, after deducting admissible business expenses, after deducting allowable interest to partners (subject to the 12% cap), but before deducting any partner remuneration. It is not the same as total income ā adjustments required under the business income provisions of the Income-tax Act must be incorporated.
The Deductibility Limits (Finance Act 2024 Onwards)
The Finance Act 2024 enhanced the Section 40(b) remuneration ceiling effective from AY 2025-26. These revised limits continue for FY 2026-27:
| Slab of Book Profit | Maximum Deductible Remuneration |
|---|---|
| First ā¹6,00,000 | 90% of book profit, or ā¹1,50,000, whichever is higher |
| Balance exceeding ā¹6,00,000 | 60% of the excess |
The "whichever is higher" clause in the first slab is critical for firms with thin margins. If book profit is ā¹1,20,000, then 90% = ā¹1,08,000 ā but the minimum of ā¹1,50,000 applies. The firm can still deduct ā¹1,50,000 even though book profit is lower.
If book profit is negative (loss year): The firm can still deduct up to ā¹1,50,000 as remuneration to working partners ā this is the absolute minimum under the proviso to Section 40(b).
Deed Requirements: Non-Negotiable Conditions
Deductibility of remuneration survives scrutiny only when:
- The partnership deed explicitly authorises remuneration to named working partners ā a general clause "as may be determined" is vulnerable to challenge.
- The deed is executed before the relevant financial year begins or, if amended mid-year, the deduction is available only from the date of amendment.
- No retrospective authorisation. Creating or amending a deed on 28 March 2027 to authorise remuneration from 1 April 2026 will result in full disallowance for the period prior to the amendment date. Courts are consistent on this point.
- Only working partners can receive deductible remuneration. Payments to non-working partners, legal heirs, or nominees are disallowed.
Interest on Partners' Capital: The 12% Rule
Section 40(b) also caps interest paid to partners on their capital contribution at 12% per annum, computed on the daily closing balance of the capital account.
Key conditions and practical points:
- The deed must authorise interest and state the rate. A deed silent on interest means the deduction is denied.
- The 12% cap applies to simple interest. Compounding arrangements are scrutinised and the compounding element disallowed.
- Excess interest (above 12%) is disallowed at the firm level. Importantly, that excess is also not taxable in the partner's hands ā it simply does not exist for tax purposes. This avoids a double-tax problem but also means paying excess interest is economically wasteful from a tax perspective.
- Interest on loans made by a partner (distinct from capital contributions) is governed by the general provisions of Section 36(1)(iii) and is not capped at 12%, though the AO can examine whether it is at market rate and commercially justified.
Practical maintenance point: Keep a capital account ledger showing the opening and closing balance for each day, with timestamps for every contribution, withdrawal, and profit credit. Daily balance computation is the basis for the 12% interest, and the AO will ask for this in any scrutiny proceeding. Accounting software with a dated-entry audit trail satisfies this requirement.
Worked Example: Optimising Tax Across the Firm-Partner Combine
Facts: Firm: XYZ Associates ā two equal partners, P and Q, both working partners. FY 2026-27 gross profit before partner adjustments: ā¹30,00,000. Capital contributed throughout the year: P = ā¹15,00,000; Q = ā¹10,00,000. Both partners are individual resident taxpayers with no other significant income, opting for the new tax regime.
Step 1 ā Interest on Partners' Capital
| Partner | Capital (ā¹) | Interest @ 12% p.a. (ā¹) |
|---|---|---|
| P | 15,00,000 | 1,80,000 |
| Q | 10,00,000 | 1,20,000 |
| Total | ||
| 3,00,000 |
Book profit after interest = ā¹30,00,000 ā ā¹3,00,000 = ā¹27,00,000
Step 2 ā Maximum Allowable Remuneration
- On first ā¹6,00,000 @ 90% = ā¹5,40,000
- On remaining ā¹21,00,000 @ 60% = ā¹12,60,000
- Section 40(b) ceiling = ā¹18,00,000
Firm pays ā¹9,00,000 to P and ā¹9,00,000 to Q ā exactly at the ceiling.
Step 3 ā Taxable Income at Firm Level
ā¹30,00,000 ā ā¹3,00,000 (interest) ā ā¹18,00,000 (remuneration) = ā¹9,00,000
- Tax @ 30%: ā¹2,70,000
- Cess @ 4%: ā¹10,800
- Total firm tax: ā¹2,80,800
Step 4 ā Income in Partners' Hands
| Item | P (ā¹) | Q (ā¹) | Tax treatment |
|---|---|---|---|
| Remuneration | 9,00,000 | 9,00,000 | Taxable ā business income |
| Interest on capital | 1,80,000 | 1,20,000 | Taxable ā business income |
| Share of firm net profit | 4,50,000 | 4,50,000 | Exempt ā Section 10(2A) |
P's taxable income from the firm: ā¹10,80,000 Q's taxable income from the firm: ā¹10,20,000
At applicable new-regime slab rates for individuals ā which involve nil tax up to the threshold and lower rates for the first few slabs ā both partners pay tax at effective rates well below 30% on this income. The combined tax burden (firm tax + partner tax) is materially lower than what would apply if all ā¹30,00,000 stayed taxable at the firm level.
Contrast ā Zero-Remuneration Scenario:
If the firm pays no remuneration and retains all profit at firm level:
- Taxable income: ā¹27,00,000 (after interest)
- Firm tax: 30% Ć ā¹27,00,000 = ā¹8,10,000 + cess ā¹32,400 = ā¹8,42,400
- Partners receive ā¹13,50,000 each as exempt share of profit ā zero personal tax
Tax saving from optimising remuneration (in this scenario, for partners in lower brackets): approximately ā¹5,61,600. The actual saving depends entirely on each partner's marginal rate. If both partners have high other income and are already in the 30% slab, the benefit of remuneration extraction narrows significantly. This is why the calculation must be done with each partner's full income picture in view.
Taxation in the Hands of Partners
Share of Profit: Exempt Under Section 10(2A)
A partner's share in the net income of a firm that has already been taxed is fully exempt under Section 10(2A) of the Income-tax Act. This avoids economic double taxation ā the firm pays 30%, and the residual profit distributed to partners is received tax-free. Critically, this exemption applies only to the share of profit. It does not apply to remuneration, interest, commission, or bonus received from the firm.
Remuneration and Interest: Taxable as Business Income
Under Section 28(v), both remuneration and interest received by a partner from the firm are chargeable as business income in the partner's hands. Practical implications:
- These amounts must be declared under "Profits and Gains from Business or Profession" in the partner's ITR-3.
- If the partner is also employed elsewhere as a salaried individual, the firm remuneration does not convert to salary ā it remains business income requiring separate books of account at the partner level.
- Partners cannot claim a fresh deduction of the firm's operating expenses in their personal returns. They can, however, deduct their own business costs (travel, professional subscriptions, etc.) incurred in connection with the partnership income.
New Tax Regime Planning for Partners
Individual resident partners can opt for the new tax regime under Section 115BAC, which offers lower slab rates and an enhanced nil-tax threshold. For partners who have limited Section 80C investments, no HRA, and no home loan interest, the new regime often produces a lower tax liability on the same income.
Critical caveat: Once a partner with business income opts out of the new regime by filing Form 10-IEA, the option to re-enter is restricted ā an individual with business income who opts out cannot toggle back easily in subsequent years. This is a one-way decision for business income holders. Partners should model out at least three years of projected income before committing.
ITR-5 Filing, Audit Obligations, and LLP MCA Compliance
ITR-5: Due Dates for FY 2026-27 (AY 2027-28)
| Scenario | Due Date |
|---|---|
| Firm not liable for tax audit under Section 44AB | 31 July 2027 |
| Firm subject to tax audit (turnover/receipts above thresholds) | 31 October 2027 |
| Firm involved in international or specified domestic transfer pricing | 30 November 2027 |
Late filing fee: Section 234F imposes ā¹5,000 where ITR is filed after the due date (reduced to ā¹1,000 if total income does not exceed ā¹5,00,000). Interest under Section 234A accrues at 1% per month on unpaid tax from the due date.
What Goes Into ITR-5
- Schedule BP: Book profit computation under Section 40(b), including the names of working partners, amounts paid, and the disallowance calculation ā this schedule is examined closely in scrutiny
- Schedule IF: Partner details, profit/loss sharing ratios, and opening/closing capital balances
- AIS/TIS reconciliation: Before filing, match every TDS credit, interest receipt, and GST turnover figure against the Annual Information Statement (AIS) and Taxpayer Information Summary (TIS) on the income-tax portal (incometax.gov.in); unexplained mismatches are the most common trigger for Section 143(2) notices
- Balance sheet and P&L: Mandatory for all firms filing ITR-5; the portal runs automated consistency checks on key ratios
Tax Audit Under Section 44AB
A firm whose business turnover exceeds ā¹1 crore (or ā¹10 crore if 95%+ of both receipts and payments during the year are digital) must obtain a tax audit by a Chartered Accountant and file Form 3CB/3CD. For a professional firm, the threshold is gross receipts exceeding ā¹50 lakh.
The tax auditor is required to report specifically on Section 40(b) compliance: whether remuneration and interest are within prescribed limits, whether the deed authorises them, and whether the amounts have actually been paid or are merely credited.
LLP-Specific MCA Filings on MCA V3 Portal
LLPs carry a dual compliance burden ā income-tax filings and annual filings with the Ministry of Corporate Affairs on the MCA V3 portal.
| Form | Content | Due Date (FY 2026-27) |
|---|---|---|
| Form 11 | Annual Return ā partner details, designated partner changes, contribution summary | 30 May 2027 (within 60 days of financial year-end) |
| Form 8 | Statement of Account and Solvency ā balance sheet, P&L, solvency declaration by designated partners | 30 October 2027 |
Late fee: ā¹100 per day per form ā uncapped.
An LLP that misses its Form 11 deadline by 200 days incurs: ā¹100 Ć 200 = ā¹20,000 for that single form alone.
If both forms are delayed by similar periods, total MCA penalties can cross ā¹40,000. Beyond the financial cost, an LLP with outstanding MCA filings cannot have partners resign, cannot be voluntarily struck off, and cannot execute certain transactional documents cleanly. Prioritise these deadlines on par with the income-tax return.
Advance Tax
Firms must pay advance tax in four instalments ā 15% by 15 June, 45% by 15 September, 75% by 15 December, and 100% by 15 March. Since remuneration and interest payments to partners directly reduce the firm's taxable income, it is worth revisiting advance tax estimates once the remuneration structure is finalised ā ideally before the 15 December instalment, not after 31 March.
Common Mistakes and Pitfalls to Avoid
1. Retrospective remuneration authorisation in the deed Amending the deed on 28 March 2027 to authorise partner remuneration "from 1 April 2026" invites full disallowance. The AO will verify the date of execution, the notarisation, and the first accounting entry. If the deed was amended mid-year, only the period after the amendment is covered.
2. Deed names sleeping partners as working partners The distinction is not merely formal ā the AO can demand evidence of actual work performed. If a partner cannot demonstrate regular involvement, the remuneration paid to them will be disallowed on facts, irrespective of what the deed says.
3. Interest computed on the current account rather than the capital account The 12% deduction is for interest on capital accounts. Many firms maintain a single combined account for each partner and label remuneration credits, drawings, and capital contributions in the same ledger. Keep capital and current accounts separate; compute interest only on the capital account balance.
4. Paying remuneration above the Section 40(b) ceiling The excess is disallowed at the firm level ā the firm does not get the deduction. But the excess is still taxable income in the partner's hands under Section 28(v). This creates a worst-case outcome: the firm bears 30% on income it cannot deduct, and the partner bears their marginal rate on the same receipt. Audit the ceiling calculation before each remuneration payout.
5. Missing LLP Form 11 while focusing only on the ITR deadline The ITR due date (31 October 2027) and the Form 11 due date (30 May 2027) are five months apart. Many LLPs miss Form 11 because it falls before the accountant's engagement for the tax return begins. Set a calendar reminder immediately after the financial year closes.
6. Not reconciling AIS/TIS before filing ITR-5 The AIS now shows GST turnover cross-referenced from GSTN, which the income-tax department uses to flag underreported business income. If your ITR-5 shows lower turnover than what the GST portal reflects, expect a notice. Reconcile before filing, and document the reason for any difference (returns, credit notes, exempt supplies).
7. Ignoring AMT on firms with deduction-heavy structures Firms that claim significant Chapter VI-A deductions or Section 10AA benefits should run the AMT computation under Section 115JC before finalising their tax liability. The 18.5% AMT floor on adjusted total income can neutralise what appears to be an efficient deduction strategy.
Key Takeaways
- 30% flat rate applies to all partnership firms and LLPs for FY 2026-27 / AY 2027-28, with a 12% surcharge where income exceeds ā¹1 crore and 4% cess; no concessional rate is available.
- Section 40(b) remuneration can be deducted up to 90% of the first ā¹6,00,000 of book profit (minimum ā¹1,50,000) and 60% of the balance ā but only if the deed pre-authorises it by naming the working partners, and only for periods after the deed takes effect.
- Interest on capital is deductible at up to 12% per annum on daily closing balances of the capital account, not the current account; excess interest above 12% is disallowed at the firm level and untaxed in the partner's hands.
- Partners' share of net profit is fully exempt under Section 10(2A); remuneration and interest, however, are taxable as business income under Section 28(v) in the partner's hands.
- ITR-5 is due 31 October 2027 for tax audit cases; LLPs must also file Form 11 by 30 May 2027 and Form 8 by 30 October 2027 on the MCA V3 portal ā late MCA fees run at ā¹100 per day per form with no cap.
- Advance tax estimates should be recalculated once partner remuneration is finalised ā ideally before the 15 December instalment ā to avoid Section 234B/234C interest.
- Review the deed every financial year: changes in partner composition, capital structure, or Finance Act amendments (such as the enhanced Section 40(b) thresholds from Finance Act 2024) may require a supplemental deed to be executed before the new financial year begins.
