Partnership is one of the simplest business structures yet very functional. Learn about the important aspects of a partnership firm here.
People entering into an agreement to start and run a business are partners and the firm they thus form is called a partnership firm. A partnership is an agreement between two or more persons to work together on certain terms and conditions.
It is not a legal entity. Whereas a company (private or public limited) is an artificial person, a partnership is merely a name given to a group of people working together (even if it is a registered partnership).
Therefore, whenever terms such as ‘firm’s property’ or ‘suit against the firm’ are used, it basically means ‘partner’s property or ‘suit against the partners’. Let us look at the partnership firm’s needs and the importance of partnership.
Important Aspects of Partnership Firm
A partnership firm is governed by the Indian Partnership Act of 1932. As per Section 4, a partnership is a relation between persons who have agreed to share profits of a business carried on by all or any one of them acting for all.
The above statement brings us to the five elements that make up a partnership:
- There must be a contract
- It is made of two or more persons
- There is an agreement to carry on with a business
- The object is sharing profits
- Either one does the business activity or it is done by someone who has been appointed by all partners
Let’s now look at the aforementioned elements of a partnership
Contract of Partnership
A partnership is the result of a contract and does not happen because of a certain status, operation, law, or any sort of inheritance. To explain this, let’s say a father (who is also a partner in a firm) dies. In such a case, his son/daughter can stake claim to a share in the partnership property, but can only become a partner once they enter into a contract with the other existing partners.
A contract is the core of a partnership firm (read about the agreement of the partnership firm).
Members of a Partnership Firm
The maximum number of partners that a firm can have are 20. Now, it is imperative to know that the India Partnership Act does not define the maximum limit, but according to the Companies Act, a partnership can have a maximum of 20 partners. Above this number, the business would be deemed illegal.
It is imperative to know that a partnership firm cannot enter into a partnership with another partnership firm or individuals. Similarly, keep in mind that if a partnership firm, under a firm name, does enter into a contract with another firm or individual, then the members of the firm become partners under law.
Business Activity Under Partnership
The parties concerned must have agreed to carry on business activity. This includes the broadest definition possible, entailing every trade, occupation, and profession. Hence, if it’s charity work, then it will not be considered a partnership firm.
Now, say a group of individuals decide to share the income from a certain property or divide certain goods that have been purchased, the people involved cannot be called partners since there is no business involved.
The objective of carrying out a partnership firm must be to share profits among the partners involved. As mentioned above, any philanthropic work which involves no profits will not be considered as a partnership. Further, the sharing of profits, however, can be decided in whichever ratio that the partners concerned prefer.
As much as sharing profits is the objective, it is not necessary for the partners to share losses too. They can even stipulate a clause in the agreement to state that all the losses will be borne by one person. However, irrespective of how the loss is shared, the liability to an outsider on all the partners shall remain unlimited.
The sharing of profits and losses, however, must be clearly stated in the contract. In case such a clause is absent, then under the law, it means that all profits and losses are to be shared equally among the partners.
The partnership can be carried out by all or any one partner who has been nominated by all partners. There has to be a mutual agreement in this regard.
Moreover, this primarily means that every partner is an agent and a principal both. This means they can be bound by the acts of others or bound by their actions.
Benefits of Registering a Partnership Firm
1. Lower Compliance Burden
The annual compliance burden of registered partnership firms is lower as compared to LLPs. There is no need for a partnership firm to appoint an auditor. Moreover, a partnership firm does not require to file sales tax, service tax, and taxes depending on turnover.
2. Higher Credibility
A registered partnership firm enjoys higher credibility as compared to an unregistered firm. Additionally, registered firms are preferred by investors and authorities over unregistered firms.
3. Ability to Set Off Claims
Registration provides the partners with the ability to set off claims, in case any third-party suit files against the firm. As per the Partnership Act, 1932, an unregistered partnership firm cannot claim set-off against the third party.
4. Dispute Resolution is Easier
A registered firm can bring other parties to the court in case of legal disputes arising out of any business matter. The partners of an unregistered partnership firm cannot enforce any rights mentioned in the Partnership Act.