Meaning, Features of Partnership and the Partnership Deed

A sole trader runs a business alone and takes all the profit, but also carries all the risk and all the work alone. The moment two or more people decide to run a business together and share what it earns, the law needs a clear definition of what that relationship actually is — that definition is what Section 4 of the Indian Partnership Act, 1932 provides: partnership is "the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all." Persons who have entered into partnership with one another are individually called partners and collectively a firm; the name under which the business is carried on is the firm name.

Breaking that definition down gives the essential features every partnership must have:

• An agreement. Partnership always arises out of an agreement between two or more persons — it is never created by status, inheritance, or operation of law the way, say, a Hindu Undivided Family is. The agreement may be oral or written, but a written one (the Partnership Deed) is always the safer, more practical choice.
• At least two persons. A single person cannot form a partnership with himself. Tamil Nadu, like every other state, follows the Companies Act's cap borrowed into partnership practice: a partnership carrying on banking business is limited to 10 members, and any other business to 50 members (as prescribed under the Companies (Miscellaneous) Rules).
• Business. The persons must be carrying on a business — some trade, occupation, or profession — not simply co-owning an asset. Two people who jointly inherit and rent out a house are co-owners, not partners, because there is no business.
• Sharing of profits. The business must be carried on with the object of sharing profits among the partners. An agreement to share profits is strong evidence of partnership, though sharing profits alone (say, paying a manager a share of profits as remuneration) does not by itself make someone a partner.
• Mutual agency. This is the feature that most distinguishes partnership from every other form of business: the business must be carried on by all the partners, or by any of them acting for all. Every partner is both a principal (bound by what other partners do) and an agent (able to bind the firm by his own acts) in the ordinary course of the firm's business. It is mutual agency, not merely profit-sharing, that is the real, legal test of a partnership.

Although Tamil Nadu's Samacheer Kalvi Class 12 Accountancy syllabus and textbook are the state's own, the double-entry principles behind partnership accounting — profit-sharing, interest on capital, and the maintenance of partners' capital accounts — are the same well-established accounting principles taught in commerce curricula right across India, including CBSE/NCERT Class 12 Accountancy; only the illustrative numbers and textbook wording differ from state to state.

The Partnership Deed

Because partnership rests on agreement, it makes enormous practical sense to put that agreement down in writing. A Partnership Deed is a written document containing the terms and conditions of partnership as mutually agreed among the partners. It is not compulsory under law — an oral partnership is perfectly valid — but a deed is what prevents a disagreement over money from becoming a dispute over memory. Once signed by all partners, stamped as required under the Indian Stamp Act, and (optionally) registered with the Registrar of Firms, it governs the day-to-day accounting and legal relationship between the partners.

A well-drafted deed typically covers:

• Name and address of the firm and of each partner, and the nature/place of business.
• Amount of capital to be contributed by each partner, and whether capitals are to remain fixed or are allowed to fluctuate.
• The profit-sharing ratio among the partners.
• Rate of interest on capital and interest on drawings, if any is to be charged or allowed.
• Salary or commission payable to any partner(s) for extra work done for the firm.
• Interest to be allowed on a partner's loan to the firm, if different from the statutory rate.
• Duties, powers and rights of each partner; the procedure to be followed on the admission, retirement or death of a partner, including how goodwill is to be valued and treated.
• The method of preparing accounts and the date on which the firm's books are closed each year.
• The procedure for settling a dispute among partners, and for dissolving the firm.

Why does all of this matter for an accountant rather than only a lawyer? Because almost every accounting entry this chapter deals with — interest on capital, salary to a partner, sharing of profit, interest on drawings — has no fixed, universal rule of its own. It exists only because, and exactly to the extent that, the deed says it exists. Reading the deed correctly is therefore the very first step of every partnership accounting problem; get the deed's terms wrong, and every rupee that follows is wrong too.