Partnership taxation and associated rules

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There are few restrictions on who can be a partner. Both natural and artificial persons, such as companies, can be partners. It is not a requirement of partnership that each member is physically capable of performing the full range of the activities of the partnership business, but each must be capable of performing a part of the activities, even if that role is only to provide finance. A partner who plays no active part in the business but has contributed capital is often described as a ‘sleeping partner’.

There may be occasions when a person is described as a partner but is, in actual fact, an employee of the business. For example, the title may be given for prestige. ‘Salaried partner’ is the term usually used to describe such an employee. It is important to be aware, however, that the term may also be used to describe a person who is an actual partner, rather than an employee. For example, the term may be used to describe a partner who receives a first share of the firm’s profits. Whether or not a person is a partner or an employee will depend on the facts.

Spouses and civil partners can enter into partnership with each other. Sometimes this is done for tax planning reasons as it may be advantageous for a person to share their business profits with his or her spouse to maximise the use of their personal allowances and basic rate tax bands. HMRC is unlikely to challenge such an arrangement.

Minor children – Although partnerships involving minor children are rare, in law, a person under the age of eighteen may be a partner provided that they have the intellectual capacity to understand the nature of the business and the obligations of partnership. The age at which they reach this point will vary according to the individual and the business. Whether they become a partner is a question of fact. A minor, though, is not liable for any debts of the firm.

Under Scottish law, a person under the age of 16 is highly unlikely to be considered to have legal capacity to enter into a partnership, however (Age of Legal Capacity (Scotland) Act 1991, sections 1 and 2).


Types of partnership

A general partnership is governed by the Partnership Act 1890. All partners of a general partnership are general partners and bear joint liability without limits for debts of the partnership.

A Limited Partnership (LP) is regulated by the Limited Partnership Act 1907 and must be registered at Companies House. As an overview, a Limited Partnership is one in which at least one of the partners restricts their liability for the debts and obligations of the firm to a pre-determined sum; such partners are known as the limited partners. A Limited Partnership must have at least one general partner who manages the business and bears unlimited liability to creditors. Limited partners must not take part in the management of the partnership business in order to preserve their limited liability.

A Limited Liability Partnership (LLP) is governed by the Limited Liability Partnership Act 2000. It must be registered at Companies House and have at least two designated members who have specific additional duties in respect of Companies House requirements, such as the filing of partnership accounts, charges and so on. In law, an LLP is a body corporate and has many similarities as a business structure to a limited company, whilst still providing the organisational flexibility offered by the partnership model. Members of an LLP have limited liability for the partnership debts to the extent of their capital contributions and, unlike limited partners of an LP, they are free to take part in management of the business. However, LLPs which are carrying on a trade or business are subject to the tax rules for partnerships rather than companies.


Taxing the profits of a business carried on in partnership

For tax purposes, a partnership is not regarded as a separate and distinct entity and we ‘look through’ to the persons making up the partnership. Partnerships are described as ‘transparent’ for this reason. This treatment applies equally to all types of partnership, including both those without separate legal personality, e.g. English general partnerships, and those with separate legal personality, e.g. Scottish partnerships and Limited Liability Partnerships. Statutory provisions exist to ensure that partnerships with separate legal identity are taxed in the same way as general partnerships.

Under this principle, partnerships have no tax liability. It should be noted, however, that profits of the partnership are computed at partnership level before being apportioned to the members. Partners are liable to tax on their share of profits from the partnership.

This treatment is in contrast to how ‘opaque’ entities, such as companies, are taxed; an opaque entity is itself liable to tax on its income and gains.

However, the partnership (that is all the partners jointly) is responsible for meeting some tax debts, such as PAYE and VAT.


Partnership Taxation: profit sharing arrangements

Profits, losses or other income may be shared as the partners may mutually agree from time to time. Partners are free to agree the sharing ratios between them, although the allocation of profits or losses for an accounting period cannot be varied retrospectively after the end of that period.


Overview of how partnerships are taxed

Although the partnership has no tax liability, a partnership return (SA800) is required in order to determine the partnership profits on which the partners will be taxed. The partnership return allows all matters relating to the calculation of profits and their allocation between partners to be dealt with centrally. Separate tax computations will be required where the partnership has mixed membership, such as individual and company members or UK resident and non-UK resident members.

Each partner must declare their share of the partnership profits on their own tax return. The share of profits that a partner enters in their own return must correspond with the allocations shown in the partnership return. However, in exceptional cases of genuine disagreement between the partners over the allocation of profits, partners should enter, as their share of partnership profits, the amount they consider to be correct and advise HMRC that they have done so by making an entry in the white space notes section of the return to show:

  • the profits as allocated in the partnership statement,
  • a deduction (or addition) of the disputed amount, and
  • an explanation about why they think the profit allocated to them in the partnership statement is wrong.


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