A Partnership is all about the agreement between the partners. Any agreement between two or more parties is shaped in a manner that it makes the win-win situation for all. Similarly, the Partnership Agreement must protect the interest of all partners. If you are a partner of the firm, before rushing to register a Partnership Firm, you must know which clauses are the part of this agreement and which you must check carefully to see your interest.
Let’s talk about the general and essential clauses in a Partnership Agreement or Partnership Deed and what you must take care while drafting these clauses:
Investment is, of course, part of the business and so does the most partnerships exist. The Capital clause provides what a partner will invest to start or run the business.
Where partners mostly focus only on cash contribution, it also covers contributions in form of assets. For example: For example: providing a business place to the firm for use without rent. This is also a contribution in form of capital asset. It can also be inventories or vehicles or goodwill – all these can be counted in contribution, too.
Note these points on Capital Clause:
- Decide what amount is required and when will it be introduced
- It is not compulsory to contribute. One may contribute “n” amount of capital and other may not need to contribute at all. It is a mutual agreement between the partners only.
- Capital can be cash or otherwise. If the assets are contributed, they must be valued to ascertain the contribution.
Clauses on Returns to Partners
The ultimate goal is to get returns from the business. The partners receive three different types of returns with a different purpose.
The fundamental objective of the partnership is to share the profit from the business activity. The partners would mutually decide that in which ratio the profit is distributed. The ratio can be as agreed by the partners. If there is no ratio provided in the partnership deed, the profit will be distributed equally among all partners. Provision to be noted here is that partners would have to contribute in the same ratio in case of loss.
The ratio can be decided on whatever basis the partners want to. Generally, it is based on the contribution by each partner in capital and business operations.
Interest on Capital
The partners have contributed the cash or assets (which are recorded in monetary value). Every partner that has contributed capital in the partnership firm may receive the interest on capital. The interest will be paid at the rate provided under the respective clause. Remember that:
- To pay interest on capital, the Partnership deed must authorise the payment and provide the rate of interest.
- The maximum interest allowed under Income Tax Act for deduction is simple interest at the rate 12% p.a.
Remuneration includes any salary, bonus, commission, or remuneration (by whatever name called) paid to a partner. Remuneration is a return to partner’s inputs in business operations and management like any employee. So, only working partners are eligible for remuneration from Partnership firm.
The Income Tax Act also provides the maximum remuneration allowable for deduction:
- In case of loss and book profit up to INR 300,000, it is higher of INR 150,000 or 90% of Book Profit
- In case, book profit is exceeding INR 300,000, it is maximum to 60% of Book Profit
Rights and Duties
Partners are the distinct persons who come together for business, maybe with different goals. Defining their rights and duties can help to direct partnership ion a right track. Outlining these clauses would favour partners in the long term as the specification is the key to accessing any right and assigning any responsibility.
Rights & Powers
Defining the rights and powers would be important for every partner. The rights can either be expressly provided by execution of Deed or it is implied by course of dealing. If there are any specified rights or powers for any partner, it must be enlisted in the Deed itself. For example, compared to working partners, the silent partners may have lesser powers.
Duties & Responsibility
If the partners are working equally and actively, their roles and responsibility would be the same. But the Partnership Deed should address the specified role assigned to partners. Thus, if there is any distinctive partnership, duties of partners must be ascertained in advance. Where departmental control is assigned to partners, their responsibilities would also be varied.
Disputes and conflicts are part and parcel of any agreement. It may not be foreseen now, but let’s not forget we can’t see future?! Dispute resolution is never a consideration while the formation of a partnership, but it must be. It may not always be major disputes, but even a small dispute is a matter of resolution. The partners have to decide the mechanism of dispute resolution at the time of formation only. Small conflicts can be resolved through voting or other similar methods. But major conflicts require specific attention and standard resolution methods. Many choose to approach courts where other chooses to prefer arbitration. This can also be decided mutually.
What you need to understand is that you must refer your dispute to an Arbitrator first, if you choose to put an Arbitration Clause in your partnership deed. The court may also direct you to first approach an Arbitrator.
Formation of a partnership is anyways an agreement between partners. There are certain clauses that must be incorporated in the Partnership Deed and requires special attention. Further, based on the needs customised clauses can also be added in the Partnership Deed. The partners have to carefully check the whole Partnership Deed before proceeding to register a Partnership Firm. Like any other agreement, Partners can also change Partnership Deed anytime with mutual consent of all partners.
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