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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 which is owned and managed by more than one person. The partners are jointly responsible for all aspects of the business and will share the profits.

What business structures can I choose?

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

Sole trader

Sole trader: This business structure is for individuals who set up on their own (a one-man band), it includes people who work in the building trade, such as plumbers, electricians and joiners, but can also include people working in service industries, such as hairdressers, IT consultants or bookkeepers.

A sole trader is responsible for all areas of the business, which includes:

  • completing all jobs or services to the customers’ satisfaction
  • finance, paying all associated costs and ensuring the customers pay on time
  • marketing and selling.

They will receive all of the rewards of the business (profits) but are also responsible for taking risks and incurring costs (liabilities).

A sole trader must register with HMRC (Her Majesty’s Revenue and Customs) under self-assessment and complete an annual self-assessment tax return. Both income tax and national insurance are payable on profits.

Partnership

Partnership: This business structure is for two or more individuals who work in business together. Partnerships were set up for professions such as doctors, dentists and solicitors but they cover a wide variety of other industries such as the building trade and beauty providers. Partners are jointly responsible for all areas of the business and will often specialise in a particular area.

For example, a partnership in the building trade may have different partners with expertise in plumbing, plastering, electrical work and general construction. In a hair and beauty salon, one partner may be a trained hairdresser and another a trained beautician. Partners will split all of the rewards of the business (profits) but are jointly responsible for taking risks and incurring costs (liabilities).

A partnership must register with HMRC under self-assessment and complete an annual self-assessment tax return for the partnership. The individual partners must also register for self-assessment and complete their own individual self-assessment tax returns. Both income tax and national insurance are payable on each partners share of their profits.

Private limited company (Ltd)

Private limited company (Ltd): The owners of a business (whether they be sole traders or partnerships) may decide to form a private limited company at any time. It could be from the date the business starts, or any point in time once the business has been established. Private limited companies must have at least one director and one shareholder, in a small business they are often the same person.

A limited company is a separate legal entity. Shareholders will only lose the value of any amounts they have invested in the business (i.e. the share capital).

Directors are responsible for the running of the company and will often receive a salary which is deducted from the profits of the business. Shareholders receive dividends based on how the company performs.

Registration of a limited company must initially be done through Companies House, who will then inform HMRC (Her Majesty’s Revenue and Customs). Limited companies pay Corporation Tax on their profits.

Why should I choose a partnership?

There are a number of questions to be answered before deciding on whether or not to choose a partnership as a business structure:

  1. Who will carry out the work? Will it be split in accordance with areas of expertise?
  2. How are the profits going to be divided? Will each partner have an equal share or will the arrangement be more complicated? Note – if no partnership agreement exists the profits will be shared equally between the partners.
  3. What are the benefits of going into business with others, will the rewards outweigh the risks?

Entering into a partnership with one or more people should mean that a business can offer more specialisms and the workload should be spread amongst the partners. Although profits must be shared, it should be easier for partners to have time off and they can share and pool ideas.

How do I earn income from a partnership?

A partners’ income is calculated in the following way:

Calculate the partnership profit

In the partnership accounts allowable business expenses are deducted from the income to arrive at the profit.

For example:

 £
Income100,000
Expenses(40,000)
Profit60,000

Split the profit – example one

The profit is split between the partners in accordance with their agreement. This may simply be an equal share to each partner.

For example, in a three partner business the profits will be split as follows:

 £
Profit60,000
Partner A’s share20,000
Partner B’s share20,000
Partner C’s share20,000

Split the profit – example two

The profit is split between the partners in accordance with their agreement.

For example, in a four partner business the partnership agreement states that the split is:

Partner A – £10,000

Partners B and C – 45% each of the remaining profits

Partner D – 10% of the remaining profits:

 £
Profit60,000
Partner A’s share10,000
Partner B’s share22,500
Partner C’s share22,500
Partner D’s share5,000

 

What tax will I pay?

Partners will pay income tax on their share of the profits (the rate and amount will be dependent on whether or not they have other sources of income).

What are my responsibilities?

Partners are jointly responsible for the filing of the partnership self-assessment tax return and registering for VAT if the VAT registration limit is reached. HMRC must be informed if there is any change to the existing partnership (i.e a partner joins or leaves).

What are my risks if the business fails?

If the business fails you may be liable for the debts of the other partners, therefore it would be advised to seek legal advice before entering into a partnership.