The Indian Partnership Act

True Test of Partnership

The Indian Partnership Act 1932 clearly defines a partnership. But how can we decide if a given association of persons is truly a partnership or not? So the Act has also given us a litmus test to determine if a firm is a partnership. This is known as the True Test of a Partnership. Let us study this.

True Test of a Partnership

The true test of a partnership is a way for us to determine whether a group or association of persons is a partnership firm or not. It also helps us recognize the partners of the firm and separate them from the third parties.

The idea behind such a true test is to examine the relevant facts and determine the real relations between parties and conclude about the presence of a partnership.

Let us take a look at the three important aspects of a true test of a partnership, namely agreement, profit sharing and mutual agency.

1] Agreement/Contract between Parties

For there to be a partnership between two or more persons there has to be an agreement of partnership between them. The partnership cannot arise family status or any operation of law. There has to be a specific agreement between the partners.

So if family members of a HUF are running a business together this is not a partnership. Because there is no agreement of partnership between them. The members of HUF are born into the HUF, so they cannot be partners.

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2] Profit Sharing

Sharing of profits is an aspect of the true test of a partnership. However, profit sharing is only a prima facie evidence of a partnership. The Act does not consider profit sharing as a conclusive evidence of a partnership. This is because there are cases of profit sharing that are still contradictory to a partnership. Let us see some such cases

  • Sharing of profits/ gross receipts from a property that two or more persons own together or have a joint interest in is not a partnership
  • A share of profits given to an agent or servant does not make him a partner
  • If a share of the profit is given to a widow or child of a deceased partner does not make them partners
  • Part of the profits shared with the previous owner as a part of goodwill or as a form of consideration will not make him a partner.

Now ascertaining this motive becomes difficult if there is no express agreement between the concerned parties. In such a case we will consider the cumulative effect of all relevant facts. This will help us to determine the true relationship between the parties.

3] Mutual Agency

True Test of Partnership: Mutual Agency

This is the truest test of a partnership, it I the cardinal principle of a partnership. So if a partner is both the principle as well as an agent of the firm we can say that mutual agency exists. This means that the actions of any partner/s will bind all the other partners as well.

So whenever there is a confusion about the existence of a partnership between people we check for the presence of a mutual agency. If such an agency exists between the parties who run a business together and share profits it will be deemed that a partnership exists.

                                                                                      Learn Types of Partners here. 

Solved Example on True Test of Partnership

Q: Sharing of Profit is the truest test of a partnership. True or False?

Ans: This statement is False. The truest test of a partnership is the existence of a Mutual Agency. There are other instances where the sharing of profit exists but there is no partnership. But if an agency exists between the parties who run a business together and share profits it will be deemed that a partnership exists.

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