Firm Assessment, Change in Constitution and Succession: Sections 185, 187 and 188 of Income-tax Act, 1961 and Current Law
This article explains the rules concerning non-compliance with the conditions for assessment as a firm, a change in the constitution of a firm, and succession of one firm by another. It also identifies the corresponding provisions now applicable under the Income-tax Act, 2025.
Current Sections under the Income-tax Act, 2025
| Subject | Income-tax Act, 1961 | Income-tax Act, 2025 |
|---|---|---|
| Assessment where conditions for firm status are not complied with | Section 185 read with Section 184 | Section 326 read with Section 325 |
| Change in constitution of a firm | Section 187 | Section 327 |
| Succession of one firm by another firm | Section 188 read with Section 170 | Section 328 read with Section 313 |
Section 326: Assessment when Section 325 is not complied with
Section 326 of the Income-tax Act, 2025 is the current counterpart of old Section 185. It applies where a firm fails to comply with Section 325 for a tax year.
Effect of non-compliance
The firm is not allowed a deduction for interest, salary, bonus, commission or remuneration, by whatever name called, paid to any partner while computing income under the head "Profits and gains of business or profession". Correspondingly, those payments are not chargeable to income-tax in the hands of the partners under Section 26(2)(g).
Section 325 contains the conditions governing assessment as a firm. In substance, the partnership must be evidenced by an instrument and the individual shares of the partners must be specified. The provision also governs furnishing of the certified partnership instrument and the consequences of changes in the constitution or partners' shares.
Section 327: Change in constitution of a firm
Section 327 of the Income-tax Act, 2025 corresponds to Section 187 of the 1961 Act. Where, at the time of an assessment under Section 270 or Section 271, a change in the constitution of a firm is found, the assessment is made on the firm as constituted at the time of making the assessment.
What amounts to a change in constitution?
A change occurs where one or more partners cease to be partners or one or more new partners are admitted, provided at least one person who was a partner before the change continues as a partner after the change. It also includes a case where all partners continue but their respective shares, or the shares of some of them, change.
The rule concerning cessation of or admission of partners does not apply where the firm is dissolved on the death of a partner.
Section 328: Succession of one firm by another firm
Section 328 of the Income-tax Act, 2025 corresponds to old Section 188. Where a firm carrying on a business or profession is succeeded by another firm and the case is not covered by Section 327, separate assessments are made on the predecessor firm and the successor firm in accordance with Section 313.
The distinction between a mere change in constitution and a succession is therefore important. A qualifying continuity of partners may bring the case within Section 327, while a succession falling outside that provision attracts separate assessments under Section 328.
Legacy provisions under the Income-tax Act, 1961
Section 185: Assessment when Section 184 not complied with
Where a firm did not comply with Section 184 for an assessment year, no deduction was allowed for interest, salary, bonus, commission or remuneration paid by the firm to a partner in computing its business or professional income. The corresponding amount was not chargeable in the partner's hands under the provision then contained in Section 28(v).
Section 187: Change in constitution of a firm
Where, while making an assessment under Section 143 or Section 144, a change in the constitution of a firm was found, assessment was made on the firm as constituted at the time of assessment. A change included the cessation or admission of partners where one or more pre-change partners continued after the change, and a change in the partners' respective shares. The provision excluded a case where the firm was dissolved on the death of a partner.
Section 188: Succession of one firm by another firm
Where a firm carrying on a business or profession was succeeded by another firm and the case was not covered by Section 187, separate assessments were required for the predecessor and successor firms in accordance with Section 170.
Practical distinction between change and succession
| Situation | General treatment under current law |
|---|---|
| A partner retires or a new partner joins and at least one existing partner continues | Ordinarily examined under Section 327 as a change in constitution. |
| All partners continue but profit-sharing ratios change | Covered by the definition of change in constitution in Section 327. |
| Firm is dissolved on death of a partner | The specific exclusion in Section 327(3) must be considered. |
| One firm succeeds another and the case is outside Section 327 | Separate predecessor and successor assessments under Section 328 read with Section 313. |
| Firm fails to comply with conditions for assessment as a firm | Section 326 disallows specified partner-payment deductions, with the corresponding partner-side tax treatment stated in that section. |
Related Income Tax pages
Assessment as a firm: old Section 184 and related provisions
Joint and several liability of partners and dissolved firms: Sections 188A and 189
Past assessments of firms, deduction at source and advance payment
The applicable Act and section should always be determined with reference to the relevant tax year, assessment year, transaction and repeal-and-savings provisions.