Partnership firms and sole proprietorship forms of business entities are popular in India. Partners who have entered an agreement to carry out a business are collectively called Partnership Firm. The name under which the business operations are carried out is termed as the “firm name”.
The partnership firm comes into existence by the execution of a partnership deed. A partnership deed can be oral or written. It can either be registered with registrar of firms or not as per the discretion of majority of partners in the partnership firm. For tax purposes though, a written partnership agreement is mandatory. Also, registering the partnership firm offers benefits which will not be available otherwise. Templates of partnership deeds are available for download here.
Key elements of Partnership Firm’s existence
Below is a list of elements which are the very essence of partnership firm.
A contract is the very foundation for a partnership firm. Unlike a HUF which arises out of Status and relationship, the partnership firm arises out of contract. Concept of inheritance of partnership does not exist. If any member of partnership passes away, the legal heir can only make a claim on the assets of the member. The legal heir cannot lay claims for partnership in the form, unless he enters a separate contract with the other partners. For more on the partnership deed, download this form here.
Minimum and Maximum Partners
The Indian Parternship Act 1932 which governs partnership firms mentions that 2 members are required to form a partnership. This is the minimum number; it does not mention any maximum number. However, the companies Act clearly mentions that any partnership firm should not exceed 20 partners. It specifies that any firm conducting banking business, having more than 10 partners and any other business (partnership firm) with more than 20 partners is considered illegal.
Conducting business and intent to make profits
The partnership firm has to be formed with a view to carry out some business. It can be trade, service, manufacturing or anything else. It has to have a profit making motive. A charitable organisation cannot be registered under partnership firm. The intent to make money out of the business operation is essential.
The partnership deed has to specify the ratio in which the profits will be shared. It can be in any ratio, if there is no ratio specified than it is divided equally. There need not be any restrictions on how the losses will be shared. It can be borne by a single partner as well.
The partnership deed (available for download here) should expressly specify the ratio in which the profits / losses will be shared. Else, the Indian Partnership Act 1932 specifies that it shall be distributed evenly. Unless, the partnership firm is registered as a Limited liability partnership (LLP), the liability of the partners in the firm will be unlimited.
Benefits of Partnership Firm
- Easy Setup: The process to register a partnership firm is fairly simple and hassle free.
- Operational Flexibility: Due to the limited number of people, the operations of business can be altered as per requirement. In consultation with the partners, the changes can be implemented, there need not be any written documentation of changes so included.
- Better control: Since the members are lesser, they hold better control over the operations and the quality. They also have better view of the fund’s movement. Operational efficiency and resource management is better than private limited and public limited companies. In fact, the management is better compared to sole proprietorship due to shared responsibilities.
- Decision Making: The decision making is more effective, given that there are more minds put together. Each may have the same intent whilst forming the business partnership. However, on operational issues, they may bring in various views and expertise.
A partnership firm is best suited for services businesses that need operational flexibility and efficient resource management. For further information on the paperwork needed to sign a partnership, download the relevant forms here.