Advanced Direct Tax Laws and Practice · Computation of Total Income, Tax Liability and Filing of Returns of various Entities excluding Companies

Taxation of Firms, LLPs and Association of Persons

Updated 11 October 2026 · Fact-checked

A firm is taxed as a separate assessee. You compute its business income, then disallow partner remuneration and interest that breach section 35(e), and add back remuneration to reach book profit. The partner is taxed on the allowed amount under section 26(2)(g). An AOP or BOI is taxed under section 309 rules, with member payments deducted first.

Understand Taxation of Firms, LLPs and Association of Persons

A partnership firm (and an LLP, which is also assessed as a firm) is a separate taxable unit. Its profit is computed under the head "Profits and gains of business or profession". Partners are paid remuneration and interest, and the Act allows these as a deduction only within limits.

The limits sit in section 35(e). Remuneration to a partner who is not a working partner is never allowed. Remuneration to a working partner and interest to any partner are allowed only if the partnership deed authorises them for that period. A deed cannot work backwards: payments for a period before the date of the deed, or not authorised by the earlier deed, are disallowed.

Even authorised amounts are capped. Aggregate working partner remuneration is capped by a formula on book profit. Interest to any partner is capped at 12% simple interest per annum. Anything above the cap is disallowed in the firm's hands.

The partner's side mirrors this. Under section 26(2)(g), interest, salary, bonus, commission or remuneration received from the firm is business income of the partner only to the extent allowed to the firm under section 35(e). So the disallowed part is taxed once, in the firm.

An association of persons (AOP) or body of individuals (BOI) is a group that is not a company, co-operative society or registered society. Section 35(f) disallows interest, salary, bonus, commission or remuneration paid to its members. Section 309 then fixes how a member's share is computed when shares are determinate and known. In short, a firm gets partial relief for partner payments, while an AOP gets none for member payments, but the member is taxed on them under section 309.

Key rules to remember

Book profit: Book profit = Net profit as per P&L (computed as per Chapter IV-D) + aggregate remuneration to all partners, if deducted in arriving at net profit; Only remuneration is added back. Interest to partners is not added back in this definition.
Allowed working partner remuneration: Lower of (actual authorised remuneration) and [on first ₹6,00,000 of book profit: higher of ₹3,00,000 or 90% of book profit; on the balance: 60%]; In case of a book loss, the ₹3,00,000 limit applies. Apply to the aggregate remuneration of all working partners.
Interest to partners: Allowed interest = lower of (interest authorised by deed) and simple interest at 12% per annum; Excess over 12% is disallowed. The deed must authorise it for that period.
Non-working partner: Remuneration to non-working partner = fully disallowed; A working partner must be an individual actively engaged in conducting the affairs of the business or profession.
Partner's taxable receipt: Taxable in partner's hands = amount allowed to the firm under section 35(e); Section 26(2)(g). Share of profit after firm's tax is dealt with by separate exemption rules, not covered in the text supplied.
AOP/BOI member share (determinate shares): Share = (Total income − payments to members) × profit ratio + payments to that member; If the apportioned amount is a loss, the payment is adjusted against it. Section 309(2).
Member's borrowing cost: Interest on capital borrowed to invest in the AOP/BOI is deducted from the member's share; Section 309(4). It reduces the share chargeable under business income.

How to solve Taxation of Firms, LLPs and Association of Persons questions

Use this order for any firm, LLP or AOP computation question.

1Identify the assessee: firm/LLP or AOP/BOI. Check that it is not a company, co-operative society or registered society.
2Start with net profit as per the profit and loss account and make all normal business adjustments, including disallowances under section 35 (such as tax paid, and 30% of resident payments without TDS).
3Check the partnership deed. Mark which remuneration and interest are authorised and for which period. Disallow anything unauthorised or relating to a period before the deed.
4Separate partners into working and non-working. Disallow all remuneration to non-working partners.
5Compute book profit by adding back the aggregate remuneration to all partners that was debited in the P&L.
6Apply the remuneration cap on book profit and the 12% interest cap. Disallow the excess.
7Arrive at the firm's business income. For an AOP/BOI, deduct member payments, apportion the balance by ratio, and add back each member's payment.
8State the partner or member side briefly: the allowed amount is the partner's business income under section 26(2)(g), and the member's borrowing interest is deducted under section 309(4).

Quickest way: Three-line firm check

When to use it: When the question gives net profit, remuneration, and interest, and asks for taxable income or allowable remuneration.

Compute book profit = net profit + all partner remuneration debited.
Allowed remuneration = ₹3,00,000 or 90% of the first ₹6,00,000 (take the higher, i.e. ₹5,40,000 when book profit is at least ₹6,00,000) plus 60% of the excess. Compare with the actual and take the lower.
Disallowed interest = actual interest − 12% on capital (if deed authorises). Then add the disallowed remuneration and interest to net profit to reach business income.

Common mistakes in Taxation of Firms, LLPs and Association of Persons

Allowing remuneration to a partner who is not a working partner.
Students treat any partner paid under the deed as eligible.
Fix: Check that the partner is an individual actively engaged in the business. Otherwise disallow the full amount under section 35(e)(i).
Computing book profit without adding back remuneration.
Net profit is already given, so students use it directly.
Fix: Add back the aggregate remuneration to all partners if it was deducted. Do not add back interest.
Applying the cap per partner instead of in aggregate.
Students assume each partner has a separate limit.
Fix: The cap applies to the aggregate remuneration to all working partners. Compare the total with the computed limit.
Allowing payments that relate to a period before the deed or are not in the deed.
Students focus on the cap and miss the authorisation condition.
Fix: Read the deed date and its terms first. Payments not authorised, or relating to an earlier period, are disallowed under section 35(e)(ii).
Taxing the full remuneration in the partner's hands.
Students forget the link between the firm and the partner.
Fix: Under section 26(2)(g) the partner is taxed only on the amount allowed to the firm. The disallowed part is not taxed again.
Allowing salary or interest to members of an AOP/BOI as a deduction.
Students copy the firm rules to an AOP.
Fix: Section 35(f) disallows such payments to members of an AOP/BOI. Section 309 then adds each payment to the respective member's share.

Worked examples

Example 1

Sharma & Co., a firm, has net profit of ₹14,00,000 after debiting remuneration of ₹9,00,000 to two working partners (as authorised by the deed) and interest of ₹1,20,000 on partners' capital of ₹8,00,000 at 15% per annum (authorised by the deed). There are no other adjustments. Compute the business income.

Show the solution

Book profit = ₹14,00,000 + ₹9,00,000 = ₹23,00,000.
Allowed remuneration: on first ₹6,00,000, higher of ₹3,00,000 or 90% (₹5,40,000) = ₹5,40,000.
On balance ₹17,00,000 at 60% = ₹10,20,000. Total limit = ₹15,60,000.
Actual remuneration ₹9,00,000 is lower than the limit, so it is fully allowed. Disallowance = nil.
Interest at 12% on ₹8,00,000 = ₹96,000. Actual interest = 15% × ₹8,00,000 = ₹1,20,000. Disallowed = ₹24,000.
Business income = ₹14,00,000 + ₹24,000 = ₹14,24,000.

Answer: Business income of the firm is ₹14,24,000.

Example 2

A firm has net profit of ₹5,00,000 after debiting remuneration of ₹4,00,000 to working partners (authorised by the deed) and ₹50,000 to a partner who is not a working partner. Compute the business income.

Show the solution

Aggregate remuneration debited to all partners = ₹4,00,000 + ₹50,000 = ₹4,50,000.
Book profit = ₹5,00,000 + ₹4,50,000 = ₹9,50,000.
Limit on first ₹6,00,000 = higher of ₹3,00,000 and 90% (₹5,40,000) = ₹5,40,000.
On balance ₹3,50,000 at 60% = ₹2,10,000. Total limit = ₹7,50,000.
Working partner remuneration ₹4,00,000 is below ₹7,50,000, so it is allowed in full.
Remuneration of ₹50,000 to the non-working partner is disallowed in full.
Business income = ₹5,00,000 + ₹50,000 = ₹5,50,000.

Answer: Business income of the firm is ₹5,50,000.

Exam tips

Write the section 35(e) conditions first: working partner, authorised by deed, period of deed. Examiners give marks for the provision before the calculation.
Show book profit as a separate working note. Marks are often tied to it even if the final figure is wrong.
Read the deed facts closely. A deed dated after the start of the year, or silent on interest, changes the answer.
For AOP/BOI questions, state that section 35(f) disallows member payments and that section 309 adds them back to the member's share.
Conclude with the partner's side in one line, citing section 26(2)(g).

Practice questions from Computation of Total Income, Tax Liability and Filing of Returns of various Entities excluding Companies

Taxation of Firms, LLPs and Association of Persons in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Taxation of Firms, LLPs and Association of Persons: frequently asked questions

What is a working partner for remuneration purposes?

A working partner is an individual who is actively engaged in conducting the affairs of the business or profession of the firm. Only remuneration to such partners can be allowed, and only if the deed authorises it.

What is the maximum interest a firm can claim on partner capital?

Interest authorised by the partnership deed is allowed only up to 12% simple interest per annum. Any excess is disallowed in the firm's hands.

Is an LLP taxed differently from a partnership firm?

The firm provisions in section 35(e) apply to a firm assessable as such. For the exact treatment of an LLP, such as its rate of tax, follow the provisions in your study material, as the section text supplied here does not cover rates.

How is an AOP taxed when members are paid interest or salary?

Such payments to members are not deductible under section 35(f). For determinate shares, section 309 deducts them, apportions the balance by profit ratio, and adds each payment to that member's share.