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Partnership-an improvement over the 'Sole-trade business'

ASWIN MALLYA 
on 06 May 2020

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PARTNERSHIP

What Is The Nature Of Partnership?

Partnership is a form of business organization, where two or more persons join together for jointly carrying on some business. It is an improvement over the ‘Sole –trade business ’, where one single individual with his own resources, skill and effort carries on his own business. Due to the limitation of resources of only a single person being involved in the sole-trade business, a larger business requiring more investments and resources than available to a sole-trader, cannot be thought of in such a form of business organization. In partnership, on the other hand, a number of persons could pool their resources and efforts and could start a much larger business, than could be afforded by any of these partners individually. In case of loss the burden gets divided amongst various partners in a Partnership.

    

Basis

Partnership

Company

Legal Status

A firm is not a legal entity. Therefore, it has no legal identity distinct from the personalities of its constituent members

A company is considered a separate legal entity distinct from its members.

Agency In a firm

all the partners are an agent for each other, as well as of the firm

In a company, a member is not an agent of any other member nor the company. A member’s actions do not bind either

Distribution of Profits

The profits of a firm must be distributed among the partners according to the terms stated in the partnership deed

There are no compulsions to distribute its profits among its members. A portion of the profits becomes distributable among the shareholders when dividends are declared

Extent of Liability

In a partnership, the liability of the partners is unlimited. This means that every partner is liable for the debts of a firm incurred during the business of the firm. These debts may be recovered the partner’s private property if the joint estate is insufficient to meet the needs entirely

In a company that is limited by shares, the liability of a shareholder is limited to the amount, if any, unpaid on his shares. In the case of a guarantee company, the responsibility is limited to the amount for which the shareholder has agreed to be liable. However, there may be companies where the liability of a member is unlimited

Property

The firm’s property is that which is called a “Joint Estate” of all the partners. It does not belong to anybody distinct in law from its members

In a company, its properties are separated from that of its members who can receive it back only in the form of a dividend or a refund of the capital

Management

If there is no express agreement formed to the contrary, all the partners of the firm are entitled to participate in the control

Company members are not entitled to participate in management unless they are appointed as a director. In such a case, they may participate. Members, however, enjoy the right of attending general meetings and voting where they can decide specific questions such as the election of directors, appointment of auditors etc

Duration of existence

If no contracts are existing to the contrary, death, retirement or an insolvency of a partner that results in the dissolution of a firm

A company has the advantage of having perpetual succession

Partnership-an improvement over the  Sole-trade business

Registration of Partnership

As per the Partnership Act 1932, it is not compulsory to register a partnership firm. The firm does not have a separate legal identity and registration will not alter this fact. However, registration is the definite proof of the existence of the firm and its legality.

Non-registration of a firm has some real-life legal consequences for the partners and the firm itself. So it is always advisable to draw up a written partnership deed and register the firm with the Registrar of Firms. The consequences of not doing so are as follows,

  1. The firm cannot file legal proceedings against any third party for any situation. For example, if the client has not paid his dues to the firm, the firm cannot sue him if it is unregistered.
  2. An unregistered firm cannot fail a case against a partner for any reason (like mismanagement, theft etc)
  3. A partner of an unregistered firm cannot file a suit against one of the other partners either.

Procedure of Registration

According to the India Partnership Act 1932, there is no time limit as such for the registration of a firm. The firm can be registered on the date when it is incorporated or any such date after so. The requisite fees and fines must be paid. The procedure for such a registration is as follows,

1. Application to the Registrar of Firms in the prescribed form (Form A). Nowadays this facility is even available online. Such an application must contain certain basic details about the firm such as,

  • Name of the Partnership Firm
  • Name and address of all partners
  • Place of business (address of main and branch offices)
  • Duration of the partnership
  • Date of joining of partners
  • Date of commencement of business

2. The duly signed copy of the Partnership Deed (which contains all the terms and conditions) must be filled with the registrar

3. Deposit/pay the necessary fees and stamp duties

4. Once the registrar approves the application, the firm will be entered into the records. And the registrar will also issue a certificate of incorporation.

Provision related to Interest & Remuneration to Partners U/s. 40(b) of the Income Tax Act, 1961

Section 40(b) of Income Tax Act places some restrictions and conditions on the deductions of expenses available to an assessee assessable as a partnership firm in relation to the remuneration and interest payable to the partners of such firm. The deductions regarding salary to partners and any payment of interest to partners cannot exceed the monetary limits specified u/s 40(b) and are available subject to the fulfillment of conditions mentioned therein.

The following conditions must be satisfied before claiming any deduction in respect of salary/remuneration or interest payable to partner by a partnership firm.

1. Partner to be paid Interest & Remuneration must be a working partner

The partners of a partnership firm whose accounts are to be credited with the salary, remuneration, commission, and bonus or by whatever name called, by the firm, must be working partners and not the silent partners. Working partner in general terms means the partner who is actively engaged in the business of the partnership firm and is not a partner for merely enjoying the profits/benefits of the partnership business. If a partner is not a working partner then remuneration to such partner will not be eligible for deduction as per section 40(b) of Income Tax Act 1961. Explanation 4 to section 40(b) provides meaning of  working partner as an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner.

2. Remuneration or interest to Partners must be authorized by the Partnership Deed

As per section 40(b) only that salary, remuneration, bonus, commission etc payable to working partners or any payment of interest payable to any partner will be allowed as deduction only if it is authorized by the partnership deed. If the partnership deed does not contain such provisions then the deductions may be disallowed if the same is claimed by the partnership firm .

3. Quantification of remuneration to Partners in Partnership Deed is must

 

CBDT in its circular no. 739 dt 25/03/1996 have clarified that no deduction under section 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration.

Thus quantification of remuneration is required to be there in the partnership deed for it to be considered as authorized by the partnership deed and to avoid any disallowance u/s 40(b).

However In Commissioner of Income Tax Versus M/s. Anil Hardware Store [2010] 323 ITR 368 (HP) where remuneration clause in partnership deed was in line with section 40(b) and It was contended on behalf of the revenue that in respect of the profits upto Rs.75,000/-, even in the partnership deed, the word “upto Rs.50,000/- or 90% of the book profits” have been used which shows that the partnership deed does not exactly determine the remuneration of the partners. But it was held that “The CBDT circular referred to above lays down two conditions. Either the amount of remuneration payable should be specified or the manner of quantifying the remuneration should be specified. In the present case, the manner of fixing the remuneration of the partners has been specified.” Hence deduction was allowed.

4. No Interest & Remuneration to Partner to be allowed which relates to any period falling prior to the date of such partnership deed

As per section 40(b)(iii) the remuneration will be allowed as deduction only for that period onwards where from the partnership deed authorizes such remuneration. Thus if a Partnership deed is executed on 01-04-2009 which doesn’t authorizes payment of remuneration to the partners and subsequently the deed is amended by a subordinate partnership deed to provide for such authorization on 01-04-2010 then remuneration to partners will not be allowed for period between 01-04-2009 to 01-04-2010 since during that period it is not authorized by the deed.

Remuneration to Partners exceeding the limit prescribed u/s 40(b) to be disallowed

As per section 40(b)(v)  any payment of remuneration to any partner who is a working partner, which is authorized by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder will be disallowed

(i) on the first Rs.3,00,000 of the book-profit or in case of a loss Rs.1,50,000 or at the rate of 90 per cent. of the book-profit, whichever is more;

(ii) on the balance of the book-profit at the rate of 60 per cent.

Explanation 3 to section 40(b) defines “book-profit” as to mean the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit .

Any interest to any partner exceeding 12% disallowed

 

As per Section 40(b)(iv) any payment of interest to any partner which is authorized by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of 12[twelve] per cent simple interest per annum shall be disallowed. Thus payment of any simple interest to any partner is allowed only to the extent of 12% per annum as deduction as per section 40(b). Even if the partnership deed authorizes any payment of higher rate of interest than 12% to any partner, the excess of interest will not be deducted.

It is here to be noted that where remuneration/salary etc is allowable only to the working partners as per section 40(b)(iii) but payment of interest not exceeding 12% per annum is allowable to any partner whether working or not, since the word any partner is used in 40(b)(iv).


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