4 min read

Should I set up my business as a partnership?

When you start a business (or if you expand a current business) you have a choice as to what business structure to operate under, a partnership being one of those structures.

What is a partnership?

A partnership is a business structure in which two or more people share responsibility for running a business and share in its profits.

There are different types of partnership. This article focuses on ordinary business partnerships, which are the most common form of partnership for small businesses. Other structures, such as Limited Liability Partnerships (LLPs), operate under different legal and tax rules.

 

 

 

What business structures can I choose?

There are typically three common types of business structure for a small business. 

Sole trader

A sole trader is a self-employed individual who owns and runs their business personally. This structure is commonly used by tradespeople, consultants, freelancers and many service-based businesses.

A sole trader is responsible for all aspects of the business, including:

  • delivering products or services to customers
  • managing finances and paying business expenses
  • marketing and selling
  • complying with tax and legal obligations

The sole trader keeps all business profits after tax but is also personally responsible for any business debts and liabilities.

Sole traders must register with HMRC as self-employed and are usually required to submit a Self Assessment tax return. They pay Income Tax and may need to pay National Insurance contributions based on their profits.

Partnership

A partnership is a business owned and run by two or more people who share responsibility for the business and its profits.

Partnerships are common across many sectors, including professional services, construction and personal care businesses. Partners often bring different skills and experience to the business and may divide responsibilities between them.

In an ordinary partnership, the partners jointly own and manage the business, and share the profits. The partnership itself is not usually treated as a separate legal entity, and the partners are jointly responsibility for the business’s debts and obligations.

The partnership must register with HMRC and submit a partnership tax return. Individual partners must also submit their own Self Assessment tax returns and pay tax on their share of the partnership profits.

The rights and responsibilities of each partner can be set out in a partnership agreement, which helps clarify how profits, responsibilities and decision-making will be shared.

Private limited company (Ltd)

A private limited company (Ltd) is a separate legal entity from the people who own and run it.

A company must have at least one director and at least one shareholder. In many small businesses, the same person acts as both director and shareholder.

The company is responsible for its own debts and obligations. In most circumstances, shareholders’ personal liability is limited to the value of their investment in the company.

Directors are responsible for managing the company and ensuring it meets its legal and reporting obligations. Company owners may take money from the business in different ways, including salary and dividends.

Limited companies must be registered with Companies House. They are generally required to file annual accounts, confirmation statements and Corporation Tax returns. The company pays Corporation Tax on its taxable profits.

Why should I choose a partnership?

A partnership can be an attractive option if you want to start or run a business with one or more other people.

The advantages of a partnership include:

  • Shared responsibility. Partners can divide the workload and take responsibility for different areas of the business.
  • Complementary skills and experience. Partners may bring different expertise, helping the business offer a wider range of products or services.
  • Shared decision-making. Partners can support each other and contribute ideas to help develop the business.
  • Shared costs and risks. The financial commitment and risks of running the business can be shared between the partners.
  • Business continuity. It may be easier for the business to continue operating when one partner is unavailable, as other partners can help manage day-to-day activities.
  • Simple to set up. Partnerships are generally easier and less costly to establish than a limited company.

Before entering into a partnership, it is important to agree how profits will be shared, how decisions will be made and what will happen if a partner wishes to leave the business. Because partners are generally jointly and severally liable for the partnership’s debts, it is also important to choose business partners carefully and put a written partnership agreement in place to help avoid misunderstandings and disputes in the future.

The disadvantages of a partnership include:

  • Shared profits. Profits must be divided between the partners according to the agreed arrangements.
  • Joint and several liability. In an ordinary partnership, each partner can be held personally responsible for the partnership’s debts. If one partner cannot pay their share, the other partners may be required to cover the full amount owed.
  • Potential disagreements. Differences of opinion between partners can affect decision-making and the running of the business.
  • Shared control. Major business decisions may require agreement from other partners.

How do I earn income from a partnership?

Partners earn income through their share of the partnership’s profits.

The partnership calculates its profit by deducting allowable business expenses from its income. The resulting profit is then divided between the partners according to the partnership agreement.

For example, if a partnership generates income of £100,000 and has allowable business expenses of £40,000, the partnership profit would be £60,000.

The way this profit is shared depends on the agreement between the partners. In some partnerships, profits are divided equally. In others, partners may receive different shares based on factors such as their responsibilities, experience, capital investment or time committed to the business.

If there is no partnership agreement in place, profits are generally shared equally between the partners.

What tax will I pay?

Each partner is responsible for paying tax on their share of the partnership’s profits.

Partners normally pay Income Tax through Self Assessment and may also need to pay National Insurance contributions, depending on their profit levels and personal circumstances.

The amount of tax a partner pays will depend on their share of the partnership profits, any other sources of income they receive and the tax rates and allowances that apply for the relevant tax year.

The partnership itself does not normally pay Income Tax. Instead, each partner is taxed individually on their share of the partnership’s taxable profits, regardless of how much money they withdraw from the business.

Depending on your income and circumstances, you may also need to comply with Making Tax Digital (MTD) for Income Tax, which requires eligible taxpayers to keep digital records and submit information to HMRC using compatible software.

Because tax rules and allowances can change, it is important to check the latest HMRC guidance or seek professional advice if you are unsure of your tax obligations.

What are my responsibilities?

As a partnership, you must:

  • register the partnership with HMRC
  • submit a partnership tax return each year
  • keep accurate business records
  • register for VAT if the business exceeds the VAT registration threshold or chooses to register voluntarily
  • inform HMRC of significant changes to the partnership, such as partners joining or leaving

In addition, each partner is responsible for:

  • registering for Self Assessment (where required)
  • submitting their own Self Assessment tax return
  • paying any Income Tax and National Insurance contributions due on their share of the partnership profits
  • complying with MTD for Income Tax (depending on income and circumstances)

Although partners may divide responsibilities between themselves, they remain jointly responsible for ensuring that the partnership meets its legal and tax obligations.

Business records should be kept safely and securely. HMRC has rules about how long records must be retained, and records may need to be kept for longer in certain circumstances.

What are my risks if the business fails?

In an ordinary partnership, the partners are generally jointly and severally liable for the debts and obligations of the business.

This means that if the partnership cannot pay its debts, each partner can be held personally responsible for the full amount owed. If one partner is unable to meet their share of a debt, the other partners may be required to cover the shortfall.

As partners are personally liable for the actions and decisions of the partnership, it is important to choose business partners carefully and to have a written partnership agreement in place that sets out each partner’s responsibilities and how the business will be run.

If your partnership is experiencing financial difficulties, it is important to seek professional advice as early as possible.