When it comes to starting a new a business, one of the key decisions you will need to make is choosing the right business structure for your needs. Business partnerships are not always the first option to be considered but can be very practical for some people. In fact, business partnerships make up the smallest group of small to medium sized businesses in the UK, whilst sole traders make up the largest percentage of businesses followed by limited companies.
What is a partnership?
A business partnership is a type of business structure where two or more people share responsibility for a single business. It is important to distinguish between the three types of partnership: general partnerships, limited partnerships and limited liability partnerships. For the purpose of this article, we will only be discussing general partnerships.
In many ways, a general partnership is similar to operating as a sole trader in that only self-assessment tax returns need to be completed as part of complying with tax obligations. Unlike the option of operating as a limited company, a general partnership is not seen as its own legal entity, which means all the people in the partnership are personally liable for the business.
Partnerships are most popular among people with close relationships wanting to start a business together. They are commonly seen between husband and wife, father and son or mother and daughter, siblings, or even friends. However, they are possibly the least popular option for business owners due to the complications that may arise if the personal relationship breaks down, or when one or more partners leave the partnership.
By setting up a business partnership, it allows you to share the costs, responsibilities, and risks with one or more people. Everything gained from the business, such as profit, is then also shared between partners unless other arrangements are agreed beforehand.
What are the advantages and disadvantages to operating a business as a general partnership?
Starting your own business can be both an exciting and daunting opportunity. It can therefore be reassuring or be the source of invaluable support when there are other people who are just as invested and involved in the business as you are. However, like all other business structures, partnerships have advantages and disadvantages that should be considered beforehand.
Advantages to setting up a partnership:
- It is much simpler to register a partnership with HMRC than it is to register a new company with Companies House and does not involve a fee
- There is significantly less form filling than operating as a limited company such as having to complete company tax returns, statutory accounts and confirmation statements.
- Your responsibility of managing a business is shared with others
- Setting up a partnership is simple, and a partnership agreement can be made verbally or in writing (however, we would always recommend creating a partnership in writing to minimise risk).
Disadvantages to setting up a partnership:
- All partners are personally responsible for the business, which means that if the business struggles financially, creditors can claim personal assets to pay off outstanding debts.
- Should a partner leave a partnership and the business continues, the remaining partners may become responsible for the entire debt of the partnership even where debts have been incurred by the partner that has left
- Partnerships are not required to be registered at Companies House and so other businesses or customers could see this as a risk due to lack of transparency
- Winding up a partnership is not as simple as ceasing to trade as you might do if you were a sole trader. It often involves going to court and paying court fees so can be expensive.
What tax and legal responsibilities does a general partnership have?
There are not as many tax or legal obligations that a partnership must conform to compared to limited companies. However, all partnerships must be registered with HMRC. Ongoing responsibilities include:
- Submit a partnership self-assessment tax return once a year
- All partners must complete their own self-assessment tax returns to declare income and pay income tax and national insurance contributions
- Draw up a partnership agreement (this is not mandatory, however, without one, you may be forced to follow regulations from the Partnership Act of 1890 which may not necessarily protect your interests
- Keep accounting records such as sales, purchases and expenses. You will need to be doing this for your self-assessment tax returns and partnership tax return anyway, but it is important to keep distinct records for the business and for your personal accounts. Moreover, you should ensure to keep these records for a minimum of 5 years should HMRC want to investigate into any historical tax returns.
How to set up a business as a general partnership
Setting up a business partnership is relatively simple and straightforward, which you can easily do yourself. However, thought and consideration should be made in the eventuality that you or other partners may want to end the business partnership at some point in the future, which is often where complexities and challenges arise.
- Choose your business partner(s)
Despite what the name may suggest, you can have multiple business partners in the same general partnership. Not only that, but a business partner can also be a limited company. The maximum number of partners allowed in a general partnership is 20 as outlined by the Partnership Act 1890, but you will often find exceptions to this in certain sectors such as law firms, accountancy practices, or estate agents.
Be careful when choosing someone to go into a partnership with, as you will be personally liable for any debts accrued by the business. You need therefore to be confident that your business partner is reliable, has aligned business goals and is prepared to work well with you.
- Choose a name for your partnership
To create an identity for your business, you can either use own names or a trading name. Personal names are very popular such as Davis and Sons or Smith and Williamson, but you may find yourself using the same name as someone else if it’s a very a common combination. Alternatively, you can use a trading name of your choice, but again, be aware that other businesses could use the same name as well. Unlike limited companies, general partnership trading names cannot be registered at Companies House to protect the name. The only way to do this as a partnership is to register the name as a trademark.
When choosing a trading name, there are rules you must adhere to:
- The business name cannot include the terms ‘limited’, ‘ltd’, ‘public limited company’ or ‘plc’
- General partnership names cannot include the terms ‘limited liability partnership’ or ‘lp’
- The business name cannot be offensive or use offensive terms or phrases
- It cannot be the same as an existing trademarksg. Marks and Spencer or Coca Cola
- Sensitive words such as ‘council’, ‘chartered’, ‘official’ or other terms that imply the business has a governed or special status cannot be used
- Draw up a partnership agreement
As mentioned above, this step is not mandatory but strongly recommended. A partnership agreement (or also referred to as a partnership deed) is a document which sets out the terms and conditions of how the partnership will operate. One of the biggest advantages of setting up a partnership is how flexible your arrangement can be, but this does mean it requires you to agree parameters. You should consider including the following details in your partnership agreement:
- How much capital each partner is contributing to the partnership and whether this dictates their share of any profits and/or losses
- Who the nominated partner will be (more on what a nominated partner is below)
- Any restrictions on partners to prevent conflict of interest
- Provisions in case of retirement, insolvency, misconduct or death of a partner
- Whether the partnership will admit new partners and how this will be achieved
- How disagreements or disputes will be dealt with
- What happens in the event that the partnership is dissolved
Partnership agreements do not need to be made in writing for them to be legally binding and relied upon in court. Some verbal agreements, including those which supersede a written agreement, can still stand in court depending on the actions of the partners. However, where possible, it would be prudent to make all agreements in writing as oral agreements are more often than not, extremely difficult to prove.
- Decide which partner will be the nominated partner
In all partnerships, there needs to be one nominated partner. This is the person who will take responsibility for registering the partnership with HMRC and completing the partnership tax returns. This does not mean that they automatically receive a bigger share of profits because they are taking on this responsibility, however it is possible that you decide this is the case. The nominated partner is simply the key contact for HMRC, but all partners will be liable should the partnership incur any penalties because the nominated partner was late to submit tax returns.
- Register your partnership with HMRC
The nominated partner should then register the partnership with HMRC. You will need a Government Gateway user ID and password to do this. If you are doing this for the first time and do not have one, it is easy to create a new one on the same page. If you are unable to register online, you can fill in form SA400 and send to HMRC.
You must register your partnership by the 5th of October in the business’ second tax year, or else you may face a penalty. For example, if you started a partnership during the 2020/21 tax year, you would need to register by 5th October 2021.
- Partners need to register for self-assessment
When the nominated partner registers the partnership with HMRC, they themselves will also be automatically registered for self-assessment. However, all remaining partners must register for self-assessment to declare any income they receive from the partnership. If you cannot register online you can use form SA401. Again, there is the same deadline as registering the partnership, so partners must register for self-assessment by 5th October in the second year they become a partner.
- Complete tax returns
Each year, you will need to adhere to the 31 January deadline to submit both the partnership tax return and self-assessment tax return for every partner. The partnership tax return declares the profits or losses of the partnership, as well as how any profits have been distributed amongst the partners. The partnership itself is not taxed. To complete the partnership tax return, the nominated partner will need to fill in and submit the SA800 form.
All partners in the partnership must submit their own personal tax return in addition to the partnership tax return. Income tax and national insurance contributions will need to be paid depending on the amount of earnings each partner has received from the partnership. Remember, partnerships can be divided in any way you see fit (as per your partnership agreement). This means that the personal tax returns of each partner may not be identical.
For example, three partners A, B and C are dividing a £100,000 annual profit. Partner A has 50%, Partner B has 35%, and the third has a 15% stake. They’d be taxed respectively on £50,000, £35,000 and £15,000. If some or all of the partners have additional sources of income, the total amount may mean that they fall into the higher or additional rate bracket for income tax.
- Register for VAT
Like any other business structure, whether that’s working as a sole trader or a limited company, where a partnership’s annual VAT-able turnover reaches the threshold of £85,000 they must register for VAT. Similarly, any partnership can voluntarily register for VAT before reaching this threshold where they are providing VAT-able goods or services. Once registered, the partnership must complete regular VAT returns to HMRC.
If you are considering how best to set up a new business with one or more other people and may be deciding between a partnership vs a limited company, then get in touch to arrange a free consultation to discuss the best structure for your needs.