An ordinary partnership, usually simply known as ‘partnership’, is legally defined by the Partnership Act 1890 as two or more people ‘trading in common with a view to profit’ and is the format normally chosen for a business that will be owned by two or more sole traders. This kind of partnership does not have to be registered with Companies House.
Each business partner has unlimited liability for the debts of the business. Partners are ‘jointly and severally’ liable, so each can be held responsible for transactions or contracts entered into by any of the others.
Partners are treated by HMRC as self-employed for tax purposes in the same way as sole traders, and they retain and share all their business profits after tax. They do not all have to be individuals, as a private limited company is treated in law as a ‘legal person’ that can also enter into partnership.
The below information explains the steps to take when setting up an ordinary partnership, including drawing up a partnership agreement, registering for tax self-assessment and choosing a business name. It also outlines record-keeping requirements.
Steps to take when setting up a partnership
There are various steps that should be taken when setting up a partnership, some of which are legal requirements while others are matters of best practice. Steps to take include drawing up a partnership agreement, registering for tax self-assessment, and choosing a business name.
Drawing up a partnership agreement
All partners have a common law duty of good faith, which means that they must act honestly and in the best interests of the partnership. However, because all partners are individually liable for the whole of the partnership’s debts and can be held responsible for acts of negligence or decisions made by other partners without their knowledge or agreement, it is essential, as best practice, to have a partnership agreement (also known as a Deed of Partnership) drawn up by a solicitor before starting to trade.
The partnership agreement clarifies each partner’s legal position and provides a framework for dealing with any problems that may arise. If there is no partnership agreement, the partnership will be governed by the terms of the Partnership Act 1890.
There are various important issues that need to be agreed at the outset and included in the partnership agreement. These include: how the profits will be shared (as they do not necessarily have to be divided equally); how business decisions will be made; and provision for the continuation or dissolution of the partnership upon resignation, retirement or death of a partner.
Registering for tax self-assessment
Partners are self-employed for tax purposes in the same way as sole traders and so do not receive a salary from which tax is deducted through Pay As You Earn (PAYE). Instead they draw money out of the business for their personal needs and pay tax and National Insurance under the tax self-assessment system.
Anyone who is required to declare their untaxed income, such as all new partners setting up a partnership, must contact HMRC (www.gov.uk/government/organisations/hm-revenue-customs) to register as self-employed for tax self-assessment when starting up. Failing to register can result in a penalty of £100 and further penalties for trading illegally and not paying tax.
The partnership and each individual partner (including partners that are limited companies) must all be registered for tax self-assessment with HMRC, and one person must be designated as the ‘nominated partner’ who is responsible for keeping the business records and managing the partnership’s tax returns.
As best practice, partnerships must register for tax self-assessment with HMRC as soon as possible after starting to trade. There is a legal requirement to register, at the latest, by 5 October after the end of the tax year for which a tax return is needed. For example, anyone starting to trade between April 2015 and March 2016 must register by 5 October 2016.
The registration process takes at least 10 working days to complete as it involves HMRC posting a 12-digit activation code, which is required when logging on to the online account.
The partners must each declare their income through an individual self-assessment tax return annually, and pay any tax and Class 2 and Class 4 National Insurance Contributions (NICs) that are due in January and July each year. A partnership tax return must also be filed by the nominated partner.
The partnership tax return includes a partnership statement summarising its business profits and losses, and the drawings and payments allocated to each partner. The nominated partner must give each partner a copy of this statement, so they can complete their personal self-assessment tax return. Go to www.gov.uk/government/publications/self-assessment-partnership-tax-return-sa800 for guidance about completing partnership tax returns.
Partnership and individual self-assessment tax returns can be filed either online using HMRC-approved specialist software or by post. While it is the responsibility of the nominated partner to complete the partnership tax return, all partners may face a penalty if the partnership tax return is late.
The partners can retain and share any profits that remain after payment of tax. Because it is not a separate legal entity, the partnership does not have a separate tax liability in addition to the partners’ personal tax liabilities.
If it appears that the partnership’s turnover will be more than the mandatory VAT registration threshold in any 12-month period, the partnership must also be registered for VAT. The VAT registration threshold is announced in the Chancellor’s annual Budget and usually changes every April.
Choosing a business name
Naming a business is an important consideration for anyone starting a new partnership. The partners must comply with strict rules governing the use of business names.
A partnership can trade under the names of the partners, for example Smith and Jones, or choose to use a ‘business name’, which is any trading name different from all the partners’ names, for example ‘Hungry Café’.
Although ordinary partnership business names do not need to be registered, they must meet certain legal requirements. In particular:
- They must comply with restrictions on certain ‘sensitive words.’ These include words that imply a particular status (e.g., ‘Tribunal’, ‘Institute’) or a connection with Government, as well as words that could be offensive.
- They must not be too similar to any registered business name.
- They must not contain inappropriate name endings – such as ‘Limited’, ‘Ltd’ or ‘plc’ if the business is not registered as a limited company.
- They must not mislead the public in any way.
If the business name does not include the surnames of all the partners, these names must be clearly displayed at the business premises and on all business stationery, communications and websites.
Partnerships with more than 20 partners don’t need to list all the partners’ names, but must supply the address of the principal place of business where a list can be obtained.
Accurate financial records must be kept to enable partnership and individual tax returns to be completed. Records must be kept for a specified period of time in case HMRC asks to inspect them.
The nominated partner must keep records of all business income and expenditure, as well as details of money drawn by and payments allocated to partners. Individual partners must also keep records of all income that they receive (including personal investment or other income). These records must be kept for at least five years after 31 January in the year following the end of the tax year to which they relate.
VAT records relating to all sales and purchases must be kept for at least six years if the business is registered for VAT.
If the business employs staff, PAYE records must be kept for at least three years after the end of the tax year they relate to.
Hints and tips
- Professional legal or financial advice should be taken before choosing the legal status of a business.
- It is important to consult a solicitor and draw up a partnership agreement before setting up an ordinary partnership.
- Business owners may start up as an ordinary partnership and change their legal status at a later date. For example, they may choose to become a limited company or a limited liability partnership.
- It is important to register for tax self-assessment as soon as possible and to allow plenty of time as the registration process takes at least 10 working days to complete.
- Self-assessment can be made easier by getting accounts prepared as soon as possible after the year end to help calculate tax liabilities.