It’s very likely your status as a taxpayer will change several times throughout your working life. As an employee, having tax deducted at source through PAYE makes your tax affairs relatively straightforward. But when your entrepreneurial spirit drives you to set out on your own, and you become responsible for reporting income and paying tax yourself, things become a little more complex.
Depending on whether you decide to operate your business as a sole trader, a partnership, or a limited company, the way your tax is calculated, how you pay it and when it’s due for payment will be different. And as your business evolves, you may well opt to move between models to suit your changing needs and optimise your tax efficiency.
In this blog, part of a series looking at the essentials of how tax works in different business models, we consider tax from the perspective of partnerships.
A partnership is a business structure in which two or more partners make an agreement to operate and share ownership of a business together. A partner can be an individual or a separate legal entity such as a limited company.
There are two main types of partnership to choose from:
- Ordinary partnership
Also known as a ‘general’ or ‘self-employed’ partnership, this is the easiest type of partnership to set up and the simplest to administrate. The key thing that differentiates an ordinary partnership from a Limited Liability Partnership (see below) is that it is not a corporate legal entity but simply a relationship between its partners. In addition to sharing any profits the partnership makes, all partners have joint liability for any debts incurred – without any limit. In the event of the partnership being sued, individual partners may find themselves personally pursued by creditors.
Many partnerships start out as ordinary and progress to become limited.
- Limited Liability Partnership
A limited liability partnership (LLP) combines the benefits of a private limited company with the structure of an ordinary partnership, providing partners with a degree of protection from liability.
An LLP is a more formalised arrangement than an ordinary partnership, requiring partners to register the business as a limited company with Companies House and HMRC.
As the name implies, partners are only liable up to the level of investment they have in the partnership. As a legal entity in its own right, an LLP can own assets and take out loans.
In both types of partnership – unless agreed otherwise – all partners will be involved in managing the business and taking decisions, and profits and losses will be shared between partners based on their percentage ownership.
How & when are taxes paid?
Because a partnership is distinct from its partners, the only taxes that a partnership is liable to pay directly are those associated with payroll if it has salaried employees (i.e., PAYE and National Insurance) and VAT if the partnership’s turnover exceeds the compulsory registration limit (£85k) or it chooses to register voluntarily.
Partners in an ordinary partnership or an LLP have responsibility for paying their own income tax based on their share of any profits or losses made by the partnership.
Each year, all partners will receive a copy of the accounts for the partnership and a copy of the partnership’s annual tax return (see below). They will also receive a personal statement setting out their share of the profits and details of any adjustments made. Partners will need to pass this information on to their accountant, who will require it when they complete a tax return on their behalf.
From this point on, the procedure for individual partners to declare their earnings and pay any tax due is the same as it is for any self-employed person. For more information about tax and self-employment, please refer to our blog Tax Essentials #1: The Sole Trader
Filing obligations on partnerships
In addition to individual partners having to file their own tax returns, there is also a legal requirement for a partnership to file its own tax return: An obligation that can sometimes catch out new partnerships – especially those with numerous partners.
There’s a danger that having submitted individual tax returns, partners may overlook filing a return for the partnership. It’s an error that can have costly consequences. If the filing deadline is missed, HMRC will issue each listed partner – as well as the partnership itself – with a £100 fine.
For ordinary partnerships, the deadline for filing a partnership tax return is 31st January, following the end of the tax year in which the partnership had its financial year-end. For a new partnership, this might mean having to file a tax return for a year in which it didn’t trade for a full 12 months.
Note: Changes coming into effect in 2023 mean all small businesses – including unincorporated partnerships – will be taxed on profits arising in a tax year, rather than on profits of accounts ending in the tax year. For more information, see Self-Employed Sole Traders & Small Businesses: Get Ready for Change to Tax Reporting Periods!
Things are slightly different for LLPs, which, in addition to filing a partnership tax return, also have a legal obligation to file their accounts with Companies House. They must do this nine months after the end of their financial year, meaning they will have two different filing deadlines to meet.
Are you in the process of setting up a new business and wondering if a partnership is the right structure for you? Are you weighing up the pros and cons of an ordinary partnership versus an LLP and need help deciding which model would best suit your situation? Perhaps you’re already operating a partnership and have a question about tax – or another aspect of your finances.
Whatever the nature of your partnership-related query, we can help. Get in touch with one of our advisors today.