Chris Thorpe looks at how best to structure a husband and wife (or civil partner) business.
There are nearly five million family businesses in the UK paying nearly £150bn in tax, so they are the backbone of our economy.
Many such businesses may start off as a husband and wife (or spousal) operation, with children joining in when they are older. As well as helping grow the business, having the kids involved may well facilitate succession planning in later life, allowing mum and dad to retire knowing the business will carry on.
Partnership
The simplest, most rudimentary way for a couple to run a business is an ordinary partnership, whereby the revenue and capital profits or losses are split according to the partners’ wishes; the profit shares can usually be changed year on year if so desired (within reason – see below), giving far more flexibility than a single class of company dividends.
Whilst the partnership has a separate trading identity, in England and Wales they are not separate legal entities and are transparent for tax purposes. This means the partners are taxed on their profit shares as they arise; the partnership itself is not subject to tax.
Also, unless it is a limited liability partnership (LLP), all that needs to be done to create a partnership is to register it with HMRC and complete annual tax returns – and ideally, draft a partnership agreement for safekeeping.
An LLP is a hybrid company-partnership creation, taxed the same as an ordinary partnership but with a separate corporate entity of which Companies House must be notified, unlike with ordinary partnerships. Profits are taxed irrespective of drawings, so there is no need to declare dividends or salary. There is much less bureaucracy and fewer compliance obligations with partnerships. Likewise, if the business does not go too well, it can simply be ceased; there is no need for liquidators or strike offs.
It is, therefore, often advisable for new businesses to start as partnerships – for the sake of simplicity and flexibility. If the business really takes off, the partners could consider incorporating it.
Limited company
There is nothing stopping a new business beginning life as a limited company. There are umpteen good non-tax reasons why a limited company may be better than a partnership: risk mitigation, customer requirements, being part of a larger business group, external investors’ requirements, involvement in research and development, and so on. But tax is likely to be an important factor, too. The corporation tax to which companies are subject is generally lower than the income tax on which individuals within partnerships are assessed.
However, there is an element of double taxation; whilst the company will be taxed on the profits under corporation tax, those same profits withdrawn from the company are taxed again on the shareholders or directors under income tax. Through careful planning, this can often be mitigated with allowances maximised. With dividends and salaries paid to two adults, and maybe some salaries to the children, the income tax burden on the individuals can be spread out with some tax relief for the company on salaries or pensions.
Don’t overdo it!
Something important to remember with spouses (for both partnerships and companies) is that the ‘settlements’ legislation is relevant. Before 1990, husbands were taxed on their wives’ income, but when individual taxation emerged, the option became available to divert income onto another personal allowance and basic rate band. If ‘excess’ dividends or profit shares go to one spouse, the settlements legislation will undo it; the capital should ideally follow the profits as much as possible.
Practical tip
Every business is different, so it is impossible to prescribe how to structure a husband-wife business; but a partnership, to start off with, is likely to be the most sensible option. Flexibility with profit-sharing whilst building the business is likely to be valuable, but once profits grow, the flexibility around profit extraction will generally be the backbone of tax planning.
