Partnership Business – How Does The Tax Work?Written on June 25, 2019 by Kirk Rice LLP
The Question:
A friend and I are planning to set up a new business as a partnership. However, I am not clear how the partnership will be taxed and how we split the tax bills between us. How is tax dealt with in a partnership?
Kirk Rice LLP answers:
In essence, a partnership comprises two or more individuals who own and run the business together. From an income tax point of view, we treat a partnership in the same way as a sole trader but with one additional step: we must share the tax adjusted profits or losses for an accounting period between the partners before we can then calculate the tax bills arising for each partner.
The important point to realise is that a partnership does not pay tax, but rather the individual partners are separately taxed on their share of profits arising. Profit calculations are an important part for you to consider. Some partnerships split profits equally and others use a ‘salary’ allocation first, and then split remaining profits equally. The term ‘salary’ in this situation is not to be confused with a salary subject to PAYE like an employee, rather it is merely a mechanism for allocating profits between the partners.
Taking an example, let’s assume John and Michael have been trading as the XYZ Partnership for the last year. John works full time in the business, whereas Michael works only 3 days per week. They therefore have agreed that John will draw a partner’s salary of £10,000 per annum and Michael £6,000 with all remaining profits being drawn equally. If the business makes a total profit of £30,000 then John will receive £17,000 (£10,000 salary and 50% of the remaining profits i.e. £7,000) and Michael will receive £13,000 (£6,000 salary plus £7,000 profits).
John and Michael will then pay tax and national insurance on their respective totals which is £17,000 for John and £13,000 for Michael.
Whilst setting up a business in partnership is a legitimate way forward for you, I do suggest that you also consider trading through a limited company as well. The tax treatment is completely different with companies, but there may be good commercial reasons to do so as well as potentially some tax benefits over a traditional partnership.
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Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The information is based on current legislation which may change in the future.
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