(INDIA) — Partnership firms and limited liability partnerships in India face a dual regulatory framework in 2026, with income earned during Financial Year 2025-26 governed by the Income-tax Act, 1961 and income from 1 April 2026 falling under the new Income-tax Act, 2025.

The distinction between Assessment Year 2026-27 and Tax Year 2026-27 determines which law applies. Income earned during FY 2025-26 is reported in a return filed for Assessment Year 2026-27 under the 1961 Act. Income earned from 1 April 2026 to 31 March 2027 falls under the 2025 Act’s tax year framework.

Return forms, audit forms, and section numbers differ depending on the year involved. A firm filing its FY 2025-26 return in 2026 should not use 2025 Act references. Firms preparing accounts from 1 April 2026 must map old provisions to the new Act.

Tax Rates and Income Categories

In AY 2026-27, a partnership firm, including an LLP, is taxed at 30% on its total income. Where total income exceeds ₹1 crore, a surcharge of 12% applies. The Health and Education Cess adds 4% on tax plus surcharge.

Not every item of income is taxed at 30%. Some categories carry special rates. Short-term capital gains on listed equity under section 111A, long-term capital gains under sections 112 or 112A, virtual digital asset income, unexplained cash credits, and lottery winnings all have separate tax treatment.

Firms must compute normal business income separately from special-rate income and complete return schedules accordingly.

ITR Forms and Filing Framework

Most partnership firms and LLPs file ITR-5. A resident partnership firm other than an LLP may use ITR-4 if it qualifies for presumptive taxation and meets the form’s conditions. LLPs generally do not use ITR-4.

Forms for AY 2026-27 remain under the 1961 Act framework. Tax years beginning 1 April 2026 require forms notified under the Income-tax Act, 2025 and Income-tax Rules, 2026. Filing the wrong form or applying the wrong legal framework can trigger defective return notices, incorrect audit reporting, or mismatches in statutory references.

Partnership Deed and Documentation

A firm must satisfy documentation requirements to be assessed as a firm. The partnership must be evidenced by a written instrument specifying individual profit shares. A certified copy of the deed must be available and furnished when firm status is first claimed.

Changes in constitution or profit-sharing ratios require a properly documented revised deed. Failure to meet these requirements can cost the firm its deduction for interest, salary, bonus, commission, or remuneration paid to partners. That loss can substantially increase taxable income.

LLPs and firms with NRI partners should ensure the deed also addresses capital contribution, profit share, management rights, remittance obligations, tax withholding responsibilities, and dispute resolution.

Partner Remuneration and Interest Deductions

Partner remuneration is deductible only when statutory conditions are met. The payment must be authorized by the partnership deed, which should state an actual amount or a clear formula. A vague clause stating remuneration will be decided later by mutual agreement does not qualify.

Only working partners qualify for the deduction. A working partner is an individual actively engaged in the firm’s business or profession. Remuneration to a sleeping partner is not deductible.

A statutory ceiling applies based on book profit. For the first ₹6 lakh of book profit, or in a loss case, the limit is the higher of ₹3 lakh or 90% of book profit. On the balance, the limit is 60%.

A firm with book profit of ₹10 lakh can deduct a maximum of ₹5.40 lakh on the first ₹6 lakh plus ₹2.40 lakh on the remaining ₹4 lakh, totaling ₹7.80 lakh. If the firm debits ₹9 lakh, the excess ₹1.20 lakh is disallowed.

Interest to partners is deductible only if authorized by the deed and capped at 12% simple interest per annum. A firm paying 15% interest on partner capital of ₹20 lakh may debit ₹3 lakh in accounts. Tax deduction is restricted to ₹2.40 lakh, and the excess ₹60,000 is disallowed.

Where an individual is a partner on behalf of another person, or receives interest for another person’s benefit, the tax treatment requires separate review.

TDS Under Section 194T

A compliance change effective 1 April 2025 introduced TDS on specified partner payments. Section 194T requires a firm or LLP to deduct 10% TDS on salary, remuneration, commission, bonus, or interest paid or credited to a partner when the aggregate exceeds ₹20,000 in a financial year.

TDS applies at the earlier of credit or payment. Crediting remuneration or interest to a partner’s capital account counts as a trigger. A firm cannot avoid TDS by routing payments through book entries instead of bank transfers.

An LLP that credits ₹2 lakh as partner remuneration on 31 March 2026 faces TDS of ₹20,000 at 10%. This rule carries particular weight for professional firms, family LLPs, and closely held businesses where partner remuneration is often recorded through year-end book entries.

A TDS default carries multiple consequences. The firm faces interest for failure to deduct or deposit TDS, late fees for delayed statements, penalty exposure, and possible disallowance of part of the expenditure.

Even if partner remuneration falls within the book-profit ceiling, a TDS default can still affect deductibility. Firms should reconcile partner remuneration and interest with TDS ledgers, challans, Form 26Q reporting, and capital account credits before filing.

Presumptive Taxation Options

Eligible firms may opt for presumptive taxation. Business presumptive income is computed at 8% of turnover, or 6% for turnover received through specified banking or digital modes. The normal turnover limit is ₹2 crore, rising to ₹3 crore where cash receipts do not exceed 5% of total turnover.

Specified professions carry presumptive income at 50% of gross receipts. The normal limit is ₹50 lakh, rising to ₹75 lakh where cash receipts stay below 5%.

A resident professional partnership firm receiving ₹70 lakh entirely through bank transfers may examine whether it can use the higher presumptive limit and declare income at 50%, subject to eligibility conditions. Presumptive taxation does not permit all expenses to be claimed separately.

Firms must check whether partner salary and interest are separately deductible under the applicable provision and subject to limits.

Audit Requirements

Audit under section 44AB continues for FY 2025-26 cases filed in AY 2026-27. Tax audit applies where business turnover exceeds the prescribed limit, professional gross receipts exceed the prescribed limit, or presumptive taxpayers declare income below the deemed profit and trigger audit conditions.

From the tax year beginning 1 April 2026, the 2025 Act introduces a new audit framework. Form No. 26 is the prescribed audit report under the new rules. Forms 3CA, 3CB, and 3CD continue for previous years relevant to assessment years up to AY 2026-27.

Record-Keeping and Common Pitfalls

Partnership firms should maintain proper books of account, invoices, bank statements, capital accounts, loan confirmations, TDS records, GST returns, and supporting documents. Professional firms should keep client-wise fee records, expense bills, payroll details, fixed asset registers, and partner capital ledgers. Where records are maintained electronically, firms must ensure backup, access, and preservation requirements are met.

Common disallowances for partnership firms and LLPs include partner remuneration not authorized by deed, remuneration paid to non-working partners, remuneration above the statutory ceiling, interest above 12%, TDS defaults on resident payments, cash payments above prescribed limits, personal expenses booked as business expenses, expenses without invoices, and income tax, surcharge, and cess claimed as business expenses.

Income tax authorities frequently compare turnover reported in income tax returns with GST returns. Differences may stem from advances, credit notes, exempt supplies, export turnover, year-end invoices, accounting method differences, and GST adjustments.

Firms with GST registration should reconcile books with GSTR-1, GSTR-3B, annual GST data, Form 26AS, AIS, and bank credits before finalizing the return.

NRI Partners and Cross-Border Issues

Firms with NRI partners face additional scrutiny. Checks include whether the partner is resident or non-resident for Indian tax purposes, whether payments to non-residents require TDS under a different provision, whether foreign professional income is taxable in India, whether DTAA relief is available, and whether transfer pricing or FEMA issues arise.

The tax treatment of a resident partner and a non-resident partner may differ. Firms should not apply domestic partner-payment rules mechanically to cross-border payments without checking withholding tax and treaty implications. LLP agreements should explicitly permit remittance and capital withdrawal.

Pre-Filing Checklist

Before filing, firms should verify the correct assessment year or tax year, the applicable Act, the ITR form, partnership deed status, working partner status, remuneration computation, interest rate compliance, TDS under section 194T, audit applicability, GST reconciliation, cash payment restrictions, special-rate income schedules, partner capital account credits, AIS and Form 26AS matching, and penalty exposure.