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Partnership Firms: A Detailed Guide

Business is any kind of commercial activity aimed at earning profits lawfully. To start a business, the first and foremost thing required is ‘capital’. If the capital is provided by a single person, the business is deemed to be a single ownership or sole proprietorship. But, if the size of a business enterprise is large and if a single owner is inadequate to run it, and if two or more persons join hands together and club their resources, skill and knowledge for jointly carrying on some business to make the business more profitable, then such an association is called as a ‘Partnership firm’. And the individual sharers are called as ‘partners’.

how to start a Partnership

In other words, partnership can be defined as an arrangement between persons (2 to 50) who have agreed to share the net gain of a business carried on by all or by any one of them in a business. But, if two or more people join together to make a bulk purchase and divide the goods among themselves with a view to having the benefit of bulk purchase, such persons cannot be called as partners, although each one of them stands to gain something, because purchasing goods without any idea of selling cannot be deemed as a business. Also, every person who shares the profit need not always be a partner. So what is a partnership?

If the basis of the relationship of certain persons is not an agreement, then it is not considered as partnership. For example, if I pay a share of profit to my manager instead of a fixed salary so that he takes more interest in the business, such a person is not considered as my partner.

Thus, it is the agreement among the partners which distinguishes a partnership from various other relationships like members of a joint hindu family, joint owners and joint heirs.

Partnership Agreement

Partnership is based on a partnership agreement between the partners which is generally in writing. The agreement can be oral or in written, but it is preferable to have any agreement in writing always. By agreeing to the terms and conditions in the agreement, two or more persons (maximum up to 50) can legally become partners.

A partnership agreement must include the following details:

  1. Name, father’s name, age and address of every partner
  2. Name, purpose and address of the partnership firm
  3. Type of business
  4. Details of Capital investment made by each partner
  5. Liabilities of each partner
  6. Duties of each partner
  7. Duration of the agreement
  8. Details about retiring partner, incoming partner and outgoing partner
  9. Terms and conditions to be followed while running the firm
  10. Details of how the profit and loss shall be shared among the partners
  11. Rules that each partner has to abide by
  12. Conditions for firm’s dissolution and its consequences

Persons Capable Of Becoming Partners

According to Section 4 of the Partnership Act, 1932, persons who can enter into a partnership are:

  • Any person who has attained the age of majority and who is of sound mind and competent to contract.
  • Any member or Karta of the Hindu Undivided Family can become a partner and the partnership would be between the nominated person and the other partners of the firm.

Persons Incapable Of Becoming Partners

  • A minor or a person of unsound mind, who is not competent to contract, cannot become a partner in a partnership firm.
  • A Hindu Undivided Family directly or indirectly cannot become a partner of a firm because partnership firm is an association of individuals. A body of persons like a firm cannot enter into partnership with other individuals.

Rights Of A Minor In Partnership Firm

A minor cannot be a partner, however, he/she may be admitted to the benefits of the partnership.

According to Section 30 of the Partnership Act, a minor has the right to such share of the property and the profits of the partnership firm as agreed upon and the minor may have access to the accounts of the firm.

Size Of A Partnership Firm

Size of a partnership firm refers to the number of partners in a partnership firm. The maximum number of partners allowed is 50, while earlier it was 20.

Types Of Partners

Active or Managing Partner – The partner who takes an active part in the management of the business enterprise.

Sleeping or Dormant Partner – The partner who do not take any active part in the conduct of the business.

Whether active or sleeping, both types of partners are equally responsible for running of a partnership business. However, this classification is nowhere mentioned in the Act.

Now, let’s understand how new partners can join an existing partnership firm and also how an existing partner can exit from a partnership firm.

Incoming Partners

A new partner can be introduced into an already existing partnership firm in the following ways:

  • Introduction with the consent of all the partners.
  • In accordance with the provisions of Section 30, a minor can be admitted to the benefits of partnership.

A person does not become responsible for any act of the partnership firm done before he/she became a partner.

Outgoing Partners

Section 32 to 38 of the Indian Partnership Act deals with the different ways in which a partner may cease to be a partner and his rights and liabilities thereafter. A partner may cease to be a partner in the following ways:

  1. By Retirement (Section 32(1)) – A partner may retire with the consent of all the other partners, in accordance with  an express agreement by the partners, in partnership at will by a notice to other partners.
  2. By Expulsion (Section 33) The expulsion of a partner is possible, in exceptional cases, when the power to expel has been conferred by a contract between the parties, and power must be exercised in good faith for the general interest of the whole firm.
  3. By Insolvency (Section 34) An insolvent partner is not allowed to continue as a partner and, therefore, a person who is adjudicated insolvent ceases to be a partner on the date on which order of adjudication is made. Whether on adjudication of a partner as insolvent, the firm is also gets dissolved or not it depends upon the contract between the partners.
  4. By death (Section 35) On the death of a partner, a firm is dissolved but, if the other partners agree, the firm may not be dissolved and the business of the firm may be continued with the remaining partners.

Rights of outgoing partners

When a partner ceases to be a partner by retirement, by expulsion, by insolvency or by death, his share in the property of the firm may not be paid immediately to him and the firm may continue the business without any final settlement of accounts between the firm and the outgoing partners and then in such case, Section 37 gives an option to the partner or the representative of the deceased partner, to claim such share of profits made since he ceased to be a partner or to claim an interest at the rate of six percent per year on the value of his share in the property of the firm.

Duties Of Partners

The partners should –

  • be faithful to each other
  • be bound to make the business more profitable
  • provide true accounts and full information about everything related to business to any partner or their legal heirs

Types Of Partnership

General Partnership – In a general partnership, each partner has true powers that means each partner acts as if he is the sole owner. A general partnership firm can have 2-50 general partners (GPs). As and when the process expands, more partners can be added with mutual consent.

The benefits of a general partnership include availability of huge capital, full control of business, full right to partners towards profit, losses shared by all partners, etc. The issues with this kind of partnership include disagreement and distrust concerns among the partners, risk of dissolution with the death of partner/s, among others.

Limited Partnership – In a limited partnership, not every partner has all powers. There will be one or more general partners who manage the process and the rest of the partners would have limited powers, and are called limited partners. Though limited partners share the profit of the firm, they do not have management authority. Also, they are not liable for the firm’s debts.  

Duration Of Partnership

Partners are free to decide as to how long the partnership between them shall continue. It may be a partnership for a fixed term, say for 1 year or 6 years, or it may be until the completion of particular ventures or undertakings (Section 8).

In Particular partnership, a person may become a partner with another person in particular adventures or undertakings.

If the partners have not decided about the duration of the partnership, such a partnership is known as ‘partnership at will’. When a partnership is at will, a partner may retire by giving notice to all the other partners of his purpose to retire.

But, if a partnership that was created for three years continues to operate even after the completion of 3 years, also without specifying the duration of the extended term, then during the extended time, it becomes a partnership at will and the same can be dissolved by notice.

Registration Of Partnership Firm

Section 58 and 59 of the Act deal with the procedure for the registration of a firm. The registering of a firm is made by submitting to the Registrar of Firms a written statement in a particular format accompanied by the prescribed fee. The fees for the registration would vary from Rs 500 to Rs 2000 depending on the capital of the firm.

The application for registering a partnership firm should include the following –

  1. The name of the firm
  2. Nature and purpose of business
  3. Names of all the partners who are getting into partnership firm
  4. The place where the business is carried on
  5. If the business is carried in more than one place then the name of that place
  6. The date when each partner joined the firm
  7. The names in full and permanent address of the partners
  8. The duration of the firm
  9. Profit-sharing ratio between the partners
  10. Rights and powers of a partner
  11. Procedure to be followed in case of death of a partner
  12. Rights of a minor in a partnership firm
  13. Retirement procedure
  14. Dissolution of the firm when necessary

The application has to be duly signed by all the partners and submitted at the registrar along with the requisite documents and fees for registration. Within around 10 working days after the submission, the registrar of firms registers the firm and issues Form C certificate as Registration certificate according to Section 59.

NOTE: For a partnership firm, it is not necessary to get the name approved from the registering authorities. However, partners can check whether the same name is registered in the books of the registrar. If the same name exists, the partners may go for a different name.

Subsequent Changes And Alterations

If there is any alteration in the firm name and place, closing and opening of branches, changes in names and address of the partners or any changes in the constitution of the firm or dissolution of the firm, the partners are required to send an intimation to the Registrar, who after verifying makes the entry in the Register of firms.

Income-tax Filing For Partnership Firm

Whether the firm is registered or not, it is mandatory to file income-tax every year. For a partnership firm, the income-tax applicable is flat 30% on the income of the firm. And a 12% surcharge will be applicable if the total income crosses 1 crore. And an education cess of 3% is applicable.

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