Partnerships: A summary of the basics

A partnership is formed by an operation of law, when two or more persons carry on a business with a view to making a profit. "Persons" can include individuals, trusts or companies. Care needs to be taken that a partnership is not formed inadvertently, making each of the partners joint and severally liable for each other’s liabilities.

We explain the intricate details of partnerships, including the different types, and the risks and benefits these provide.

A partnership agreement defines the terms under which the business trades, and without a formal written agreement, the terms set out in the Partnership Act 1890 will apply. For example, the Act dictates that a partnership automatically comes to an end on the death of a partner, which can cause significant issues.

A written agreement specifically excluding that section means the partnership can continue; we always recommend a written partnership agreement is drafted on formation of a partnership to prevent unwelcome surprises. Normally the clarification provided by a partnership agreement is needed most when partners fall out, where an agreement written in advance can be invaluable.  

Depending on its structure, a partnership can be a general partnership, limited partnership (LP) or limited liability partnership (LLP).  There are also Scottish partnerships and foreign partnerships, which are outside the scope of this note. 

In a general partnership, all partners are responsible for the management of the business and are jointly and severally liable for the partnership’s debts.  In theory, this means unlimited liability.

A general partnership is simpler to set up, with fewer compliance obligations than LPs and LLPs. 

A less common structure of partnership, where at least one partner, often a company, has unlimited liability for the partnership’s debts. The remaining partners are known as limited partners, whose liability is restricted to their contribution. Limited partners (sometimes referred to as silent partners) must not take any part in the management of the business and have no authority to make binding decisions on behalf of the partnership.  Should they do so, they lose the protection of the limited liability status.

Such a structure can be ideal when investment is required for a short-term project, such as property development. The general partner will manage the project in return for a share of profits.

A limited partnership must be registered with Companies House; otherwise, unlimited liability will automatically apply to all partners.

Another formal structure, but one which is regarded as a separate legal entity, unlike a general or limited partnership. All partners’ liabilities are restricted to their contribution to the partnership. Formation documents are required, which must be submitted to Companies House. Annual accounts and annual returns must also be filed with Companies House. 

Whichever legal form a partnership takes, it has its own identity for administrative purposes and so must file a tax return to outline the profits or losses of the partnership business. A partnership business is, however, transparent for tax purposes, such that the partners are assessed on their own entitlement to income and gains through their self-assessment tax returns.

Whilst a general partnership is the simplest in terms of creation and administration, the spectre of joint and several liability often steers people into the protection of LLPs and LPs. Each situation is different and there is no blanket answer.

Each form of partnership can include individuals, trustees or companies as partners. A partnership that includes a corporate partner, LLP or trustee is known as a mixed partnership.

Mixed partnerships differ from partnerships with only individuals as partners, as a mixed partnership is not entitled to an annual investment allowance (AIA) for capital allowance purposes. Where the partnership includes a company, there used to be the potential to pay tax at a lower rate on profits within the corporate partner.

Over the last decade, anti-avoidance legislation has been introduced that allows HMRC to allocate excess profits from corporate partners to individual partners for tax purposes.

The Balfour case, relating to the availability of business property relief (BPR) on the Whittingehame estate on the death of Lord Balfour, established key principles relating to a trading business and inheritance tax relief.

In order for a BPR claim to be made, reducing the IHT burden on a partner’s interest in the partnership, a partnership business must be considered mainly trading when considering the following markers:

• Turnover
• Profits
• Capital values
• Employee time

"Mainly trading" is considered to be more than 50% based on current principles, and should be based on the business in the round. The trading must be commercial and carried on with a view to profit, and be capable of making a profit before relief can be considered any further.

A business may therefore attract BPR in its entirety, even when it holds investment assets such as rental properties, providing these make up less than 50% of the overall value of the business. 

A partnership structure can provide an effective shield for business assets otherwise exposed to inheritance tax, by incorporating them into the partnership business. Care must be taken to ensure the business, considered as a whole, is not wholly or mainly an investment business, which could scupper a claim for BPR in its entirety. An example would be a surplus grain store being let to a third-party as commercial property, if the partnership has significantly reduced its arable operations.

Making sure a business qualifies for BPR often requires detailed work, including:

• Preparation of budgets and business plans
• Valuations of the assets used in the business
• Examination of accounts for the previous two years
• Ensuring all the assets on the balance sheet are in fact used in the business for a business purpose

To demonstrate a single, composite trading business made up of both trading and investment assets, we recommend including all assets under consideration on the partnership balance sheet.

Introducing property into a partnership can give rise to both capital gains tax and stamp duty land tax consequences, so it does need to be thought about and planned carefully.

Please get in touch with your usual contact, or one of the contacts listed, if you would like to discuss this in more detail.

Approval code: NTEH7102553