In this blog post, Turab Chimthanawala, a visually challenged student, completing his Company Secretary course from Nagpur describes the process of conversion of a sole proprietorship into a partnership firm.
For any person desirous of commencing entrepreneurial activity, there are various forms of business available. These include sole proprietorship, partnership, joint stock company, cooperative society and the like. Depending on the nature and scale of business one has to take a call on the form of business to be adopted.
What is Sole Proprietorship?
A sole proprietorship is the oldest and by far the simplest and most convenient form of business.
Ease of formation, less legal compliances, secrecy of operations and complete control are some of the reasons which compel new entrepreneurs with relatively scarce resources to start as a sole proprietor. However, in order to expand their operations, to raise more capital and get more managerial and technical ability, sole proprietors often consider converting their ventures into partnerships.
However, the Indian Partnership Act 1932 does not contain extensive provisions to convert a proprietorship into partnership. Hence, one has to enter into a fresh partnership. It may be noted that in the partnership deed one can incorporate a recital in the partnership deed which provides that the proprietorship ‘s assets are transferred at book value to the partnership and that the partnership shall carry on the business of the sole proprietor. As a result, the sole proprietorship shall be dissolved.
Incorporation of a Partnership
While incorporating into a partnership, the following points are to be kept in mind:
- Members: Inorder to form a partnership there should be a minimum two members, i.e., the proprietor shall have to induct at least one more person into the business. Also, the number of partners shall not exceed ten in the case of banking and twenty in the case of other businesses.
- Agreement: The Partnership Act, 1932 defines partnership as a relationship between persons agreeing to share profits arising from a business carried on by all or any one of them acting for all. Thus, the Act nowhere mandates the entering into a written agreement. However, for commercial convenience and bring in greater clarity in working, generally a partnership agreement is reduced into writing. Moreover many laws require a partnership agreement to be in writing and to be registered. Also, a partnership can only arise from a contract, not from the status. The relation between partner, i.e., partnership arises from a valid agreement, i.e., contract. It must be voluntary and contractual. It may be express or implied.
- Partnership deed: The partners shall have to draw up a partnership deed. This is like the Charter of the business. It shall include the object of the business, the rights, and liabilities of the partners, profit sharing ratio, etc. It vitiates proper drafting so as to spell all necessary facts relating to the business and inter se relations among the partners. The Partnership Deed created by the partners should be on a stamp paper in accordance with the Indian Stamp Act, and each partner should have a copy of the partnership deed. The following points deserve consideration while drafting a partnership deed:
- Name and place of business.
- Duration of the partnership.
- Shares of each partnership in the profits and losses of the business.
- The management of the business.
- Nature of principal work agreed to be carried on in partnership.
- The number of partners and initial capital employed by each one of them.
- Provision and the manner for raising future capital, if required.
- Work distribution, if any, of each of the partners.
- The obligation of partners who are members of a partnership firm.
- The operation of Bank Accounts.
- Withdrawal by partners.
- The accounting system of the business.
- Whether place of business belongs to a partnership or any individual partner.
- Division/Devolution of goodwill of the business in case of dissolution of a partnership.
- Distribution of assets and liabilities amongst partners at the time of dissolution.
- Provisions for bringing in or admitting new partners.
- The effect of the death of a partner, whether his heirs will take his place, or the partnership will be continued by the remaining partners, or it will stand dissolved.
- Provision for resolving disputes relating to a partnership if a dispute arises amongst the partners.
- Registration: Registration of partnership is not mandatory. However, it is generally advisable to get it registered with the Register of Firms since the following rights are denied to an unregistered firm:
- A partner cannot file a suit in any court against the firm or other partners for the enforcement of any right arising from a contract or right conferred by the Partnership Act
- A right arising from a contract cannot be enforced in any Court by or on behalf of an unregistered firm against any third party
- The firm or any of its partners cannot claim a set off (i.e. mutual adjustment of debts owned by the disputant parties to one another) or other proceedings in a dispute with a third party.
- Profit sharing ratio: This is one of the most integral points to be decided while incorporating a partnership. This ratio is generally contained in the partnership deed. However, it shall be noted that if the partnership deed is silent about the profit sharing ratio, then the partners shall share profits equally. Also, the profit sharing ratio is independent of the ratio of capital contribution by the partners. Unless otherwise provided the sharing of profits includes the sharing of losses as well. However, in certain cases, a person may be admitted to only the profits of the firm such as a minor.
- Mutual agency: This is the true test of partnership. It means all partners are both principals and agents of other partners, i.e., they are bound by the acts of others and bind other partners by their actions.
- Name: The partners are free to choose any name as they desire for their partnership firm subject to the following rules, like:
- The names must not be too identical or similar to the name of another existing firm doing similar business so as to lead to confusion.
- The name must not contain any words which indicate any patronage or relation of the Government of India or any State Government.
- Minor: A minor is incompetent to contract. Hence, it is not lawful for him to become a partner. However, he may be admitted to the profits of a partnership without being subject to any liability or having to incur any losses. This is a unique feature of a partnership and distinguishes it from other forms of business.
A partnership firm can be registered whether at the time of its formation or even subsequently. An application has to be filed with the Registrar of Firms having jurisdiction in the area in which the principal office of the business is located.
Application for partnership registration should include the following information:
- Name of the partnership firm
- Name of the principal place of business
- name of other places of business
- Date of partners joining the firm
- Full name and permanent address of partners.
- Duration of the firm
Every partner needs to verify and sign the application. Ensure that the following documents and prescribed fees are enclosed with the registration application:
- Duly filled Specimen of Affidavit
- Certified copy of the Partnership deed
- Proof of ownership of the place of business or the rental/lease agreement thereof
Once the Registrar of Firms is satisfied that the application procedure has been duly complied with, he shall record an entry of the statement in the Register of Firms and issue a Certificate of Registration. The firm shall have to make an application to the Income Tax Department for a separate PAN.
After obtaining a PAN Card, the Partnership Firm would be required to open a Current Account in the name of the Partnership Firm and operate all its operations through this Bank Account.
The partnership firm shall also have to apply for registration under other statutes such as Central Excise Act, Customs Act, Sales Tax Act, Shop and Establishments Act and the like depending on the nature of the business.
It may be noted that conversion of proprietorship into a partnership is a subjective matter and varies on a case to case basis. Let’s look at some common instances where proprietors decide to convert his venture into a partnership.
Case Study A:
Mr. A a proprietor trades in pharmaceutical products in the name and style of ABC Medicos in Nagpur. Now, owing to increased competition he desires to diversify into manufacturing. However, due to lack of finance, human resource and technical capability he is unable to launch the same on his own. Hence, he desires to enter into a partnership with Mr. Y a pharmacist.
They decide to launch the new venture in the old name ‘ ABC Medicos.’ Mr. Y shall bring a capital of Rs. 500,000 and Rs. 400,000 as goodwill. The assets of the erstwhile proprietorship shall be revalued at their market value and be transferred to the new firm. An amount equivalent to the value of the assets shall be credited to Mr. A’s capital account. They shall share profits equally. They shall then draw up a partnership deed and get it registered with the Registrar of Firms Mumbai. They shall make an application for a new Permanent Account Number. Also, fresh registration under Central Excise Act, Central Sales Tax Act, MVAT, Shop, and Establishment Act shall be obtained. A new current account shall be opened in the name of the firm.
Case Study B:
A lawyer Mr. X has a flourishing practice in company law in Mumbai. Now, inorder to offer a complete package to his clients and to gain a competitive advantage he wants to broaden his base and offer consultancy in other allied laws such as Security Laws, Taxation, FEMA, etc. However, bereft of requisite technical and managerial ability he wants to enter into a partnership with Mr. Z a prominent Tax consultant and Mr. Q an expert in Security laws.
Since they all are established practitioners, they shall share profits equally. Moreover, now they shall run their business under a new name, i.e., ‘Corporate Consultants’. The assets of each of the partners including books, journals and intellectual property apart from office furniture shall now vest in the new firm. The assets shall be revalued, and an amount equivalent to the market value of the assets brought in by each partner shall be credited to their individual capital accounts. To avoid any conflicts and discords in future, they shall draw up a partnership deed and get it registered with the Registrar of Firms Mumbai.
The partnership deed shall contain a covenant in the recitals stating the fact of the proprietors merging their individual entities into a partnership and shall specify the value of assets brought by each partner. They shall then obtain a new Permanent Account Number for the firm and open a fresh bank account in its name.
Case Study C:
A proprietor Mr. B runs a hotel in the name and style of ‘ Yummy Cuisines’ in Nagpur.
After enjoying great success in Nagpur, he wants to expand to other cities in Maharashtra. Hence, he decides to induct his two friends Mr. W and Mr. C who have recently graduated in his business. Thus, they decide to enter into a partnership. The assets of the earlier business will be revalued and transferred to the new firm at their market value, and the equivalent amount shall be credited to Mr. B’s capital account.
Mr. W and Mr. C will bring goodwill equivalent to the market value of the assets of the business plus an additional amount representing the brand value or goodwill of the erstwhile proprietorship (which can be calculated by any reliable method such as Superprofit method, Average profit method). They shall share profits in the ratio of B:W:C 2:1:1. They shall draw up a partnership deed and get it registered with the Registrar of Firms Mumbai. The deed shall contain a covenant specifying that Mr. B has transferred the assets of the proprietorship to the new firm, and the proprietory concern is hitherto dissolved. They shall then obtain a new Permanent Account Number for the firm and open a fresh bank account in its name. Also, a separate registration/license shall be obtained from the Food and Drug Authority.
Case Study D:
A proprietor Mr. T is carrying a wholesale cloth business in Nagpur since 20 years in the name and style of ‘ T Fashions’. Now, he decides to induct his daughter Ms. S and minor son Master. R in the business. Hence, they shall have to enter into a partnership.
Since Master R is a minor, he shall be only admitted to the profits. He cannot bare any loss or liability. Hence, it is decided that 10% of profits after tax shall be disbursed to Master R and the remaining profits shall be shared equally by Mr. T and Ms. S. They shall draw up a fresh partnership deed and get it registered with the Registrar of Firms Mumbai.
The assets of the erstwhile proprietorship shall be revalued at their market value and be transferred to the new firm, and the proprietorship shall be hitherto dissolved. An equivalent amount shall be credited to Mr. T’s capital account. Since it is a family concern, the new inductee are not required to bring in any goodwill. A separate Permanent Account Number shall be obtained. A new bank account shall be opened. Also, separate registration under MVAT shall be obtained.
Partnership as a form of business has really stood the test of time. The Indian Partnership Act, 1932 has been so lucidly drafted that it hardly required any amendment. The credit must go to the draftsmen of those times. The partnership is so practical and convenient, the only aspect remaining of limited liability.
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