Starting a business is a significant step, and forming a partnership firm in India is a popular choice for entrepreneurs who wish to bring together talent, resources, and capital. Partnership firms provide flexibility, shared responsibilities, and a range of tax benefits. In this post, we’ll cover the basics of starting a partnership firm in India, including the Taxation and Compliance for Partnership Firms steps, and tips for managing a partnership successfully.
Partnership firms are businesses run by two or more partners Only partnership firms, and not companies or LLPs, enjoy certain unique benefits, such as flexibility in business operations and profit-sharing structures.
Formation of a Partnership Firm:
– To start a partnership firm, you need at least two legal persons (e.g., individuals or companies) as partners.
– Partners can contribute assets or money, but there are no strict capital requirements or profit-sharing limits.
– The firm’s rules (like profit-sharing, partner roles, and capital contributions) are usually written in a “Partnership Deed,” which serves as a legal document to prevent future disputes.
Types of Partnership Firms:
There are two types: Registered and Unregistered. Although most firms in India are unregistered, registering offers benefits, such as the ability to file lawsuits in the firm’s name and buy assets under the firm’s name.
Registration Process:
Registration requires basic documents like Aadhaar IDs and a Partnership Deed. This deed is typically stamped (for example, on Rs. 2000 stamp paper in Rajasthan), notarized, and uploaded to the Registrar of Firms. Additionally, if the firm doesn’t yet have its own address, a rent agreement may be used as a temporary address.
Read This Also: Partnership Firm Registration Guide
Capital and Profit Distribution:
Capital: Partners contribute capital in the form of cash or assets. For instance, if one partner brings a laptop or desktop or other required accessories and the other partner contributes cash, both count as capital.
Profit-sharing: Profit doesn’t have to match each partner’s capital contribution; partners decide on the sharing ratio themselves.
Partners can also lend money to the firm, unlike in proprietorships where a sole person cannot loan to themselves. Firms can pay partners interest on their capital at a maximum rate of 12%, which is tax-deductible for the firm.
Taking Money Out of the Firm:
There are multiple ways for partners to receive payments:
Interest on Capital: Partners can earn up to 12% interest on their contributions, which counts as personal income and is taxable.
Remuneration/Salary: Based on Section 40 of the Income Tax Act, partners can receive a salary based on the firm’s “book profit” (the profit after deducting interest). For example, up to 90% remuneration can be given on the first Rs. 3 lakh of profit.
Profit Share: Any remaining profit after tax can be distributed among partners, tax-free at the individual level since the firm has already paid tax on it.
Changing Partners in a Partnership Firm:
Partnerships are flexible; partners can enter or exit based on mutual understanding. If a partner wants to leave, the other partners or a new partner can buy out their share based on the firm’s current value. Partnerships can add or remove partners by updating the partnership deed in India.
Compliance and Legal Requirements:
Shops and Establishment Act: Registration under this act may be needed depending on the state.
Professional Tax (PT): Paid for partners, and once employees are hired, PT is paid for them as well.
Labor Welfare Fund (LWF): Required in some states, like Maharashtra.
TDS and TAN Compliance: For making payments to vendors or employees, firms need a TAN for tax deduction at source (TDS) compliance.
Income Tax: Firms pay 30% tax on profits, file annual returns, and pay advance tax every three months.
Special Tax Benefits for Partnership Firms:
Partnerships benefit from Section 44AD, which simplifies tax on cash transactions. For example, 8% tax applies to cash and 6% on digital transactions, making compliance easier.
GST Compliance:
Firms engaged in service activities register for GST if their annual turnover exceeds Rs. 20 lakh, while those trading goods register at Rs. 40 lakh. Registration isn’t mandatory below these limits.
Audit Requirements:
Audits are required if the firm’s turnover exceeds certain thresholds. For non-cash businesses, this threshold can go up to Rs. 10 crore.
Partnership firms are a flexible way to do business, offering tax benefits and easy profit-sharing. However, partners should understand the liability differences between a traditional partnership and an LLP, as LLPs offer limited liability, making them better for riskier ventures.
If you have more questions, consult a Chartered Accountant or legal expert to ensure your firm is fully compliant and tax-efficient. Following these guidelines will set your partnership firm in India up for success
