Partnership is one of the most popular form of business organizations in India. Its very easy to set-up and require lesser compliance in comparison to a limited liability partnership firm (LLP) and companies.
To form a partnership business, the first and foremost thing you need to do is drafting your partnership deed.
Partnership deed is an agreement or contract signed by all the partners on variety of issues such as main business purpose, profit sharing ratio, interest on partner’s capital, salary, bonus, commission or remuneration for partners, rights and obligations of members and rules about its day to day operations.
These main components of Partnership deed has been discussed below in this article. This agreement has to be created by the partners on a stamp paper in accordance with the Indian Stamp Act. Stamp duty varies from state to state.
Generally, the partnership deed is notarized on a non-judicial stamp paper with minimum value of Rs. 200 or more.
Name of the Partnership firm
Name has to be specifically mentioned in the Partnership deed. Partners are free to choose any name. It’s the trade name on which you will be operating your Partnership firm.
You can change it at a later stage. But, we suggest you to make sure that you don’t change it more often as Permanent Account Number (PAN) and other government certificates will get issued in this name. In case of any change in name, you need to make similar changes in all such documents including changes to the main partnership deed. This takes time and money.
While choosing name of the Partnership firm, you need to make sure that similar name doesn’t have any trademark registration. To avoid future disputes, we suggest you to check trademark registrations database thoroughly. If you find a trademark registration for that name or similar to it, then consult a legal practitioner before using it.
The easiest way is to do an internet search.
Business objective
The main business purpose of forming a partnership business should be stated in the Partnership deed or agreement.
Objective should be stated clearly in a detailed form, with the kind of services you want to render and the type of business you would like to do after forming the Partnership firm.
Based on your objective, various other provisions such as provisions of the tax laws and goods and services tax will be applicable.
Places of business
Places of business is another most important point in your agreement. In this section, you define the principal place of business and other branch office addresses from which the partnership firm will operate.
You can change these addresses at a later stage, but, it’s better to define it at the time of signing the agreement as your firm’s permanent account number, other certificate of registrations and other legal communications will be sent to the principal or registered office address of the firm.
Startup capital
Share capital clause of the partnership deed will define who will contribute what? Under this clause each partners initial capital contribution will be stated clearly.
If any partners are contributing capital assets to the firm as their share capital contribution, then it should be valued and the value has to be stated in the Partnership deed with details of the property contributed.
We suggest you to consult a finance consultant on this as you may have to pay capital gain tax based on the asset you transfer.
Profit or loss sharing ratios
Each partner’s profit and loss sharing ratio must be clearly stated in the contract. Without it, your Partnership deed will not be complete.
This sharing ratio is important for partners as based on it you will be distributing profits of the business. Share of profit received from firm will not be taxable in the hands of the partners.
You can also define your profit sharing ratio based on the capital contributed by each partners.
Decision making authority
Among all the partners, one should be appointed as a managing partner. Along with managing partner, you can also appoint another partner to manage firm’s day to day operations.
There is no restrictions on such appointment. However, you have to clearly mention it in the Partnership deed to know exactly who is managing firm’s day to day operations.
You are also required to state who will operate firm’s bank account. Whether the bank account will be operated by managing partner or any other partners or by all of the partners individually.
It has to be clearly mentioned in the partnership deed as based on it bank will process the application to open a current account in the firm’s name.
Interest on partner’s capital
Interest on partner’s capital can be disallowed while calculating firm’s tax liabilities if you have not defined it in the deed or agreement.
Section 40(b) of income tax act 1961, allow a partnership firm to claim interest on capital as an expense up to a maximum limit of 12%.
If you have defined a higher rate of interest in the partnership deed, then interest on capital as a allowed expenses will be restricted to 12% while calculating firm’s tax liability.
If you have defined a lower rate of interest on capital, then such lower amount as calculated will be allowed as expenses.
This means the rate of interest on capital as defined in the agreement or 12%, whichever is lower will be considered as rate of interest on capital for the purpose of section 40(b) of income tax act,1961 as tax deductible.
Salary, bonus, commission or remuneration to partners
Salary, bonus, commission or remuneration to partners will be disallowed for income tax purpose if it’s not specifically included in the partnership deed.
You are not only require to include it in the agreement, but should also quantify salary, bonus, commission or remuneration to be paid to each partner. If you can’t exactly specify the quantum of salary or remuneration, then at least the manner of fixing it should also be clearly stated in the deed.
However, the amount calculated as per partnership deed should not exceed the maximum permissible limit of section 40(b) of Income Tax Act, 1961.
The excess amount over and above the maximum permissible limit will be disallowed in the hands of the partnership firm while calculating it’s tax liability.
You should be very careful while drafting salary, bonus, commission or remuneration to partners in the agreement.
We suggest you to take help of a legal practitioner if you are new to drafting agreements or deeds.
Dissolution of the firm
If you have not correctly drafted your partnership deed, then dissolution may trigger by the death of a partner.
To avoid such type of problem, you need to specifically mention it in the agreement that upon the death of a partner, the partnership shall not terminate and the business shall continue.
You should also state how the deceased partner will share his profit/loss and capital contributions.
You should also state the rules and regulations to be followed on the death of partner.
If you want a partnership firm to be dissolved after a time period or on a specific date or after achieving certain target or on an event, then clearly specify that the partnership will be automatically be dissolved or dissolution process will start on that date or after completion of a period. In this way, life of a partnership will be limited by the partnership agreement.
Rules to be followed in case of retirement, admission of a partner
Similar to dissolution, you should also state the rules and regulations for retirement and admission of a new partner. How the capital will be returned back and introduced into the firm, the period of notice for retirement should also be stated in the deed.
To introduce new capital to the firm, you need to have a valuation of the firm. You need to specify the rules and regulations for it.
In addition to above important points, you are also required to include the method of operating accounts, audit of books of accounts, financial year to be followed for accounting, how legal matters will be handled and other terms and conditions based on the requirements, into your partnership deed or agreement.
Photo of all the partners should be pasted on the agreement and partners should write their name and date while signing the agreement. It should be signed in presence of witness and all of them should sign the agreement.
Registration requirements of a Partnership Firm
A partnership firm can be registered. It’s a optional requirements of the partners.
If you want to register it, then a certified true copy of the partnership deed should be filed with the registrar of firms along with all other documents such as rent agreement, application form and affidavits.
Registration will give you certain additional benefits of the Indian Partnership Act, 1932. For instance, if a firm wants to file a case, then they have to compulsorily register their partnership deed.
However, registration with income tax department is not optional. After forming your partnership firm, you are required to apply for registration with income tax department and have a permanent account number issued to your firm.
Application form for PAN has to be signed by the managing partner.
With PAN and registration certificate from registrar of firms, you can open your current account with a nationalised or private bank in India.
If you have not registered so far, then to get a legal proof of the firm’s existence, we suggest you to get your firm registered with registrar of firms.
Based on your requirements, we suggest you to make notes on the above points and draft a agreement on your own. Before signing the agreement, you can consult a legal practitioner.
Your partner may say that he did not understand the agreement or he has not signed the agreement. To avoid such type of dispute, we suggest you to notarize and register the partnership deed with the registrar of firms.
One of the biggest drawbacks of Partnership firm business is unlimited liabilities of it’s partners. This means partners are personally liable to firm’s debt.
Based on your requirements and type of business, a finance consultant may guide you to form a limited liability partnership firm or private limited company.
If you have decided to go for a partnership firm, then a meeting with the legal practitioner may help you to identify flaws in your draft agreement. Such legal practitioner can also add new terms and conditions that you missed out or can modify your language of writing legally.