Illegal Partnerships Under Firm, Partner, Partnership

Under the Income Tax Act, 1961, the concept of partnership is defined in Section 2(23) and the consequences of non-compliance with the requirements of the Act by the partnership firm and its partners are provided under sections 184, 185, and 186.

What is a Partnership Firm?

A partnership firm is a business entity formed by two or more persons who have agreed to share the profits of a business carried on by all or any of them acting for all. The Indian Partnership Act, 1932 governs the formation, operation, and dissolution of partnership firms in India.

Illegal Partnerships and Their Consequences

Under the Income Tax Act, the existence of a partnership must be legal and valid to claim the benefits available to a partnership firm as per the Act. If a partnership is found to be illegal, then the consequences are severe and can lead to various penal actions against the firm and its partners.

Section 184 of the Income Tax Act, 1961

Section 184 of the Income Tax Act, 1961 deals with the charge of income tax in the case of a firm. This section provides that where any person is a partner in a firm, the share of the partner in the total income of the firm is chargeable to tax as the income of the partner.

However, this provision applies only to a firm that is validly constituted under the law. If the firm is found to be illegal, the provisions of Section 184 will not apply, and the consequences will follow as if no partnership exists.

Section 185 of the Income Tax Act, 1961

Section 185 of the Income Tax Act, 1961 deals with the assessment of individuals as a firm in certain cases. This section provides that if the Assessing Officer is satisfied that a genuine firm exists, and such firm has not been registered under the Income Tax Act, then the share of the partners in the total income of the firm shall be chargeable to tax as the income of the firm.

It is important to note that this provision also applies only to a validly constituted firm. If the firm is found to be illegal, the provisions of Section 185 will not apply, and the consequences will follow as if no partnership exists.

Section 186 of the Income Tax Act, 1961

Section 186 of the Income Tax Act, 1961 deals with the question of firm's failure to furnish a return of its income. This section provides that where a firm fails to furnish a return of its income within the time allowed under Section 139(1), or where the firm, having furnished a return, fails to comply with all the terms of a notice issued under Section 142(1), the provisions of the Act shall apply as if the firm had not furnished any return.

This provision also applies only to a validly constituted firm. If the firm is found to be illegal, the provisions of Section 186 will not apply, and the consequences will follow as if no partnership exists.

How to Determine the Validity of a Partnership

In order to determine whether a partnership is valid or illegal, it is essential to consider the following factors:

Compliance with the Indian Partnership Act, 1932: A partnership must be formed in compliance with the requirements of the Indian Partnership Act, 1932. This includes the registration of the partnership deed, compliance with the registration process, and adherence to the provisions of the Act.
Capacity and Consent of Partners: Each partner must have the legal capacity to enter into a partnership, and their consent must be free and genuine. Any coercion, fraud, or misrepresentation in forming the partnership will render it illegal.
Compliance with the Income Tax Act: The partnership must comply with the requirements of the Income Tax Act, including the filing of returns, maintenance of proper accounts, and adherence to the provisions related to taxation of partnership firms.

Consequences of Illegal Partnerships

If a partnership is found to be illegal, the following consequences can arise:

Taxation of Income: The share of the partners in the total income of the firm will not be chargeable to tax as the income of the partner. Instead, the income will be taxed as if no partnership exists.
Non-Availability of Deductions and Exemptions: The partnership firm will not be eligible to claim any deductions or exemptions available to validly constituted firms under the Income Tax Act. This can lead to higher tax liabilities for the firm and its partners.
Penal Actions: The partners of an illegal partnership may be subject to penal actions under the Income Tax Act, including penalties for non-compliance, evasion of taxes, and misrepresentation of facts.
Disqualification for Future Benefits: If a partnership is found to be illegal, the partners may be disqualified from availing any benefits available to genuine partnership firms under the Income Tax Act in the future.

Conclusion

Illegal partnerships can have serious consequences under the Income Tax Act, including taxation of income, non-availability of deductions and exemptions, penal actions, and disqualification for future benefits. It is essential for partners to ensure that their partnership is validly constituted in compliance with the Indian Partnership Act, 1932 and the Income Tax Act, to avoid any legal and tax implications. Seeking professional legal and tax advice can help in ensuring compliance and mitigating the risks associated with illegal partnerships.