Business organisations can take many forms like company, partnership, joint ventures etc. One of the most common and popular form of business organisation is partnership. Two or more persons can enter into partnership. Formation of partnership is a very simple process. Statutory compliances involved are very less as compared to formation of corporates and LLPs. Time and cost involved is also not huge. Partnership is supported by a partnership deed. Partnership deed is like a legal agreement between all partners which conveys their right, obligations and sharing of profits/losses etc
The partners collectively are called ‘firm’ and individually as partners.Partnership is carried on with the intention to make profits. Partnership deed can be oral or written. It is always advisable to have written registered deed in order to avoid conflict as oral agreements does not carry legal value To start a business we need to introduce funds into it. The funds in case of partnership business will be introduced by partners and this becomes the capital of partners in the partnership firm.
The partners would be getting interest on capital as mentioned in the partnership deed. There is no restriction on the maximum or minimum interest which can be given to partners but maximum allowable interest on capital for tax purpose is 12% p.a
Similarly for efforts to run the business, partners would be remunerated in the form of salary, commission or bonus etc. Profits/losses will also be shared between the partners as decided by them mutually. Apart from above, the firm can charge the partners on the amount withdrawn by them (as per partnership deed)
Types of Capital
Partners can maintain capital accounts in two ways- fixed capital and fluctuating capital.
If the capitals are fixed, we maintain two types of accounts for partners- One is capital accounts showing original capital introduced or withdrawal of the same capital.Current accounts will show the amount due to the partners on account of salary, interest, commission, share or profit/losses etc. If capital are fluctuating then only one Capital account is maintained and all amount due including original capital introduced will be shown in this account.
Treatment of Interest on capital
Interest on capital can be considered as an expense for the business/charge against the profits OR appropriation of profits If the firm is having profits/losses, and interest on capital is treated as charge against the profits, then it has to deducted. The profits/losses after deducting interest on capital will be distributed to partners in profit sharing ratio. But if the interest is treated as an appropriation of profits OR if the partnership agreement is silent as to the treatment of interest on capital.
In case of losses, interest on capital will not be deducted.
In case of profits, full interest on capital will be provided.
If the firm is having profits but such profits are not sufficient to cover interest on capital (i.e amount of interest on capital> profits available for distribution to partners), then such profits will be distributed to partners in capital ratio.
Admission or Retirement of a Partner
The procedure specified in the partnership deed has to be followed to admit a new person as partner in a firm or when an existing partner retires from the firm.
If there are two partners and one of them wishes to retire, then the partnership will come to an end. The other partner who wishes to carry on same business alone will have to form a proprietorship concern. Otherwise a new partner needs to be admitted before the existing partner retires to continue the same partnership firm.
Usually the procedure specified is simple, consent of majority or all partners is required to admit a new partner in the firm.
A new agreement needs to be drafted and registered as there is change in Profit sharing ratio and other terms and conditions for carrying the business.