Analysis of Section 194T of Income Tax Act 1961: TDS on Payments to Partners

Analysis of Section 194T of the Income Tax Act, 1961: Tax Deduction at Source on Payments to Partners

I. Executive Summary

Section 194T of the Income Tax Act, 1961, effective from April 1, 2025, introduces a mandate for Tax Deducted at Source (TDS) on specific payments made by partnership firms and Limited Liability Partnerships (LLPs) to their partners. This new provision requires firms to deduct TDS at a rate of 10% on the aggregate amount of salary, remuneration, commission, bonus, or interest paid or credited to a partner within a financial year, if such aggregate amount exceeds ₹20,000. The implementation of Section 194T will place an increased compliance burden on firms, requiring them to adhere to new procedures for tax deduction, deposit, and reporting, and may also have an impact on the liquidity of partners. This shift in tax responsibility necessitates firms to diligently manage their financial processes to ensure compliance with the updated regulations.

II. Introduction to Section 194T

Section 194T of the Income Tax Act, 1961, is a newly introduced provision through the Finance Bill 2024. Its primary objective is to bring payments made by partnership firms and LLPs to their partners, specifically in the nature of salary, remuneration, commission, bonus, and interest, under the ambit of Tax Deducted at Source (TDS). Previously, there was no specific provision mandating TDS on such payments. The introduction of this section is aimed at enhancing tax compliance within the partnership sector and broadening the overall tax base. This new regulation will come into effect from April 1, 2025, and will be applicable to Assessment Year (AY) 2026-27 and subsequent years, corresponding to Financial Year (FY) 2025-26. The implementation of Section 194T represents a significant shift in the tax treatment of payments made by firms to their partners, necessitating a thorough understanding of its provisions and implications.

The introduction of Section 194T addresses a gap in the existing TDS framework. While salaries paid to employees were already subject to TDS under Section 192, similar payments to partners were not explicitly covered. This distinction might have led to inconsistencies in tax compliance and potential underreporting of income by partners. By bringing partner payments within the TDS net, the government intends to ensure a more uniform and timely collection of tax revenue from this income stream. This proactive measure reflects the tax authorities’ aim to enhance transparency and accountability in financial transactions between firms and their partners.

III. Scope and Applicability

Section 194T is applicable to any “firm” responsible for making payments to its partners. The term “firm” under this section encompasses both traditional partnership firms registered under the Indian Partnership Act, 1932, and Limited Liability Partnerships (LLPs) as defined in the LLP Act, 2008. However, it is specified that Section 194T will apply to Indian LLPs. This broad definition ensures that a wide range of business entities operating as partnerships or LLPs within India fall under the purview of this TDS provision.

The types of payments made by a firm to its partners that are subject to TDS under Section 194T include: salary, remuneration, commission, bonus, and interest on any account. This list is comprehensive and indicates that Section 194T is designed to cover all forms of compensation and financial benefits that a partner might receive from the firm, including interest on their capital contributions or loans to the firm. This aligns with the intention to treat various forms of partner income similarly to employee income for TDS purposes.

IV. TDS Rate and Threshold

The applicable rate for deducting TDS under Section 194T is 10%. This rate is generally applicable to resident partners. While the snippets primarily focus on this 10% rate, it is important to note that a higher TDS rate of 20% will be applicable if the partner fails to provide their Permanent Account Number (PAN) or Aadhaar. This provision serves as an incentive for partners to disclose their PAN, ensuring proper tax credit and tracking of deductions.

TDS under Section 194T is required to be deducted only when the aggregate amount of the specified payments made or credited to a partner during a financial year exceeds ₹20,000. This threshold applies to the cumulative total of all payments made to a partner within the financial year, including salary, remuneration, commission, bonus, and interest. Once the aggregate payments to a partner in a financial year exceed ₹20,000, TDS at 10% is required to be deducted on the entire amount of such payments, not just on the amount exceeding the threshold.

The calculation of the ₹20,000 threshold is based on the total of all specified payments made or credited to a partner from April 1st to March 31st of a financial year. Consider a scenario where a partner, Rajesh, receives ₹12,000 in June and ₹15,000 in December as remuneration. The aggregate payment of ₹27,000 exceeds the threshold of ₹20,000. Therefore, TDS at 10% will be applicable on the entire ₹27,000, amounting to ₹2,700. Another example involves Seema, who receives ₹18,000 in July as salary and ₹5,000 as interest in February. The total payment is ₹23,000, which is above the threshold. Consequently, TDS of ₹2,300 (10% of ₹23,000) must be deducted. These examples illustrate that firms must track all payments to a partner throughout the financial year to accurately determine the applicability of TDS under Section 194T.

V. Timing of TDS Deduction

Under Section 194T, the obligation to deduct TDS arises at the earlier of two events: when the sum is credited to the partner’s account in the books of the firm (including the capital account) or when the payment is made to the partner in cash, by cheque, draft, or any other mode. This rule ensures that TDS is deducted promptly, either when the firm recognizes the liability to pay the partner or when the actual transfer of funds occurs, whichever happens first.

The fact that credit to the partner’s capital account is also considered a trigger for TDS deduction is significant. For instance, if a firm decides to credit a bonus of ₹25,000 to a partner’s capital account on March 31st, 2026, even if the actual payment is made later in the next financial year, the TDS obligation arises on March 31st, 2026. This prevents firms from delaying TDS deduction by merely crediting the amount and postponing the actual payment.

VI. Compliance Requirements for Firms

Partnership firms and LLPs are obligated to fulfill several compliance requirements under Section 194T. Firstly, any firm responsible for deducting TDS must obtain a Tax Deduction and Collection Account Number (TAN) if it does not already possess one. This is a fundamental requirement for reporting and remitting TDS. Secondly, firms must diligently assess all payments made to their partners to determine if they fall under the ambit of Section 194T and if the aggregate amount for the financial year exceeds the ₹20,000 threshold.

Once the threshold is crossed, firms are required to deduct TDS at the rate of 10% on the entire amount of the specified payments made to the partner. The deducted TDS must then be deposited with the government within the prescribed time limits, which are typically on a monthly or quarterly basis. Maintaining accurate records of all payments made to partners and the TDS deducted is another crucial compliance obligation. These records will be essential for filing quarterly TDS returns (e.g., Form 26Q) that provide detailed information about the TDS deducted and deposited. Furthermore, firms are required to issue TDS certificates in Form 16A to their partners, serving as proof of the tax deducted from their payments, which partners can use to claim credit while filing their individual income tax returns. Finally, it is advisable for firms to proactively educate their partners about these new TDS provisions to ensure a smooth transition and address any potential queries or concerns.

Table 3: Compliance Checklist for Firms under Section 194T

VII. Exemptions and Non-Applicability

While Section 194T mandates TDS on several types of payments to partners, certain payments are specifically excluded. TDS under this section is not applicable to the repayment of capital account balances to partners. Similarly, withdrawals of capital by a partner and the distribution of profits among the partners are also not subject to TDS under Section 194T. Additionally, reimbursements made to partners for business expenses incurred on behalf of the firm are exempt from TDS. These exemptions clarify that the provision primarily targets payments that represent a form of income or financial benefit to the partner, rather than a return of their capital or share in the firm’s earnings.

VIII. Practical Implications and Challenges

The introduction of Section 194T is likely to result in an increased administrative burden for partnership firms and LLPs, particularly for smaller entities. Firms will need to establish new processes for tracking partner payments, ensuring timely TDS deductions, depositing the deducted tax with the government, and filing the necessary returns. For firms that do not already have a TAN, obtaining one will be an additional step in the compliance process. Updating accounting systems to accommodate these new TDS requirements will also be necessary.

The deduction of TDS will also have an impact on the liquidity of partners, as they will receive their payments after the 10% deduction. While partners can claim credit for this TDS against their final tax liability when filing their individual income tax returns, and may even receive a refund if the TDS amount exceeds their total tax obligation, there can be a time lag between the deduction and the receipt of any refund. This could potentially affect the immediate cash flow planning of the partners.

Another practical challenge might arise concerning the timing of determining partner remuneration, especially in cases where it is linked to the firm’s profitability, which is often finalized after the end of the financial year. Despite this, firms will be required to deduct and deposit TDS on the remuneration pertaining to the financial year ending March 31st by April 30th of the following year. This might necessitate firms to expedite the finalization of their books of accounts to ensure timely compliance with the TDS obligations.

On a positive note, the implementation of Section 194T is expected to foster greater financial discipline among firms, encouraging them to maintain more accurate and transparent financial records related to partner payments. This increased accountability can contribute to better overall financial management within these entities.

IX. Illustrative Examples

To further clarify the application of Section 194T, consider the following examples:

1. Single Payment Exceeding Threshold: ABC Partnership Firm pays a remuneration of ₹30,000 to partner Mr. X in July 2025. Since this single payment exceeds ₹20,000, ABC Firm is required to deduct TDS at 10% on the entire amount, i.e., ₹3,000 (10% of ₹30,000) ⁷.

2. Aggregate Payments Exceeding Threshold: XYZ LLP pays a monthly salary of ₹2,500 to partner Ms. Y. By the end of the financial year 2025-26, the total salary paid amounts to ₹30,000 (₹2,500 x 12 months). As the aggregate payment exceeds ₹20,000, XYZ LLP must deduct TDS at 10% on the total amount of ₹30,000, which is ₹3,000.

3. Timing of Deduction: PQR & Associates, a partnership firm, credits a bonus of ₹40,000 to partner Mr. Z’s capital account on March 31, 2026. The actual payment of this bonus is made on May 10, 2026. In this case, TDS at 10% (₹4,000) must be deducted on March 31, 2026, as the credit to the partner’s account occurred earlier than the actual payment.

4. Payments Below Threshold: If a partnership firm makes aggregate payments of ₹18,000 as interest to a partner during the financial year 2025-26, no TDS is required to be deducted under Section 194T as the total amount does not exceed the threshold of ₹20,000.

Conclusion and Recommendations

Section 194T of the Income Tax Act, 1961, represents a significant development in the taxation of partnership firms and LLPs by mandating TDS on payments made to their partners, effective from April 1, 2025. This provision, with its 10% TDS rate on aggregate payments exceeding ₹20,000 annually for salary, remuneration, commission, bonus, and interest, aims to enhance tax compliance and broaden the tax base. While this new regulation introduces an increased compliance burden for firms and may impact the liquidity of partners, it also promotes financial accountability and transparency.

To ensure a smooth transition and compliance with Section 194T, partnership firms and LLPs should consider the following recommendations:

• Obtain TAN: If the firm does not have a Tax Deduction and Collection Account Number, it should apply for one well in advance of the effective date.
• Update Accounting Systems: Firms should review and update their accounting software and processes to accurately track all payments made to partners and facilitate TDS deductions.
• Establish TDS Policies: Implement clear policies and procedures for determining when TDS is applicable, calculating the amount, and ensuring timely deduction and deposit.
• Ensure Timely Deduction and Deposit: Firms must adhere to the “earlier of” rule for TDS deduction and ensure that the deducted tax is deposited with the government within the stipulated deadlines to avoid penalties and interest.
• Maintain Comprehensive Records: Accurate and detailed records of all partner payments and TDS-related activities should be maintained for compliance and audit purposes.
• File TDS Returns Regularly: Quarterly TDS returns (Form 26Q) must be filed accurately and within the due dates.
• Issue TDS Certificates: Form 16A certificates should be issued to partners in a timely manner to enable them to claim the TDS credit in their individual tax returns.
• Communicate with Partners: Firms should proactively inform their partners about the implications of Section 194T and the TDS process to ensure transparency and address any concerns.
• Seek Professional Advice: It is advisable for firms to consult with tax professionals to gain specific guidance based on their unique circumstances and ensure full compliance with the new regulations.

By taking these steps, partnership firms and LLPs can effectively navigate the requirements of Section 194T and contribute to a more transparent and compliant tax environment.