Definition of ‘Firm’ – Section 2(23)(i) of the Income tax Act, 1961;

As per Section 2(23)(i) of the Income Tax Act, 1961, unless the context otherwise requires, the term ‘firm’ shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include a limited liability partnership (LLP)  as defined in the Limited Liability Partnership Act, 2008 (6 of 2009).

a) Section 4 of the Income Partnership Act, 1932: Definition of “partnership”, “partner”, “firm” and “firm name”. —”Partnership” is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.

Persons who have entered into partnership with one another are called individually “partners” and collectively a “firm”, and the name under which their business is carried on is called the “firm name”.

b) Definition of ‘Partner’ – S.2(23)(ii) of the Income tax Act, 1961;

As per S.2(23)(ii) of Income Tax Act, 1961, unless the context otherwise requires, the term “partner” shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include, –

(a) any person who, being a minor, has been admitted to the benefits of partnership; and

(b) a partner of a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 (6 of 2009).

c) Definition of Partnership – S.2(23)(iii) of the Income tax Act, 1961;

As per S.2(23)(iii) of Income Tax Act, 1961, unless the context otherwise requires, the term “partnership” shall have the meaning assigned to it in the Indian Partnership Act, 1932 (9 of 1932), and shall include a limited liability partnership as defined in the Limited Liability Partnership Act, 2008 (6 of 2009).

Section 2(31) of the Income Tax Act, 1961 provides that;

2(31) ” person” includes-

(i) an individual,

(ii) a Hindu undivided family,

(iii) a company,

(iv) a firm,

(v) an association of persons or a body of individuals, whether incorporated or not,

(vi) a local authority, and

(vii) every artificial juridical person, not falling within any of the preceding sub- clauses;

 Thus, under Income Tax Act, 1961 a firm (including LLP) is a separate and distinct personnel and will be assessed separately.


Section 4 of the Indian Partnership Act, 1932 provides that Partnership is the relationship between persons who have agreed to share the profits of a business carried on by all or any of them. The partners who have entered into an agreement among them are called partners singly and a firm collectively. 

Section 5 states that the relationship of partnership arises from contract and not from status.

Essential Elements of a Partnership; from above definitions we find below mentioned three essential conditions of a Partnership;

1. There must be at least two or more persons who must have entered into in agreement;

2. The agreement must be to carry on business and share profit;

3. The business must be carried on by all or any of the persons concerned, acting for all.

All above three elements must be present to give name to an association of persons a “Partnership”.

Dulichand Laxminarayan Vs. CIT (1956)29ITR535(SC): it was held that provisions of Section 4 of the Indian Partnership Act, 1932 contemplates only natural or artificial i.e. legal persons. Therefore, only individuals or companies can be partner. A firm is not a person and as such is not entitled to enter into partnership with another firm or HUF or an Individual.

Chhotalal Devchand Vs. CIT(1958) 34ITR219(SC)  it was held that if on reading of instrument it is found that the constituent members of a firm and not the firm itself have entered into partnership and that fact is borne out both by recital and the fact that the partnership deed has been signed by the constituent members of the two firms , the refusal to register the firm on the ground that there was no partnership is erroneous.

Bagyalaxmi & Co. Vs. CIT (1965) 55ITR660(SC); it was held that when a Karta of a HUF enters into a contract of partnership with a stranger, the other members of the family do not ipso facto become partners of the firm. In such case, family as a unit does not become partner. The other members of the family are not parties of the firm so constituted and as such the other members cannot demand an inspection of the books of accounts of the firm not bring about dissolution of the firm or winding up the business.


1. Section 2(31) of the Income Tax Act, 1961 includes “HUF” in the definition of Person, but it is not a juristic person for all purposes. HUF is not like a corporation or limited company, and it has therefore, no legal entity different from, and separate from the members who comprises the HUF.

2.  A Karta can join others in Partnership in dual capacity i.e. in his individual capacity, as well as Karta of a HUF.

3.The Government of India through Circular No. 2/2016, dated 15/01/2016 F. No. 1/13/2012 CL-V clarified that “as per Section 5 of LLP Act, 2008 only an individual or body corporate may be partner in an LLP. A HUF cannot be treated as a body corporate for the purpose of LLP Act,2008. Therefore, a HUF cannot be a partner in LLP.


Section 2(n) defines: “limited liability partnership” means a partnership formed and registered under this Act;

Section 2(o) defines:limited liability partnership agreement” means any written agreement between the partners of the limited liability partnership or between the limited liability partnership and its partners which determines the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership;

Section 2(q) defines: “partner”, in relation to a limited liability partnership, means any person who becomes a partner in the limited liability partnership in accordance with the limited liability partnership agreement;

Nature of LLP

1. A LLP is a body corporate formed and incorporated under provisions of Limited Liability Partnership Act, 2008 and is separate from the persons forming it. It has perpetual term and shall carry on business on its own, name and can be sue or be sued with its name;

2. A LLP shall have perpetual succession;

3. Any change in partners or partnership agreement does not affects its existence, rights, liabilities etc.

4. The provisions of Indian Partnership Act, 1932 are not applicable to LLP.

5. Only an individual or a body corporate can be partner of a LLP;



1. A Firm (including LLP) is treated as a separate tax entity and there is not distinction between Registered or Unregistered Firms, its total income should be computed under four heads of income; 

2. The share of the partner in the income of the firm is not to be included in computing his total income;

 3. Any salary, bonus, commission or remuneration by whatever name called, which is due to or received by  partner is allowed as a deduction subject to certain restrictions;

4. Where a firm pays interest to any partner, it can claim deduction subject to condition that the rate of interest to partner in any case shall not increase @12p.a.;

 5. The income of the firm shall be taxes @30% (+SC+HEC) flat rate;

 6. A LLP (from AY 2012-13) or any firm (from AY 2013-14) is subject to Alternate Minimum Tax @15%(+SC+HEC) of the adjusted income.


1. A firm must be evidenced by an instrument [Section 184(1)(i)] 

The firm should be evidenced by an “Instrument”. The “Instrument” dose not only mean a regular partnership deed but it may constitute any other formal document. If the terms of partnership are contained in a number of documents or in the correspondence between parties, the documents or letters would constitute “Instrument” for the purpose of this section. 

2. Individual share of partners must be specified in instrument; 

The instrument of partnership or partnership agreement among partners of a firm must specified profit sharing ratio or ratio in which profit/loss of partnership will be shared by all partners.

 3. Certified copy of instrument to be submitted with department; 

Earlier when we were submitted return of a firm in physical form, then a copy of instrument of partnership or partnership deed was submitted with the department. But after coming of online submission of ITRs regime, a copy of the Partnership Deed should be kept by the firm ready, to submit with the department, when asked.


To obtain deduction of remuneration paid to partners, the provisions of Section 184 and Section 40(b) of the Income Tax Act,1961 must be complied;

Section 40(b) provides that; 

1. Remuneration should be paid to only working partner;

2. Remuneration must be authorised by Partnership Deed;

3. Remuneration should not pertain to a period prior to Partnership Deed;

4. Remuneration should not exceed permissible limited under Act, 1961.

Sood Brij & Associates Vs. CIT [2011] 203 Taxman 188(Delhi):  it was held that the quantum of remuneration or the manner of computation of remuneration should be stated in the partnership deed and should not be left undetermined, undecided or to be determined or decided on the future date.

In various cases the AO has disallowed the remuneration paid to partners on the basis of non-availability of specific amount of remuneration in the partnership Deed.

The CBDT has clarified that in cases where neither the amount has been quantified nor even limit of total remuneration has been specified but the same has been left to be determined by 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 firm’s income.

It is further clarified that for AYs subsequent to the AY 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 lay down the manner of quantifying such remuneration-Circular No.739 dated March 25, 1996.

Suman Construction Vs. CTI [ 2009]34SOT495(Pune) it was held that Since Section 40(b) used the term “authorise” and not “quantify”, the Assessing Officer cannot disallow salary to partners mainly because of reasons that salary is not quantified by the Partnerships deed. CBDT has no jurisdiction to substituted term “authorise” occurring in section 40(b) by the term “quantify” in its Circular No. 739, dated March 25, 1996. 



Book Profit Amount deductible in respect of remuneration to partners under Section 40(b) with effect from the assessment year 2010-11.
If Book Profit is negative Rs. 1,50,000
In case Book Profit is positive

i)  On first Rs.3.00 Lakhs of book profit

ii) On balance of book profit

Rs. 1,50,000 or 90% of the book profit, whichever is more. 

60% of book profit.


 If following conditions have been satisfied, then remuneration paid shall not be disallowed u/s. 40A (2) of the Income Tax Act, 1961;

1. Salary is paid to working partner;

2. The terms and conditions of the Partnership Deed provides for payment of remuneration, salary to the working partners;

3. The remuneration provided is within the limit prescribed under Section 40(b)(v).

Section 40A(2) of the Income Tax Act, 1961 provides that: Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub- section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction:

Provided that for an assessment year commencing on or before the 1st day of April, 2016 no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F. 


The interest paid to partner is deductible if paid @12% p.a., any excess interest paid above 12% p.a. is not deductible.


Explanation I- provides that, where an individual is a partner in a firm on behalf or for the benefit of any other person, interest paid by firm to such person otherwise than as a partner in a representative capacity, is not taken into account for the purpose of Section 40(b). 

Further provided that the interest paid by firm to individual as partner in representative capacity and interest paid by the firm to the person so represented, is taken into account for the purposes of Section40(b). 

Suppose Mr. X is a partner in a firm on behalf of HUF. The firm pays Mr. X, interest on deposit and capital Rs. 4000(otherwise than as a partner in representative capacity) and Rs. 5000(to the XHUF). In this case payment of Rs. 4000 shall not be accounted for the purposes of Section40(b) and same will be deductible under provisions of Sections 36(1)(iii), 40(a)(i) and 40A (2). 

Explanation-II provides that where an individual is a partner in a firm ,otherwise than representative capacity, the interest paid by the firm to such individual will not be taken into account for the purpose of Section 40(b) , if such interest is received by his on behalf of or for the benefit of other person. 


 A firm pays as well as receive interest from partners and receipt of interest from partner will be chargeable to tax.

 VII. ALTERNATE MINIMUM TAX; [SECTION 115JC to 115JF]; which shall be determines as

Step-1; Find out regular income -tax liability of LLP/Firm, ignoring provisions of Sections 115JC to 115JF;

Step-2; Find out Adjusted Total income of LLP/Firm;

Step-3; Find out 18.5% [ +SC+HEC] of Adjusted Income under Step-2;

Step-4; If amount computed in Step-1 is equal or more than amount determined in Step3, then the provisions of AMT will not be applicable. If, however amount computed under Step-3 is more than the Step-1 then-

1. Adjusted Total Income determined in Step-2 will be deemed as total income of LLP/Firm for the previous year; and

2. Tax rate 18.5%[+SC+HEC] of Adjusted Total Income will be deemed as tax liability of LLP/Firm. 

Step-5; The excess amount as computed under Step-3 over tax liability computed in Step-1 will be available as credit for Alternate Minimum Tax and shall be carried forward and can be settled against regular tax liability of the Firm/LLP for the next or subsequent year [ but not beyond 15th assessment years. No interest is payable on such credit and Tax Credit shall be allowed to be set off for an assessment year in which the regular income -tax -exceeds the AMT to the extent of the excess of the regular income-tax over the AMT.

Step-6:  if provisions of Section 11JC to 115JF or AMT are applicable to a Firm/LLP, then the Firm/LLP is required to submit a Report in Form 29C from a CA.


1. Section 10(2A) provides that the share of profit of a partner or a minor admitted for the benefit of the firm shall be exempt from tax. Since Firm/LLP is already paying tax on its income and same cannot be taxable again in the hand of partners;

2. Any interest, salary, bonus, commission or remuneration, by whatever name called, which is due to or received by a partner of a firm from the firm is taxable in his hands under Section 28(v), under the head” Profit and Gains of business or profession”.

3. Any expenditure to held to earn such income shall be allowed as deduction under provisions of Sections 32 to 37. Suppose a partner has borrowed some amount to pay his Capital Contribution in firm. Then interest received on capital introduced will be taxable and interest paid by him on loan taken for Capital Contribution will be allowed as deduction, while computing his total income, under “Profit and gains for business or profession”.

4. If any remuneration/interest (or part thereof) has not been allowed as deduction by virtue of Section 40(b) (read with Section 184) in hand of firm, it shall not be chargeable to tax in the hand of partners.

Conclusion: While going through above , we find that it is necessary for a Firm to have an instrument of partnership and profit sharing ratios of partners should  be mentioned clearly. It is also necessary to mentioned salary and quantify the same to avoid dispute with department. In case of a LLP ,only individual or body corporate shall be admitted as partners. A HUF, Firm ( registered or Unregistered ), AOP or BOI shall not be admitted as partner of a LLP.  


Disclaimer:  The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided, author assume no responsibility, therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws and take appropriate advice of consultants. The user of the information agrees that the information is not professional advice and is subject to change without notice. Author assume no responsibility for the consequences of the use of such information.

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