Partnerships

Fundamentals

You may wish to set up a Partnership as your business structure. A Partnership is where two or more people set up in business together. A formal Partnership Agreement should be in place setting out all the rules, policies and procedures as to how the partnership is to operate.

Unlike a limited company or LLP a partnership is not a separate legal entity. Each partner is self employed and takes a share of the partnership profits. The partners are taxed in a similar way to sole traders and this income is liable to tax at their marginal rate.

As this is not limited liability, as a partner you will be personally liable for any debt of the partnership. It is recommended therefore that you should only form partnerships with people you can really trust.

A partnership is where two or more people set up a business together, sharing the risks, costs and responsibilities of being in business. Each partner is self-employed and takes a share of the profits. Usually, each partner shares in the decision-making and is personally responsible for any debts that the business runs up. Unlike a limited company, a partnership has no legal existence distinct from the partners themselves. If one of the partners resigns, dies or is declared bankrupt, the partnership must be dissolved. However the business can still continue.

A Partnership Agreement should be in place to set out the rules as to how the partnership is to operate. In order to avoid any misunderstanding or uncertainty this should cover all aspects in respect of financial matters, how the business is run and any contingency arrangements to be agreed upon. These could include for instance the Partnership capital, the financial arrangements including profit-share arrangements and drawings on account, banking arrangements, accounting arrangements and the provision for tax payments. The Agreement would also include details of each Partners´ duties, the decision making procedures, matters surrounding the business premises and the working hours and all holiday arrangements. The contingency arrangements would include arrangements when a partner retires and providing for dependants, in the event of the death of a partner, or a partner becoming disabled as well as for disputes with partners including the right to a partner being expelled and the business valuation procedures.

It is recommended that a Partnership Agreement is drawn up by a legal adviser.

Managing a Partnership

Partners themselves usually manage the business although they can delegate responsibilities to employees. Partners finance the business out of their own assets and/or with loans. Some partnerships have ‘sleeping’ partners who contribute money to the business but are not involved in running it.

When a partnership business is formed this must be registered with HM Revenue & Customs (HMRC). Each partner needs to register as self-employed – see the page in this guide on self-employment.

As a partner in a business you are taxed on your share of the partnership profits for the tax year, similar to the way a self-employed individual is taxed. The taxable profits of the partnership is based on the the profit and loss account figures. The income will be liable to tax at your marginal rate.

Payments on account of income tax and Class 4 NIC will be due on 31 January and 31 July. These interim payments will be based on one half of the total liability (less any tax deducted at source). You will have the right to reduce payments on account if you believe the income tax for the current year is less than the previous year. Interest and surcharges will be levied for late payment.

In the first year of the business, or your first year as a partner of an existing business, you will not have made payments on account towards your tax liability, as these are based on the previous year’s tax liability. This means that the first tax bill can potentially be a bit of a shock as this is a full year’s tax and NIC, plus a payment on account towards the following year. After a period of time of not having paid tax this, at the same time can be an unpleasant surprise!

If a partner’s spouse works in the business, the wages are an allowable deduction, provided they are actually paid and are a reasonable reward for what is done.

Over the lifetime of your business the profits should be taxed in full, once, and once only. The general rule is that the tax for a particular tax year is based on the profits of the twelve months to your accounting date in that tax year. For instance, the tax for 2015/16 could be based on accounts for a year ending on various dates ranging from 6 April 2015 to 5 April 2016. By having a year end on 30 April this allows more time for the tax to be worked out.

In the first tax year of your business, the tax payable is based on the profit arising between the starting date (or the date you joined the partnership) and the following 5 April. For example a partnership starts up on 1 June 2015 and the first accounts run to 30 June 2016 with a profit of £30,000 shared equally between the two partners the tax is calculated to the nearest month on the profits of the following periods:

Period Calculation Profits
2015/16 1 June 2015 to 5 April 2016 10/13 x £30,000 £23,076
2015/16 1 July 2015 to 30 June 2016 12/13 x £30,000 £27,692

Each partner is then allocated his share of the amounts taxable on the partnership for the two years. The profit from 1 July 2015 to 5 April 2016 (9 months) has been taxed twice on each partner. The ‘overlap’ profit is however available for deduction when the partnership comes to an end, or one of the partners leaves the firm. Overlap profits also change when the partnership changes accounting date. In a partnership, overlap profits are personal to each partner, rather than applying to the firm as a whole, as each partner will generate overlap profits on joining the firm, depending on his share of the profits at the time he joins.

In calculating taxable profits the Partnership may claim deductions in respect of any expenses incurred “wholly and exclusively” for the purposes of the trade. All expenses must be included in the profit and loss account as it is not possible to deduct expenses from the partners’ share of the profits after allocation between the partners.

Equipment or motor vehicles purchased by a partner will be deductible on a proportion of the cost each year they are owned and used in the business. Claims for such capital expenditure are known as Capital Allowances. If partners take stock for their own use, the disposal should be shown in the accounts at market value, and not at original cost.

You are also liable to National Insurance Contributions (NIC), Class 2 and Class 4 contributions. The fixed rate Class 2 NIC is (currently) £2.80 a week and is currently payable on 31 July and 31 January each year in line with payments on account and final payments due under Self Assessment. Class 4 NIC is also payable. The amount of Class 4 is based on your annual profit and is payable together with your income tax under Self Assessment.

With regard to Class 2 contributions you must notify HMRC by 31 January after the end of the tax year in which you became a partner. You may register online, by telephone or by using the form (CWF1) incorporated in leaflet SE1 (Are you thinking of working for yourself?). If you do not register your liability to Class 2 contributions you will be liable to a penalty of up to a maximum of 100% of the lost contributions for deliberate failure; concealed failure 70% and all other cases the penalty is 30%. However no penalty will be charged if there is a reasonable excuse for failing to notify.

With effect from 6 April 2018 Class 2 NIC will be abolished and  only a newly reformed Class 4 NIC will be due.

It is essential that you make proper provision to ensure the availability of funds to pay income tax and Class 4 NIC. Interest on unpaid tax is chargeable by HM Revenue & Customs, and is not deductible from business profits.

VAT

You may chose to register your business for VAT. Businesses with a turnover currently above £83,000 (from 1 April) are required to be VAT registered. The rate of turnover is reviewed and effective from 1 April each year.

As a VAT-registered business you have to complete a VAT return form for each tax period, usually every three months. This details how much VAT you:

  • have charged your customers
  • have been charged by your suppliers
  • owe HM Revenue & Customs or are owed by them

You will be sent your VAT return form towards the end of your tax period. You must return the form and payment (if appropriate), normally no later than one month after the end of your tax period.

PAYE

If you employ and pay staff you will have additional responsibilities as an employer which could include a number of returns needed to be prepared and made to HMRC each month/quarter and at the end of each tax year. These include:

  • P60 End of Year summary (for each employee)
  • P11D Return of Expenses and Benefits (for each employee)
  • P11D (b) Employer Declaration of Return of Expenses and Benefits

If the business pays deductions for PAYE and NIC to HMRC of more than £1,500 per month you must make your payments monthly. If the business pays less than £1,500 per month to HMRC, you may make payments on a quarterly basis. You should use form P31 to tell HMRC you want to pay every three months.