A Winding Road? From Sole Trader To Partnership

Sarah Laing looks at some of the practical issues to look out for when moving from a sole trader business to a partnership.

A partnership can be a simple and extremely flexible way for two or more people to own and run a business together. However, bear in mind that in general partners do not have any protection if the partnership fails. Unlike a limited company, a partnership has no legal existence separate from the partners themselves. If one of the partners resigns, dies, or goes bankrupt, the partnership has to be dissolved, even though the business itself may not need to cease.

Although there are no legal formalities involved in establishing a partnership, and a partnership may come into existence under an oral agreement, it is advisable that a formal partnership deed is drawn up. This is a legal document that sets out what each partner is responsible for, and what he can expect from the business. Many partnerships ask a solicitor to help with the deed, but it is possible for the partners to draw one up themselves.

In a partnership situation, each partner is self-employed and takes a share of the profits. Usually, the partners share the decision-making and management of the business. Each partner is personally responsible for any (and potentially all) debts that the partnership incurs, and each person pays income tax and National Insurance contributions (NICs) on his share of the partnership profits.

As well as an active partner (or partners), your partnership may include a ‘sleeping’ partner. Broadly, the sleeping partner contributes money to the business but doesn’t get involved in running it. This partner usually receives a smaller annual share of the partnership profits.

Naming the partnership

This is often one of the most difficult practicalities of forming a partnership! The name cannot include ‘limited’, ‘Ltd’, ‘limited liability partnership, ‘LLP’, ‘public limited company’ or ‘plc’. It must not contain a sensitive or offensive word or expression, or suggest a connection with government or local authorities (unless prior permission is obtained). The business name and names of all the partners must be included on the firm’s official paperwork, for example, invoices and letters.

The partnership needs to appoint one of its officers (the nominated officer) to fill in the partnership tax return each year and send it to HMRC. This return includes a Partnership Statement, which shows how profits or losses have been divided amongst the partners. The nominated partner also has to give each partner a copy of the Partnership Statement to help them complete their own personal tax return correctly.

All partners will be responsible for submitting their own individual tax returns. However, the partnership must register with HMRC by 5 October in the business’s second tax year, or a penalty may be incurred. Registration should generally be done online, although it can be done manually using form SA400 (for the partnership) and forms SA401(for the partners).

Where a sole trader takes in one or more partners, there is a change in business entity for VAT purposes. If the sole trader is VAT registered, the change must be notified to HMRC within 30 days and his/her VAT registration will be cancelled. Alternatively, an application may be made (on form VAT 68) for the VAT registration to be transferred to the partnership. The partnership itself must register if the VAT taxable turnover is more than the VAT registration threshold (currently £85,000). 

A limited liability partnership (LLP) is similar to an ordinary partnership in that a number of people (and/or companies) join together and share the costs, risks, and responsibilities of the business. They also take a share of the profits and pay income tax and NICs on their share of the partnership profits. An LLP differs from an ordinary partnership in that debt is limited to the amount of money each partner invested in the business and to any personal guarantees given to raise business finance. Therefore, members have some protection if the business runs into difficulties because their liability is restricted in general terms to the level of their investment.

Although you can go into partnership with anyone you choose, if a member of a partnership is under the age of 18, he can’t be legally bound by the terms of a partnership agreement.