In India, partnership firm is a default choice when two or more people decide to start a business.
In simpler terms, a partnership is an agreement between two or more persons to operate a business. These people who joined hands together by signing an agreement to form a partnership firm are known as partners.
A partnership firm is similar to a proprietorship form of business except instead of one owner or proprietor, there is more than one owner / partner.
A minimum of two persons are required to form a partnership firm in India.
Partners pull money towards a common purpose by forming a legal relationship. All the terms and conditions such as capital introduced by each partner, salary of partners, business objective, interest and profit sharing ratio and how and when partnership firms will be dissolved is mentioned in the agreement known as partnership deed, which is signed by each partner.
In simple terms, partnership deed is a formal agreement signed by two or more persons to manage and operate a business and share its profits. The form of business created out of this agreement is known as Partnership Firm.
The Indian Partnership Act, 1932 is specifically applicable to partnership firms in India as it is created to govern and regulate partnership firms in India.
You are not required to register your partnership firm.
To get legal proof of the existence of your partnership firm, you can apply for registration with the Registrar of Firms of the state where the partnership firm is located as per the deed.
Registration with the state’s Registrar of firms gives certain legal advantages which an unregistered firm does not get. Therefore, it’s always suggested to get your partnership firm registered with the Registrar of Firms.
How to create a partnership firm in India – step by step procedure
Before starting the process of creating a partnership firm in India, we suggest you to first decide on following important things;
- Profit and loss sharing ratio of each partners
- Business objective of the partnership firm
- Registered and branch offices from where the partnership firm will run its business.
- Total capital contribution and capital to be introduced by each partners
- Remuneration of each working partners
- Interest on capital to be paid, if any
- Admission, retirement and resignation of partners
After deciding on the above points, creating a partnership firm is easy. You can even get started within a day. You need to follow below steps to create it;
Choose partnership firm name
You can choose any name for your partnership firm based on your requirements.
However, we suggest you check the trademark database to know if that name is already registered. In absence of trademark registration, you are free to use the name for your commercial purpose.
To avoid future disputes, we suggest you take trademark registration for your partnership firm name.
Avoid using all prohibited words and expressions in your partnership firm’s name.
Create a partnership deed
Partnership deed is the document which mentions all the terms and conditions of forming a partnership firm.
You need to specifically include the name and address of the business and partners, business objective, when to commence business, duration, capital contribution, profit sharing ratio, remuneration of each partner and other important points. We suggest you take help of a finance professional to draft the partnership deed for you.
After drafting all the terms and conditions, take print out on a stamp paper in accordance with the Indian stamp act.
The first page can be taken on the stamp paper and all others in A4 size paper.
Each page including the last page has to be signed by each partner and two witnesses. Photos of all the partners are to be pasted on the front page by identifying each partner.
After preparing the partnership deed, you need to get it notarized.
Here is a list of questions that your partnership deed or agreement must answer;
- Who is responsible for the day-to-day operation of the business?
- Who is liable for the debt of the business?
- How Profit/loss is distributed among the owners/partners?
- How much salary will be paid to partners and how to derive it?
- What will be the interest on capital and how will it be paid?
- How will new people be added or join the business?
- What business will it carry after signing the deed?
- What will be the firm’s registered office?
Apply for Income tax PAN
After preparing a partnership deed, you need to apply for its permanent account number or PAN. You can use form 49B and submit it to any TIN FC along with a certified true copy of the deed. You can also apply PAN online by using net banking to pay the fee.
Registration
If you want your firm to be registered, then you can apply to the Registrar of Firm along with a certified true copy of the partnership deed, address proof and duly filled specimen of affidavit.
If the registrar is satisfied, then your firm name will be entered into the registrar of firms and you will be issued a certificate of registration.
A partnership firm is required to register their firm with the registrar of firms of the state where the firm is located as per the deed. Please note, such registration of partnership firms is not mandatory. Partners have liberty either to apply for registration of partnership firms at the beginning or at any time after starting their business.
However, it’s always suggested to register your partnership firm with the registrar of firms of the state as a registered firm enjoys certain legal advantages in comparison to an unregistered firm.
For instance, a partner of an unregistered firm can not sue against any partners or the partnership firm in case of any dissent. The unregistered firm can not sue a third party to enforce a right but the third party can file a suit against the unregistered firm.
After getting income tax PAN and Certificate of registration, you can open a current account in the name of a partnership firm and start operating your business.
For registration and drafting the deed, we suggest you to take help of a chartered accountant or advocate as certain terms and conditions in the deed may put you in trouble to claim tax deductions and in other legal matters.
In India, a partnership firm is taxed as a separate entity even though it’s not legally a separate entity. Each partner of the firm reports his or her share of profit, interest on capital and remuneration on his or her personal income tax return.
In certain professions including accounting, audit, law, architecture and consultancy services, businesses are commonly organized as partnerships.
In comparison to a company, proprietorship and partnership businesses are very easy and inexpensive to establish. Company formation and post incorporation compliance is very complicated and costly for a small business.
However, if you want your business to grow and attract investors to join in, then it’s worth investing money in a private or public limited company.
Let us discuss advantages and disadvantages of a partnership firm in detail.
What are the advantages of a Partnership Firm in India?
Easy to incorporate
Partnership firm registration in India is very easy compared to a private limited company, One person company, public limited company or LLP.
Any two people can easily form a partnership firm by just signing the legal agreement with all the terms and conditions in it, known as partnership deed. No other documents are required to get started a business except income tax PAN.
Registration with the Registrar of firms is not mandatory. However, to open a bank account and to have a government recognition under the Indian Partnership Act, you need to register your partnership deed with the registrar of firms.
You can also register your partnership deed at a later date.
Less legal compliance
Legal compliance compared to a private limited company, public limited company, OPC and LLP is very less. Partners are not required to have director identification number (DIN) and digital signature certificate (DSC) like in the case of a company or LLP.
Changes to the constitution of the partnership firm or terms and conditions are very easy to incorporate compared to a company or LLP. Legal cost of such changes and annual filing is very less compared to a company and LLP.
Closing a partnership firm is easy and cost effective compared to closing any other form of business such as private limited company, LLP and OPC. Closing does not require much legal formalities.
A partnership firm is not required to be audited by a chartered accountant in practice unless and until its required to be done under section 44AB of the Income tax act, 1961. However, a company is required to be audited even if it has zero turnover.
Quick Decision
Partners are binding by the terms and conditions of their partnership deed. A partner can make any business decision immediately. They are not required to follow any legal process to take a decision like in the case of a company.
Partners have wide power and flexibility in comparison to a director in decision making.
If any changes are to be made to the terms and conditions, it can be done with a simple amendment to the original partnership deed. Partners are not required to get legal approval from authorities to implement such changes.
Profit sharing
The partners share their business profit or loss as per the deed signed by them. They can share profits based on their own decision. Changes to profit sharing ratio of partnership firm can be done anytime by simple amendment to the deed. They are not required to follow complex legal processes as it’s in the case of a company.
What are the disadvantages of partnership firms?
Like any other form of business, a partnership firm also has certain disadvantages.
Unlimited business liability of partners
The business liability of the partners of a partnership firm is unlimited. Which means for a business loss of the partnership firm, partners are personally liable, their personal assets will be used to recover business losses. This is one of the biggest disadvantages of a partnership firm.
Liability created by one partner is to be borne by all the partners. In case a partnership firm’s assets are insufficient to pay back the liability or debt, then the partners will be liable to pay it out of their personal assets.
Whereas, in the case of private limited company, LLP, OPC and public limited company, the shareholder or partners liability is limited to the extent of capital invested by them. Their personal assets will not be touched to settle business losses.
Perpetual succession – limited life of the business
A partnership firm will be closed upon the death of a partner.
Partnership firms can be dissolved if a single partner gives a notice of dissolution to the other partners. Such a thing is not possible in the case of a company. Therefore, a partnership firm can come to an end at any time if there is dissent among partners.
Limitation in number of partners and difficulty in raising capital
A partnership firm can have up to a maximum number of 20 partners. Due to this reason, capital investment can also be restricted up to an extent based on the wealth of individual partners.
Due to this reason, you will not find a large scale of business under a partnership firm.
In comparison to a private and public limited company, you don’t have many options for raising capital and growing business.
Due to lesser compliance and perceptual existence of the partnership firm, outsider investors and business partners will not be interested to invest or do business with your firm.