Introduction - Carson & Trotter

1 Partnership taxtaxb-tg-bk-en-GBOctober 5, 2012 - 09:41352 All Rights ReservedPage 1 of 16 IntroductionA business partnership is a relationship between two or more persons who are in businesstogether with a view to making a pro t. Those persons may be individuals, companies or possiblyeven existence of a partnership is a question of fact. There does not have to be a writtenpartnership agreement, but it is preferable to formalise the relationship between the partners ina written agreement to avoid future disputes, which sadly are all too common with written agreement is also useful in cases where HM Revenue & Customs (HMRC) disputes that apartnership conventional partnership is not a legal entity in England and Wales, unlike a company. It cannotexist separately from its members. Even where it is a legal entity as in an LLP (see below), formany tax purposes it is treated as being transparent.

2 Every partner is jointly and severally liablefor all debts and obligations of the partnership while they are a , tax on partnership pro ts is not a joint liability of the partnership. Instead, each partneris taxed individually on their share of pro ts and is liable only for the tax and national insuranceon that limited liability partnership (LLP) is a separate legal entity that combines the organisational exibility of a partnership with the limited liability of a company. The pro ts of an LLP are taxedlargely in the same way as those of a conventional income tax, capital gains tax (CGT), inheritance tax (IHT) and value added tax (VAT) rules forpartnerships are broadly similar to those for sole traders. There are special stamp duty land tax(SDLT) rules that deal with certain partnership transactions involving chapter outlines the key issues that are peculiar to of partnershipTypes of partnerThere are ve main types of partner in a conventional partnership: Afull partner, also known as an equity partner, is a partner in every sense of the word.

3 Sucha partner shares the pro ts or losses, is liable for all partnership debts and takes part in themanagement of the business. Asalaried partneris normally an employee of the partnership and pays tax under the PAYE system. Salaried partners often appear as full partners to outsiders. However, they aregenerally employees whom the rm wishes to promote but who are not yet readyfor the bene ts and liabilities of full partnership. Salaried partners can be taxed on a self-employed basis if they are in effect fullpartners. Key indications of this would be having capital at risk and acting with fullauthority, rather than under the direction and control of other partners. Alimited partnercannot take part in the management of the partnership. As the namesuggests, the liability of that partner for partnership debts is 5, 2012 - 09:41353 All Rights ReservedPage 2 of 16 A limited partner is not to be confused with a partner in an LLP (see the separatetopic Partnership tax ).

4 A limited partner is a member of a conventional partnership in which at least oneother member is a full partner. The tax rules restrict the partnership trading losses that limited partners can reclaimagainst their other income to the amount of their capital at risk, and capped at 25,000 per tax year. Any excess losses can be carried forward and set against the individual s share ofpro ts from the partnership in subsequent years. A limited partner s share of pro ts is treated as unearned income rather than earnedincome. The main effect of this is that the pro t share is not treated as relevant UK earningsfor the purpose of supporting pension contributions. Asleeping partnerhas unlimited liability for the debts but is otherwise treated for taxpurposes as a limited partner. Acorporate partneris a partner that is a limited company. Such a partner pays corporationtax on its share of pro ts computed, broadly, using corporation tax and wife partnershipWhere a spouse or civil partner would otherwise have little or no income, a couple could achievesubstantial tax savings if business pro ts can be shared between them rather than taxed as theincome of one spouse only.

5 For this reason, HMRC will sometimes look closely at a husband andwife partnership. It is important to be able to demonstrate that a partnership is genuine and notsimply a way of transferring income between spouses. General points that can help in establishing that a genuine partnership exists include: A deed of partnership expressing the intention to carry on the business with acommon view to pro t, and giving details of the way in which pro ts are shared. Accounts prepared in accordance with the agreement. The Introduction of capital by the new partner, if a spouse joins an existing businessof the other spouse. The capital introduced could be either cash or assets. Bank account mandates, VAT registration, business stationery, etc. showing thenames of both partners. Introducing a spouse as a partner is not always possible or desirable. In some professions, all members of a partnership must be suitably quali ed.

6 The husband or wife could instead be an employee, which could also providetax-saving opportunities, but care must be taken to ensure that the salary paid is notexcessive for the work done. There is also a national insurance cost if the salary is more than the nationalinsurance earnings threshold ( 144 a week for 2012/13). HMRC has tried to use the settlements anti-avoidance legislation to attack variousarrangements for transferring income from a working spouse to a non-working spousewithin companies. In their guidance to the settlements legislation, HMRC argued thatwhere a non-working spouse receives a disproportionate share of pro ts compared totaxb-tg-bk-en-GBOctober 5, 2012 - 09:41354 All Rights ReservedPage 3 of 16the contribution made to the partnership, the working partner may be taxed on thenon-working partner s pro t share. However, in its Trusts and Estates manual HMRC states: Where the incoming partner is a spouse or civil partner and he or she acquires anunlimited share in the partnership assets and income and there are no other arrangementsor conditions applied to the gift then the exemption for outright gifts will apply and achallenge under the Settlements legislation is not appropriate.

7 Limited liability partnership (LLP)In a conventional partnership, partners, other than limited partners and most salaried partners,have joint unlimited liability for business debts. Although insurance provides some protection,partners are at risk of having to forfeit personal assets if a claim against the rm exceeds thepartnership assets plus its insurance cover. An LLP provides a means of restricting that liability. An LLP is a separate legal entity, which is liable for business debts up to the value of itsassets. Claims can normally be made only against the LLP, not against the individual partners. An individual partner could still have personal liability, but this is likely to occur only wherea partner has been negligent and had assumed personal responsibility for the advice. Other partners cannot normally be made liable for the consequences of one partner snegligence.

8 Although LLPs are of most interest to larger partnerships, any partnership of two or morepersons (including an individual and a company) can register as an LLP by submitting anincorporation document to Companies House. An LLP s accounts must be lodged with Companies House, so that anyone can check on thepartnership s nancial position. In contrast, such information about a conventional partnership is only available to outsiderswith the partners permission. Partners in an LLP are taxed on their pro ts and gains on disposals of partnership assets inthe same way as partners in a conventional partnership. Although the LLP is a separate legal entity, it is not taxed as such, except after it goes intoliquidation. At that point it is taxed as a company. There is a restriction on loss relief for members of an LLP carrying on a trade, and some taxexemptions and reliefs are not available to members of a property investment LLP or aninvestment LLP.

9 Many of the rules concerning ling of annual returns and accounts apply to LLPs as they doto service partnershipsA partnership can be taxed as an intermediary under the personal service company legislationcommonly known as the IR35 rules . The rules come into play where a partnership provides theservices of one or more individuals to a client in such a way that if the individual worked directlyfor the client under the same terms, they would be taxed as an employee under the normalrules for distinguishing employment and self-employment. Such contracts are called relevantengagements .taxb-tg-bk-en-GBOctober 5, 2012 - 09:41355 All Rights ReservedPage 4 of 16 The intermediary partnership has to operate PAYE on income received from a relevant engagement,minus some very limited expenses, where: The worker (on their own or with relatives) is entitled to 60% or more of the pro ts, or Most of the pro ts of the partnership come from work for a single client, or The individual s income from the partnership is based on the income generated personallyfrom relevant amount that is subject to PAYE is called the deemed payment.

10 The deemed payment plus the employer s national insurance contributions (NICs) on it isthe income from relevant engagements less the permitted expenses. The amount of the deemed payment is not included when computing the individual s shareof partnership pro practice most partnerships, other than those where the partners are close relatives, will notfall within these rules. For example, a partnership will be outside the rules if it has two unrelatedpartners who share pro ts equally, and it does not receive most of its pro ts from one a partnership would fall within the rules, there may be scope for ensuring that the termsof contracts under which work is carried out takes them outside the de nition of relevantengagement .Partnership tax return Under self-assessment, the partnership must submit an annual partnership tax returnshowing: Full details of all partners.