Complete Guide on Partner’s Remuneration & Interest for Partnership Firms and LLPs Income tax Act 2025
Section 35(e) of the Income Tax Act, 2025, applicable from Tax Year 2026-27, governs the allowability of remuneration and interest paid by Partnership Firms and LLPs to partners. Deduction is permitted only when payments are authorised by the partnership deed or LLP agreement and made to working partners actively engaged in business operations. Salary, bonus, commission, or remuneration paid to sleeping or non-working partners is fully disallowed. The section also prescribes maximum allowable remuneration based on book profit, allowing higher of ₹3,00,000 or 90% of the first ₹6,00,000 of book profit and 60% of the balance. Interest on partner capital is deductible only up to 12% simple interest per annum. Retrospective amendments in partnership deeds cannot validate earlier unauthorised payments. The article explains key concepts such as working partner, book profit, representative partner, drafting requirements, common compliance mistakes, and practical illustrations to help firms and LLPs avoid tax disallowances and litigation.
Section 35(e) – Income Tax Act, 2025
Applicable from Tax Year 2026-27
Section 35(e) of the Income Tax Act, 2025 contains provisions regarding the allowability of salary, bonus, commission, remuneration and interest paid by a Partnership Firm or LLP to its partners. This section is highly important for Partnership Firms, LLPs, Chartered Accountants, tax consultants and business owners because incorrect treatment may result in disallowance of expenditure and increase in taxable income.
The objective of this provision is to ensure that firms and LLPs do not reduce taxable profits by making excessive or unauthorised payments to partners. Therefore, deduction is allowed only when prescribed conditions are properly fulfilled.
Applicability of Section 35(e)
This section applies to:
- Partnership Firms
- Limited Liability Partnerships (LLPs)
Remuneration to Non-Working Partner Not Allowed
Any payment made to a non-working partner is fully disallowed under the Income Tax Act.
The following payments are covered:
- Salary
- Bonus
- Commission
- Incentive
- Remuneration
- Any payment by whatever name called
A working partner means a partner who is actively engaged in conducting the affairs of the business or profession.
Example
| Particulars | Amount |
| Salary paid to sleeping partner | ₹5,00,000 |
| Allowable deduction | Nil |
| Amount disallowed | ₹5,00,000 |
Payment Must Be Authorised in Partnership Deed or LLP Agreement
For claiming deduction, remuneration and interest must be properly authorised in:
- Partnership Deed
or - LLP Agreement
If there is no clause authorising such payment, deduction shall not be allowed.
Example
| Particulars | Amount |
| Interest paid to partner | ₹2,40,000 |
| Interest clause in LLP agreement | No |
| Amount allowable | Nil |
| Amount disallowed | ₹2,40,000 |
Retrospective Amendment Not Valid
A deed amended later cannot authorise payments for earlier periods.
Example:
- Deed amended on: 1 October 2025
- Salary authorised from: 1 April 2025
Result:
- Salary relating to April–September 2025 shall still be disallowed.
Maximum Allowable Remuneration to Working Partners
Even where remuneration is properly authorised, deduction is allowed only up to prescribed limits based on Book Profit.
Limits of Allowable Remuneration
| Book Profit | Maximum Deduction |
| On first ₹6,00,000 or loss | Higher of ₹3,00,000 or 90% of Book Profit |
| On balance Book Profit | 60% of balance Book Profit |
Practical Illustration
Example: Book Profit ₹20, 00,000
Calculation Table
| Particulars | Amount |
| 90% of first ₹6,00,000 | ₹5,40,000 |
| 60% of remaining ₹14,00,000 | ₹8,40,000 |
| Maximum allowable remuneration | ₹13,80,000 |
If actual remuneration paid is ₹16,00,000:
| Particulars | Amount |
| Actual remuneration paid | ₹16,00,000 |
| Allowable remuneration | ₹13,80,000 |
| Disallowed amount | ₹2,20,000 |
Meaning of Book Profit
Book Profit means:
- Net Profit as per Profit & Loss Account
- Computed under Chapter IV-D
- Increased by remuneration already debited to Profit & Loss Account
Example
| Particulars | Amount |
| Net Profit as per P&L | ₹15,00,000 |
| Add: Partner remuneration debited | ₹4,00,000 |
| Book Profit | ₹19,00,000 |
Interest on Partner’s Capital
Interest paid to partners is allowed only up to:
12% Simple Interest per annum
Any excess interest is disallowed.
Example
| Particulars | Amount |
| Capital contribution | ₹10,00,000 |
| Interest paid @15% | ₹1,50,000 |
| Maximum allowable @12% | ₹1,20,000 |
| Excess disallowed | ₹30,000 |
Explanation of Important Terms
1. Working Partner
A working partner means an individual partner who is actively engaged in conducting the affairs of the business or profession of the firm or LLP.
Activities generally treated as working participation:
- Managing business operations
- Client handling
- Supervising employees
- Accounting and administration
- Marketing and business development
- Decision-making activities
Sleeping partners or investors are not considered working partners.
2. Book Profit
Book Profit means:
- Net profit shown in Profit & Loss Account
- Computed under Income Tax provisions
- Increased by remuneration already debited to partners
This figure is used for calculating maximum allowable remuneration.
3. Partnership Deed / LLP Agreement
This is the legal document governing rights and responsibilities of partners.
It should clearly mention:
- Partner remuneration
- Interest on capital
- Working partner eligibility
- Rate of interest
- Method of remuneration calculation
Without proper authorisation in the deed/agreement, deduction may be denied.
4. Representative Partner
A representative partner is a person who becomes partner on behalf of another person or entity.
In such cases:
- Interest received personally may not be considered for limit purposes.
- Interest received in representative capacity may be considered separately.
Important Drafting Points for Partnership Deed / LLP Agreement
Every deed or LLP agreement should clearly mention:
- Working partner clause
- Salary/remuneration clause
- Interest on capital clause
- Interest rate
- Basis of remuneration calculation
- Authority for bonus and commission
Recommended Drafting Clause
“Working partners shall be entitled to remuneration as allowable under Section 35(e) of the Income Tax Act, 2025 or any statutory modification thereof.”
Common Mistakes by Firms & LLPs
Many firms face additions during assessment due to the following mistakes:
- Salary paid to sleeping partners
- No remuneration clause in deed
- Interest exceeding 12%
- Incorrect calculation of book profit
- Retrospective amendment of deed
- Lack of proof regarding active involvement of working partner
Compliance Checklist
| Particulars | Check |
| Working partner status verified | √ |
| Remuneration authorised in deed | √ |
| Interest clause available | √ |
| Interest within 12% | √ |
| Correct book profit calculation | √ |
| LLP agreement updated | √ |
Conclusion
Section 35(e) is one of the most important provisions for taxation of Partnership Firms and LLPs. Proper planning, drafting of partnership deeds and accurate calculation of allowable remuneration and interest are essential to avoid tax disallowances and litigation.
Firms and LLPs should regularly review their partnership documents and ensure proper compliance with prescribed limits under the Income Tax Act, 2025.
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Disclaimer
This article is prepared solely for educational and study purposes. The contents are general in nature and should not be considered as professional, legal or tax advice. Readers are advised to consult their Chartered Accountant or professional advisor before taking any decision based on this article. The author shall not be responsible for any loss or liability arising from reliance on the above information.
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