Chris Thorpe explores some aspects of running a business through a partnership.
A partnership is defined (by Partnership Act 1890, s 1(1)) as ‘the relation which subsists between persons carrying on a business in common with a view of profit’.
There is a large body of partnership law, which I will not be going into here in any detail, but suffice to say that in England, Wales and Northern Ireland an ordinary partnership is not regarded as a separate legal entity, whereas in Scotland it is.
For tax purposes, however, the partnership throughout the UK does have its own identity for administrative (and VAT) purposes; it has its own unique tax reference number for self-assessment and completes a separate return for reporting profits/losses; but the partners, not the partnership itself, are responsible for paying income and capital gains tax on their share of profits.
Limited liability partnerships
There are other types of partnerships that have different legal characteristics. The limited liability partnership (LLP) was introduced throughout the UK in April 2001 and is now a very popular vehicle for professional firms in particular.
The LLP is a separate legal entity and gives ‘members’ (as LLP partners are called) the protection of limited liability and removes the burden of joint and several liability (a central feature of a partnership), whilst retaining the flexibility of an ordinary partnership. For all their legal differences, LLPs are treated in just the same transparent way as ordinary partnerships under UK tax law.
Tax implications
Like a sole trader, a partner will be taxed on their share of the profits at their own marginal income tax rate, irrespective of their actual drawings from the business. Limited company profits are subject to a flat 19% corporation tax rate, with the directors/shareholders facing income tax liabilities only on those profits actually withdrawn. Unless a partnership is an LLP, each partner faces potentially unlimited liability, not only from creditors, but also from the vagaries of the economy; in the current climate, the lack of limited liability could mean the shirt off one’s back!
In addition, like a sole trader, a partner is automatically deemed to be self-employed for tax purposes, usually for employment law purposes too, which may have implications for job security, rights to pensions etc.
Partnership flexibility
An implication of having a partnership without an express agreement is that the Partnership Act 1890 makes certain assumptions about the business which may be undesirable; for example, when one partner dies, the partnership is automatically dissolved! The presumption is also that profits are split equally, as is capital ownership of partnership assets. This also hints at one of the main advantages of the partnership.
A partnership is effectively like a bare trust rather than having any limited company attributes; so as far as profit distribution is concerned there is much more flexibility than there is with dividends and respective shareholdings. If the partners so decide, one partner can have more or less profit than the others, or none, or a fixed share. There are some limitations on this for partnerships with corporate members, and generally the settlements legislation will ensure any excess partnership profit allocations are rectified, but the flexibility on a year-by-year basis in still there. Besides the partnership’s self-assessment tax/VAT returns, there are neither further compulsory compliance requirements nor potential benefit-in-kind issues for the equity partners.
Practical tip
A partnership is a vehicle that offers a great deal of flexibility, but the limited company has many features that would suit some businesses better, from all perspectives. Each business, with its own characteristics, prosperity, risks and profit withdrawal policies, will need to consider which is more suitable.
