The Indian government has introduced a new tax rule for partnership firms, which will come into effect from April 1, 2025. This rule mandates that firms must deduct Tax Deducted at Source (TDS) on certain payments made to their partners. The provision was introduced in the Union Budget of July 2024 through the inclusion of Section 194T in the Income Tax Act.
Applicability of the New TDS Rule
Under Section 194T, partnership firms will be required to deduct TDS at the time of payment or at the time of crediting money to the capital account of their partners, whichever happens earlier. This rule covers various types of payments made by firms to their partners, including:
-
Partner’s salary
-
Renewal payments
-
Commission
-
Bonus
-
Interest on any account (including the capital account)
However, profit sharing between partners will not be subject to TDS, as the firm already pays tax on its profits before distributing them among partners.
TDS Rate and Exemption Limit
The new rule outlines specific thresholds and rates for TDS deduction:
-
If the total amount credited or paid to the partner during a financial year is less than ₹20,000, no TDS deduction is required.
-
If the total payment exceeds ₹20,000, the firm must deduct TDS at 10% on the entire amount.
Impact of Section 194T on Partnership Firms and Partners
This amendment is expected to impact both partnership firms and their partners in multiple ways:
For Partnership Firms:
-
Firms must deduct TDS before making payments to partners.
-
Proper record-keeping and timely closure of accounts will become essential.
-
Non-compliance with this rule could lead to penalties and tax mismatches during audits.
For Partners:
-
Partners will receive payments after TDS deduction, which will be reflected in their tax filings.
-
They must accurately report deducted TDS while filing their income tax returns (ITR).
-
Advance tax calculations will become more crucial to avoid late payment interest or penalties.
Why Has the Government Introduced This Rule?
Before Section 194T, firms were not required to deduct TDS on payments to partners because these payments were taxed under the ‘business income’ category in the partner’s income tax return. However, this led to tax evasion in some cases, as firms could credit payments to partners’ accounts without immediate tax deduction.
With the introduction of TDS on partner payments, the government aims to:
-
Ensure timely tax collection by the Income Tax Department.
-
Improve tax compliance among businesses.
-
Reduce the chances of income misreporting by firms and partners.
Steps Partnership Firms Must Take for Compliance
To comply with Section 194T, partnership firms must:
-
Review all payments made to partners and categorize them under taxable transactions.
-
Deduct TDS at 10% for amounts exceeding ₹20,000 before making payments.
-
File TDS returns on time to avoid penalties and interest charges.
-
Communicate with partners regarding TDS deductions so that they can report the same in their ITR.
Consequences of Non-Compliance
Failure to deduct and deposit TDS under Section 194T could lead to:
-
Penalties and fines imposed by the Income Tax Department.
-
Additional tax liability for the firm due to disallowance of expenses.
-
Interest on late tax payments, increasing the financial burden on businesses.
Final Thoughts
The implementation of Section 194T is a significant move towards improving tax compliance among partnership firms. Small and medium enterprises (SMEs), including Limited Liability Partnerships (LLPs), must ensure timely deductions and proper documentation to avoid any legal issues. Both firms and partners should remain updated about this tax regulation to avoid discrepancies in their income tax filings.
With the April 1, 2025 deadline approaching, it is advisable for partnership firms to consult with tax professionals and accountants to ensure a smooth transition under this new tax rule. Proper planning and compliance will help businesses avoid penalties while ensuring seamless financial operations.
