Decoding Section 194T Income Tax Act : TDS on Payments to Partners

Last Updated on: March 11, 2025

Decoding Section 194T Income Tax Act : TDS on Payments to Partners

The introduction of Section 194T in the Income Tax Act, 1961, has brought about a significant change in the tax landscape for partnership firms. Effective from 1st April 2025, this section mandates Tax Deducted at Source (TDS) on certain payments made by firms to their partners. As a Chartered Accountant, I aim to clarify the key aspects of this new provision and address common queries surrounding it.

Why TDS on Partner ( Section 194T ) introduced

Previously, payments to partners were not subject to TDS, leading to a disparity compared to salaried employees. Section 194T aims to bridge this gap and ensure that income earned by partners is also subject to TDS, promoting tax compliance and transparency.

Problem:
- Currently, firms/LLPs weren’t required to deduct TDS on payments to partners, leading to potential underreporting of income by partners.
- This discrepancy allowed firms to claim deductions under Section 40(b) while partners might not report the income, causing revenue loss.
- The Dhar Construction Company case highlighted that existing TDS provisions (194H, 192) didn’t apply to partner payments.
Solution:
- Section 194T was introduced to address this gap, ensuring tax compliance on payments to partners.

Date of Applicability of Section 194T TDS on Payments to Partners

It is Effective from 1st April 2025, i.e all the payments to be made from FY 2025-26 and onwards have to comply TDS requirements on payments to partners

Legal Wording of Section 194T As per Income Tax Act

Section 194T to come on the statute by the Finance (No. 2) Act, 2024 w.e.f. 01.04.2025. Section 194T reads as under:

Refer Section 194T Income Tax Act TDS on Payments to partners of firms

What is Section 194T?

Section 194T requires firms to deduct TDS at 10% on payments made to partners exceeding ₹20,000 in a financial year. This applies to payments in the nature of:

Salary
Remuneration
Commission
Bonus
Interest to partner

Who needs to deduct TDS

Firms need to deduct TDS .

Definition:
- “Firm” includes partnerships under the Indian Partnership Act, 1932, and LLPs under the Limited Liability Partnership Act, 2008.
Applicability:
- Applies to firms assessed as partnerships or Associations of Persons (AOPs).
- Does not apply to foreign LLPs.

Whose TDS will be Deducted

TDS of partner will be dedcted.

“partner” shall have the meaning assigned to it in the Indian Partnership Act, 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);

Scope:

- Applies to all partners, including minors admitted to partnership benefits.
- Covers resident and non-resident partners.

Working vs. Non-Working Partners

Section 194T applies regardless of whether the partner is working or non-working.
This differs from Section 40(b), which distinguishes between working and non-working partners for deduction purposes.

When to deduct TDS?

TDS must be deducted at the earlier of:

Credit of the sum to the partner’s account in the firm’s books
Payment to the partner

Threshold Limit and Calculation

The threshold limit of ₹20,000 applies to aggregate payments made to a partner during the financial year.

Example: If a partner receives a monthly salary of ₹15,000, TDS will be applicable from the month in which the cumulative payments exceed ₹20,000.

Rate of TDS

The TDS rate is 10% on the entire amount exceeding the threshold limit.

Important Points:

No surcharge or cess for resident partners.
Surcharge and cess apply to non-resident partners.
Section 197 (lower deduction certificate) is not applicable.
TDS @ 20% apply as per Section 206AA (no PAN/ Inopertive PAN).

Impact of Non Deduction of TDS on Payment to partners

Disallowance Under Section 40(a) (8.15-3):

Interest Disallowance :
- Non-deduction under Section 194T can lead to disallowance of interest under Section 40(a).
Remuneration Disallowance :
- Disallowance of remuneration to non-working partners is primarily under Section 40(b).
- The applicability of Section 40(a) to remuneration of working partners is debated, with a view that Section 40(b) being the specific section, that section will be used.

Compliance Requirements for Firms

Obtain TAN: Firms must obtain a Tax Deduction and Collection Account Number (TAN) if they don’t already have one.
Deduct TDS: Deduct TDS at 10% on applicable payments.
Deposit TDS: Deposit the deducted TDS with the government within the prescribed timelines.
File TDS Returns: File quarterly TDS returns (Form 26Q) providing details of TDS deducted and deposited.
Issue TDS Certificates: Issue TDS certificates (Form 16A) to partners as proof of tax deducted.

Impact on Partners

Partners can claim credit for the TDS deducted from their payments while filing their income tax returns. This ensures that they are not taxed twice on the same income.

Example of TDS on Partners Payment

Here is the break down Section 194T with some practical examples to illustrate how it will function once it goes into effect on April 1, 2025.

Understanding the Basics

Who Deducts: Firms (partnerships) are responsible for deducting tax.
What Payments: Salary, remuneration, commission, bonus, and interest paid to partners.
When to Deduct: At the earlier of crediting the payment to the partner’s account (including their capital account) or making the actual payment.
Tax Rate: 10%.(if PAN is available and Operative)
Threshold: No deduction if the total payments to a partner in a financial year are ₹20,000 or less.

Examples

Example 1: Salary and Interest (Above Threshold)

“ABC & Co.” is a partnership firm.
Partner “Rohan” receives a monthly salary of ₹30,000 and annual interest on his capital of ₹50,000.
Calculation:
- Annual salary: ₹30,000 x 12 = ₹360,000
- Total payments: ₹360,000 (salary) + ₹50,000 (interest) = ₹410,000
Action:
- ABC & Co. must deduct 10% tax on each salary payment and the interest payment.
- Tax deducted on each salary payment: ₹30,000 x 10% = ₹3,000.
- Tax deducted on Interest payment: ₹50,000 x 10% = ₹5,000.
- The firm must deposit this tax with the government on each salary payment say TDS Deducted in April needs to be deposited by 7th May and on Interest (paid at the end of year) Tds to be deducted in the month of March needs to be paid by 30th April.

Example 2: Commission (Below Threshold)

“XYZ Enterprises” is a partnership firm.
Partner “Priya” receives a commission of ₹15,000 for a specific project.
Action:
- Since the commission is below the ₹20,000 threshold, XYZ Enterprises is not required to deduct any tax.

Example 3: Multiple Payments (Crossing Threshold)

“LMN Associates” is a partnership firm.
Partner “Suresh” receives the following payments during the financial year:
- April: ₹8,000 (remuneration)
- July: ₹7,000 (bonus)
- October: ₹10,000 (interest)
Calculation:
- Cumulative total as of july: 8,000+7,000= 15,000
- Cumulative total as of October: 15,000+10,000= 25,000
Action:
- LMN Associates does not deduct tax on the April and July payments because, at those times, the cumulative total was below ₹20,000.
- When the october payment is made, the cumulative total crosses 20,000. At this point, the firm must deduct 10% TDS
- when the payment of Rs 10,000 is made, that causes the total to be Rs 25,000, which exceeds the threshold. Therefore, TDS is deducted on the entire Rs 25,000.
- So in the case of LMN associates, TDS will be deducted on Rs. 25,000 @ 10% = Rs 2500
- And, all further payments made to Suresh within that financial year, will also have TDS deducted from them.

Example 4: Credit to Capital Account

“PQR Traders” is a partnership firm.
The firm credits ₹25,000 as interest on partner “Anita’s” capital account on December 31st. The actual payment is scheduled for the following financial year.
Action:
- PQR Traders must deduct 10% tax on ₹25,000 when the credit is made to Anita’s capital account on December 31st, even though the actual payment is deferred.
- Tax deducted: 25,000 * 10% = 2,500.

Key Considerations

Accurate record-keeping of all payments to partners is crucial.
Firms must ensure timely deposit of the deducted tax with the government.
Partners should receive TDS (Tax Deducted at Source) certificates from the firm, which they can use to claim credit when filing their income tax returns.

These examples should provide a clearer understanding of how Section 194T will operate.

TDS Rate if Partner Do Not have PAN

When a payee, in this case, a partner of a firm, does not furnish their Permanent Account Number (PAN), the tax deduction at source (TDS) is required to be done at a higher rate. Specifically, Section 206AA of the Income Tax Act comes into play.

Here’s a breakdown:

Section 206AA:
- This section mandates that if the payee fails to provide their PAN to the deductor, TDS must be deducted at the higher of the following rates:
  - Twice the rate specified in the relevant provision of the Income Tax Act.
  - 20%.
  - The rate in force.
Application to Section 194T:
- In the context of Section 194T, the specified TDS rate is 10%.¹
- Therefore, if a partner does not provide their PAN, the TDS rate would be 20% (as it is higher than twice the specified rate, which would be 20%).

In summary, if a partner fails to provide their PAN, the firm is obligated to deduct TDS at a rate of 20% on the payments covered under Section 194T.

Let’s illustrate the PAN non-availability scenario with an example:

Example: Partner Without PAN

“Sunrise Enterprises” is a partnership firm.
Partner “Rahul” receives a commission of ₹50,000 during the financial year.
Rahul fails to provide his PAN to Sunrise Enterprises.

Calculation:

Normally, under Section 194T, the TDS rate would be 10%.
However, since Rahul has not provided his PAN, Section 206AA applies.
Therefore, the TDS rate is 20%.
TDS amount: ₹50,000 x 20% = ₹10,000.

Action:

Sunrise Enterprises must deduct ₹10,000 as TDS from Rahul’s commission.
The firm must deposit this deducted tax with the government.
Rahul will have a difficult time claiming the TDS credit when filing his income tax return, because he does not have a PAN.

Key Points:

The absence of a PAN significantly increases the TDS liability.
This highlights the importance of partners providing their PAN to their firms.
It is very important for the firm to document the fact that the partner did not provide their PAN.

TDS rate if PAN of the partner is not linked with Aadhaar

The relationship between PAN and Aadhaar linking and TDS rates is a critical aspect of Indian tax law.

PAN Inoperative Status:

If a PAN is not linked with Aadhaar within the stipulated deadlines, it can become “inoperative.”
An inoperative PAN has significant consequences, particularly concerning TDS.

Impact on TDS:

According to the provisions of Section 206AA of the Income Tax Act, if a PAN is inoperative (which occurs when it is not linked to aadhaar), TDS is required to be deducted at a higher rate. This higher rate is the higher of:
- Twice the rate specified in the relevant provision.
- 20%.
Therefore, if a partners PAN is inoperative due to not being linked to aadhaar, the firm will be required to deduct TDS at the rate of 20% on payments that are subject to TDS.

Difference between Section 194T and Section 192

While Section 192 deals with TDS on salaries paid to employees, Section 194T specifically covers payments made to partners of a firm. This distinction is crucial as partner payments are not considered “salary” under the Income Tax Act.

Practical Implications for Firms

Increased compliance burden: Firms need to implement systems to track partner payments, deduct TDS, and fulfill compliance requirements.
Potential cash flow impact: Deducting TDS may impact the firm’s cash flow, especially for smaller firms.
Changes in accounting and reporting: Firms need to update their accounting and reporting processes to reflect the TDS deductions.

When dealing with a new tax provision like Section 194T, it’s natural to have many questions. Here’s a breakdown of common questions and their answers, categorized for clarity:

FAQS on TDS on Payments to Partners

1. Basic Applicability:

Q: What is Section 194T?
- A: Section 194T mandates that partnership firms deduct Tax Deducted at Source (TDS) on certain payments made to their partners.
Q: When does Section 194T come into effect?
- A: It becomes applicable from April 1, 2025.
Q: Who is responsible for deducting TDS under Section 194T?
- A: Partnership firms are responsible for deducting the TDS.
Q: Does Section 194T apply to Limited Liability Partnerships (LLPs)?
- A: Yes, for the purposes of this section, the term “firm” includes LLPs.

2. Payments Covered:

Q: What types of payments are subject to TDS under Section 194T?
- A: The section covers payments like:
  - Salary
  - Remuneration
  - Commission
  - Bonus
  - Interest
Q: Does it include interest on a partner’s capital account?
- A: Yes, it includes interest on any account, including the capital account.

3. TDS Rate and Threshold:

Q: What is the TDS rate under Section 194T?
- A: The TDS rate is 10%.
Q: Is there a threshold limit for TDS deduction?
- A: Yes, TDS is deducted only when the aggregate payments to a partner exceed ₹20,000 in a financial year.
Q: If the payments exceed ₹20,000, is TDS deducted on the entire amount or just the excess?
- A: TDS is deducted on the entire amount of the payments made to the partner, once the 20,000 rupee threshold has been passed.

4. Timing of TDS Deduction:

Q: When should the firm deduct TDS?
- A: TDS must be deducted at the earlier of:
  - The time of credit of such sum to the account of the partner (including the capital account).
  - The time of actual payment.

5. Practical Implications:

Q: How will Section 194T affect partnership firms?
- A: Firms will need to:
  - Implement systems for tracking partner payments.
  - Ensure timely TDS deductions and deposits.
  - Issue TDS certificates to partners.
Q: How will this affect individual partners?
- A: Partners will receive TDS certificates, which they can use to claim credit when filing their income tax returns. This will also increase tax compliance for income received from partnerships.

6. Exemptions:

Q: Is TDS applicable on the repayment of a partner’s capital?
- A: No, TDS is not applicable on the repayment of capital account balances.

7. Compliance:

Q: What are the consequences of non-compliance with Section 194T?
- A: Non-compliance can lead to penalties and interest charges.

References:

Section 194T of the Income Tax Act, 1961
Finance Act, 2024

Conclusion

Section 194T brings partner payments under the TDS ambit, aligning them with the existing provisions for salaried employees. By understanding and complying with this new section, firms can ensure smooth tax compliance and contribute to a more transparent tax system.

Disclaimer: This article provides a general overview of Section 194T. It is advisable to consult with a tax professional for specific guidance on your tax matters.