Section 194T: What It Means for Partnership Firms and LLPs

With effect from April 1, 2025, Section 194T of the Income Tax Act brings about major changes for partnership firms and LLPs (Limited Liability Partnerships). Payments made to partners, whether in the form of salary, remuneration, bonus, commission, or interest, will now be brought under the Tax Deducted at Source (TDS) provisions. This is mandatory if the aggregate payments made to partners exceed ₹20,000 in a financial year, and a flat rate of 10% TDS is applicable.

At first glance, this rule seems simple enough to comply with. However, firms are about to face a series of practical hurdles. Let’s break down the three key challenges you need to prepare for immediately.

1. The "Year-End Profitability" Crunch

Traditionally, partnership firms calculate and finalize their partners’ remuneration based on the book profit limits set under Section 40(b) of the Income Tax Act. This typically happens at the end of the financial year, after reviewing the firm’s performance.

The Problem:

Section 194T demands that TDS be deducted at the time of payment or credit, whichever is earlier. So, if a firm books provisions for remuneration in March, the tax deduction must be deposited by April 30—before the financial year ends.

The Impact:

This gives companies a hard deadline to calculate book profits, finalize compensation amounts, and make the TDS payment, as they are closing their books for the year. The traditional “let’s sort it out during the tax audit” will not work anymore. Default charges may apply if companies do not comply with this deadline.

2. The Double Whammy of Disallowances (Sec 40)

Another major concern for firms is the double whammy of disallowances under Section 40.

The Problem:

If a firm fails to deduct TDS as required under Section 194T, 30% of the partner’s remuneration could be disallowed as an expense under Section 40(a)(ia). This means the firm loses that deduction from its taxable profits.

The Complexity:

What if the remuneration exceeds the permissible limits specified under Section 40(b)? In this scenario, the company is required to deduct 10% TDS on the gross amount credited to the partner, despite the fact that a part of the same expense will be disallowed in the company’s books under Section 40(b) on account of the permissible limit. This is a rather confusing scenario where a company is required to deduct TDS on amounts that will eventually not be deductible as expenses in the company’s books.

3. Blocked Capital & No “Lower TDS” Relief

For partners in smaller firms or those whose total income falls below the taxable threshold, TDS deductions on their drawings can cause an immediate cash flow blockage.

The Catch:

Under Section 194T, the TDS is mandatory at 10%, even if the partner’s total income is below the taxable limit. Currently, the provisions under Section 197 allow taxpayers to apply for a lower or nil TDS certificate, but Section 194T has not been amended to include this relief.

This means partners in smaller firms have no choice but to wait and claim a refund when they file their returns—creating an unnecessary delay in cash flow.

Strategic Takeaway: Overhaul Your Accounting Systems

As Section 194T comes into effect, partnership firms need to take proactive steps to stay compliant. The days of finalizing partner remuneration at year-end and tracking it casually during audits are over.

Firms must now adopt a more strategic approach:

• Monthly or quarterly tracking of partner accounts and estimated book profits is no longer optional.
• Accounting systems must be overhauled to ensure timely TDS deductions, accurate calculations, and seamless tax compliance.

This shift in approach will help avoid penalties, ensure smooth cash flow, and prevent any unexpected complications due to disallowances or blocked capital.

In Conclusion: While Section 194T is aimed at enhancing tax compliance, its practical execution will require firms to adapt quickly. By staying ahead of these challenges, partnership firms can manage their obligations efficiently and ensure smooth operations for both the business and its partners.

At IndiaFilings, we understand the complexities involved in TDS compliance under Section 194T and its effects on partnership firms and LLPs. Our team of experts is capable of assisting you in the process of TDS compliance. With our TDS Compliance services, you can concentrate on the growth of your business while we take care of your tax compliance. Reach out to us today to make sure your firm is in compliance with the changing tax environment and avoid penalties.