What Happens When a Partnership Firm Fails to Meet Section 184 Conditions? Section 185 of the Income Tax Act

Many partnership firms believe that once a deed is drafted & signed, the tax treatment automatically follows. But the Income Tax Act doesn’t work on assumptions. It works on compliance — especially when it comes to firms.

Section 184 is the provision that lays down formal conditions for a firm to be assessed as a “partnership firm” for tax purposes. But what happens if these conditions are not met? Does the firm still get recognition? Does it lose tax benefits? Does the assessment change?

This is exactly where Section 185 of the Income Tax Act steps in.
It deals with the assessment of a partnership firm when it does not comply with the conditions prescribed under Section 184. In simpler words:
If you don’t meet the eligibility rules for being assessed as a firm, Section 185 decides how your income will be taxed.

Understanding the Purpose of Section 185

Section 185 ensures that partnership firms follow the documentation, filing, & procedural rules set under Section 184. If a firm does not comply with Section 184 for any assessment year, the assessing officer is required to deny firm-status benefits and treat the entity differently while computing tax.

This has a direct financial impact.

Under Section 184, a validly assessed firm enjoys:

• Deduction of partner’s remuneration
• Deduction of interest paid to partners
• Separate taxation at firm-level

But when Section 185 applies:

• The firm loses these deductions"
• Partner payments may not be allowed
• The firm may be assessed as an AOP, not a registered firm

This can sharply increase the tax liability.

When Does Section 185 Apply?

Section 185 applies when a partnership firm fails to comply with the mandatory provisions of Section 184. These may include:

1. Failure to Submit a Valid Partnership Deed: If the deed is missing, unsigned, incomplete, or not filed in time, the firm cannot claim the benefits of a registered firm.
2. Failure to Submit the Application for Registration: The law requires the firm to apply for assessment in the prescribed manner. Non-submission or incorrect submission leads to consequences under Section 185.
3. Non-Compliance in Subsequent Years: Even if registration was granted earlier, the benefit can be denied in later years if conditions are not continuously met.
4. Procedural Errors: Incorrect filings, late submissions, wrong partner details, or deed inconsistencies can trigger Section 185.

Also Read: Tax Audit Limit: Who Needs a Tax Audit and Why?

Effect of Non-Compliance Under Section 185

Once Section 185 applies, the consequences are straightforward:

1. The Firm is Not Assessed as a Registered Firm: It loses special tax treatment available to validly registered firms.
2. No Deductions for Partner Remuneration or Interest: Section 40(b) benefits that allow remuneration & interest to partners are denied.
3. Higher Tax Liability: The firm may be taxed at maximum marginal rate if treated as an AOP.
4. Impact on Partners’ Individual Returns: Since partner income depends on firm assessment, partners may also face recalculation of tax.

Practical Illustration

Let’s consider a simple scenario:

A new partnership firm files its return but does not submit a partnership deed or the required application under Section 184.

Even if the firm shows genuine business activity, claims interest to partners, & books salary payments — the Assessing Officer will deny all such claims under Section 185.

Instead, the firm may be taxed at a higher rate, and partner remuneration will not be deductible. This is one of the most common mistakes small and medium firms make.

Important Link With Other Provisions

Section 185 interacts with:

• Section 184 (conditions for firm assessment)
• Section 40(b) (disallowance of partner payments)
• Section 44AD/44AB (turnover-based presumptive & audit rules)

It also indirectly connects with rules around:

• Application for registration
• Timeliness of documentation
• Compliance with procedural conditions

The intention is simple:
The tax department will only extend benefits to a firm that follows the law fully.

Common Mistakes That Trigger Section 185

✔ Partnership deed not executed properly
✔ Signatures missing or partner details inconsistent
✔ Deed not filed with return
✔ Changes in partnership not reported
✔ Delay in filing the application under Section 184
✔ Assuming oral partnership is enough for tax purposes

Many firms unknowingly commit these mistakes and face heavy disallowances during scrutiny.

Why Section 185 Matters in Today’s Compliance Environment

With tighter scrutiny, digitization of filings, & AI-based cross-checks, non-compliance with registration conditions gets detected quickly.
Section 185 now plays a more active role than before.

It protects the system from misuse and:

• Ensures only compliant firms claim tax benefits
• Maintains transparency of partner remuneration
• Reduces manipulation through informal partnerships

For genuine businesses, it acts as a reminder to maintain clean documentation from Day 1.

Also Read: Joint and Several Liability of Partners for Tax Payable by Firm

Best Practices for Firms to Avoid Section 185 Issues

Here’s what every partnership should follow:

✔ Execute a proper partnership deed

Clear terms, partner roles, profit sharing, and remuneration clauses.

✔ File the deed with the return

This is mandatory for Section 184 compliance."

✔ Keep supplementary deeds updated

Whenever partners change, revise the deed.

✔ Maintain proper books of accounts

Especially partner capital accounts & loan details.

✔ File returns timely

Delayed filings weaken your case.

✔ Take professional guidance

A misplaced clause can cost lakhs during scrutiny.

Conclusion

Section 185 of the Income Tax Act is not a punitive provision — it is a compliance safeguard. It ensures partnership firms meet the required conditions under Section 184 & prevents misuse of tax benefits. For any firm, understanding this section is essential because the implications directly impact how the business is taxed and how partner remuneration is treated. When a firm does not comply with the provisions of Section 184 for any assessment year, Section 185 decides the tax consequences — and those consequences can be significant.

If you want to protect your firm from unwanted tax exposure, keep your documentation clean & your compliance timely.

Need help with partnership deed drafting, Section 184–185 compliance, or scrutiny replies? Talk to a qualified CA at CallMyCA.com — expert guidance is one click away.