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What is a Partnership Firm?

Meaning of Partnership Firm:

A partnership firm is created when two or more persons unite together and pool resources to establish a business. The name under which their business is carried on is referred to as the “Firm Name.” Individual partners are referred to as “Partners,” while the entire partnership is referred to as a “Partnership Firm.”

The Indian Partnership Act of 1932 defines the laws that apply to partnership firms in the country. According to Indian Partnership Act, 1932, Section 4 defines Partnership as – “An agreement between persons who have agreed to share profits of the business carried on by all or any one of them acting for all.”

5 Essential Elements of a Partnership Firm:

i) Contract for Partnership

Partnership is the result of a contract. It does not arise from status, operation of law or inheritance. Thus, at the time of death of the father, who was a partner in the partnership firm, the son can claim share in the partnership property but cannot become a partner unless he enters into a contract for the same with other persons concerned.

ii) Maximum No. of Partners in a Partnership is 20

Since partnership is the result of a contract, at least two people are necessary to constitute a partnership. The Indian Partnership Act, 1932 does not mention anything about the maximum no. of partners in a partnership firm but as per the Companies Act, a partnership consisting of more than 10 persons for a banking business and more than 20 persons for any other business would be considered as illegal. Hence, these should be regarded as the maximum limits to the number of partners in a partnership firm.

iii) Carrying on of Business in a Partnership

The third essential element of a partnership is that the parties must have agreed to carry on a business.  The term “business” is used in its widest sense and includes every trade, occupation or profession. Therefore, if the purpose us to carry on some charitable work, it will not be a partnership.

Similarly, if a number of persons agree to share the income of a certain property or to divide the goods purchased in bulk amongst them, there is no partnership and such persons cannot be called partners because in neither case they are carrying on a business.

iv) Sharing of Profits

Among the most important requirements is that the agreement to carry on business must be made to distribute earnings equally among all of the partners. As a result, there would be no partnership when the firm is operated solely for charitable purposes rather than for profit, or where only one of the partners is entitled to all of the business’s profits. The partners, on the other hand, may agree to divide the earnings in any manner they see proper.

It should be noted that, while a partner may not be liable for the losses of a business, his or her obligation to third parties is unbounded under the law of partnership. A new type of partnership known as Limited Liability Partnerships (LLPs) has been developed in India to allow partners to limit their liability towards third parties. When the partners form a Limited Obligation Partnership, their liability to the outsiders is significantly reduced.

v) Mutual Agency in a Partnership

The fifth element in the definition of partnership provides that the business must be carried on by all the partners or any (one or more) of them acting for them all, i.e. there must be a mutual agency.

Thus, every partner, is both an agent and principal for himself and other partners, i.e. he can bind by his acts the other persons and can be bound by the acts of other partners. The importance of the element of mutual agency lies in the fact that it enables every partner to carry on the business on behalf of others.

Advantages of Partnership Firm:

There are many advantages but some of them are mentioned following: –

  • Easy To Form A Partnership Firm Is Easy To Form And Close Without Many Fulfillments Of Formalities. A Partnership Firm Can Be Formed With An Agreement And Registration Of The Partnership Firm Is Also Not Mandatory.
  • More Capital If There Are Two Or More Partners Then The Funds Raised Can Be More. It Provides An Advantage Over Various Other Forms Of Entities Like Sole Proprietorships Where The Amount Of Capital Is Limited.
  • Risk Sharing According To The Indian Partnership Act Of 1932, The Risk Is Shared Between All The Partners Because The Burden Of Losses Doesn’t Come Upon Any Single Person Or Individual.
  • Secrecy It Is Not Necessary To Publish The Accounts Which Lead To The Secrecy Of Its Operations And Confidentiality Is Maintained.

Disadvantages of the Partnership Firm:

There are some disadvantages of the Partnership Firm also which are given below: –

  • Unlimited Liability One Of The Biggest Disadvantages Of A Partnership Firm Is That Its Partners Have Unlimited Liability. It Means That The Personal Assets Or Property Of The Partners May Be Used For Paying Companies Debts.
  • Lack Of Continuity It Is The Main Demerit Of The Partnership Firm That Comes To An End With The Death, Insolvency, Or Retirement Of Any Of Its Partners So The Result Is A Lack Of Continuity Of The Partnership Firm. However, If The Remaining Partners Want To Continue The Partnership Firm, Then They Have To Form A Fresh Agreement.
  • Conflicts – When Two Or More Persons Are Involved Then The Conflicts Always Arise. The Different Opinions Of Each Partner Or Some Issues May Lead To Disputes Between The Partners. 
  • Limited Resources – It Is The Restriction On The Number Of Partners. As A Resulting Partnership Firm Faces Many Problems In Expansion Beyond A Certain Size.

Types of Partners:

The distinct classes of partners in a partnership firm can be determined by the amount of their liability.

i) Active/ actual/ ostensible partner

When a partner of a partnership business, who has become a partner by contract, actively participates in the partnership’s management.
The partner of the firm acts as the representative of the other partners for all actions performed within the typical business lifecycle. In the event of a partner’s retirement, he or she must provide a public notice to absolve themselves of responsibility for actions committed by the other partners following his departure.

ii) Sleeping or dormant partner

A Dormant or Sleeping Partner is a partner who is a partner by agreement but does not actively participate in the business’s operations.
These partners share earnings and losses and are liable to third parties for the partnership’s commercial dealings. However, they are not compelled to announce their retirement from the partnership firm to the public.

iii) Nominal partner

A nominal partner is a person whose name appears on the partnership document. When this is done without having an actual stake in the business, the individual is considered a nominal partner. This type of partner is not entitled to a portion of the firm’s profits. This partner has neither invested in nor participated in the firm’s business operations. However, such a partner is liable to third parties for all of the firm’s conduct.

iv) Partner only in profits

This partner is entitled to a portion of the earnings but is not responsible for the losses. This type of partner is only liable to third parties for acts of profit.

v) Sub-partner

A Sub-partner is a partner in a partnership firm who agrees to split his profits with a non-partner. A sub-partner has no rights against the firm and is not responsible for any obligations incurred by the firm.

vi) Incoming partners

This refers to a partner who is admitted as a partner into an existing firm with the approval of all current partners. This partner is not accountable for any actions the firm committed prior to his admission as a partner.

vii) Outgoing partner

A departing partner is a partner who leaves the business while the remaining partners continue to operate. Until a public announcement is made regarding his retirement, this partner is accountable to third parties for any activities conducted by the firm.

viii) Partner by estoppel (holding out)

By estoppel, a person will be legally regarded as a partner if he or she verbally or in writing informs a client that he or she is a partner and then receives credit or some other favour.

Is it essential to register a Partnership Firm?

It is not mandatory by law to register a partnership firm. However, it is preferable to register the business as a partnership in order to enforce the partners’ interests in court, if necessary.

Income Tax Rate on Partnership Firm:

Under the Income Tax Act, 1961, a partnership firm is liable to pay the following tax percentages: – 

  • 30% income tax 
  • 12% surcharges where taxable income is above one crore rupees  
  • Up to 12% on interest of capital is allowed 
  • Health and Education Cess 4% of tax including surcharges

Partnership Firm Tax Return Due Date:

The due date for filing an income tax for a partnership firm is dependent upon whether the firm is required to be audited or not. The due date for filing income tax return are as follows:

  • Where the firm is not required to be audited – the income tax returns must be filed by 31st July. 
  • Where the firm is required to be audited  – the firm has to file its income tax returns by 31st October.

Penalty For Non Filing of Income Tax Return:

Section 234 F of Income Tax is applicable for penalty for non filing of Income tax return of partnership firm. For income tax filing after due date penalty upto Rs. 10000 is applicable. To avoid late filing fees one should file income tax return on or before 31 July or 31st october.

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Note: This Post was last updated on November 6, 2022

Disclaimer: The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation i.e. November 6, 2022. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, We assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. We assume no responsibility for the consequences of use of such information. IN NO EVENT SHALL WE SHALL BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL OR INCIDENTAL DAMAGE RESULTING FROM, ARISING OUT OF OR IN CONNECTION WITH THE USE OF THE INFORMATION.

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