UK: New Partner/Member – Introductory Guide

There are a number of practical issues to consider when joining a partnership, some of which are detailed below.

This guide sets out the main issues that arise when becoming a partner or member. Admission into a partnership means that you become self-employed and are therefore no longer an employee of the business.

Capital

You may be required to introduce capital into the partnership. This is commonly funded by a business loan from a bank. Often firms will have existing arrangements with a bank offering these facilities. Care should be taken to ensure that the loan is correctly structured in order to qualify for tax relief. Providing it is correctly structured tax relief on the loan interest paid may be claimed at your marginal rate of taxation.

Income

Your income will be a share of the partnership's total profit. Following adjustments to the firm's accounting profit, for example for expenses that are claimed in the accounts but not allowable for tax purposes, such as client entertaining and depreciation, the partnership will share the taxable profits in accordance with the profit sharing arrangements for the accounting period. It should be noted that a partner's taxable profits will be different from those shown in the partnership accounts.

Assessable profits

Ordinarily, as a partner, your profits are assessed on a current year basis, ie the profits assessed in the tax year are those for the accounting period ending in that tax year. Therefore where the partnership has a 30 April year-end, the profits assessable in the 2011/2012 tax year are the tax adjusted profits attributed to the partner during the year ended 30 April 2011.

There are special commencement rules for the first year of assessment for a new partner. Assuming admission to the partnership on 1 May 2011, for 2011/12 you will be assessable on the taxable profits to 30 April 2012 apportioned for the period from commencement to the following 5 April, namely 1 May 2011 to 5 April 2012. In the second year of assessment the current year basis applies. Therefore in this example profits for the year ended 30 April 2012 will form the basis of the 2012/13 tax year.

These special provisions create a double assessment on the first year's profits which, in the above example is the period from 1 May 2011 to 5 April 2012. Relief for the profits in this period is known as "overlap relief" and will be available to offset against profits in the year of departure from the partnership or in some cases where there is a change of accounting date.

Drawings

As a partner you will no longer receive a monthly salary, however a proportion of your share of profits will be paid to you probably monthly as drawings from the firm. Drawings are usually calculated as a share of the budgeted profits of the firm and paid as a fixed amount each month, net of a tax provision.

Additional distributions may be made during and after the year-end when the firm's actual level of profitability is known.

Tax provisions

It is common practice in many firms to retain tax on all profits earned by the firm in the accounting period. This tax will be released to partners to enable payments to be made to HM Revenue & Customs (HMRC) shortly before the appropriate payment dates of 31 January and 31 July. Alternatively the firm may settle the tax liability direct on your behalf from your tax reserve.

The calculation of the provision will normally take into account the various allowances and deductions available to each individual partner, including pension contributions.

Tax payments

Even though the partnership may make payments on your behalf, as a self-employed taxpayer you are nevertheless legally responsible for settling all of your own tax liabilities.

The tax due is payable in three instalments namely:

  • first payment on account – 31 January in the year of assessment
  • second payment on account – 31 July after the year of assessment
  • final payment – 31 January after the tax year.

Each payment on account is equal to 50% of your total income tax and Class 4 National Insurance contribution liability for the preceding year. The final payment is the difference between the actual liability for the year and the amounts paid on account.

As a new partner in, say, 2011/2012 who was previously taxed under PAYE, it is unlikely that there will be a requirement to make payments on account on 31 January 2012 and 31 July 2012. Therefore the first tax payment is likely to be on 31 January 2013, which will be equal to your total liability for the 2011/2012 tax year plus one half again as a payment on account of your 2012/2013 tax bill. This liability could be quite substantial.

Where tax is paid late, interest will be added automatically to the amount due for payment.

National Insurance contributions (2011/12)

On becoming an equity partner it is necessary to notify the National Insurance Contributions Office (NICO) of your change in status by 31 January following the end of the tax year when you commenced self-employment. Failure to meet this deadline may result in a penalty. Notification should be made on form SA401, and this will also notify HM Revenue & Customs (HMRC) of your change in status.

As a partner you are liable to pay both Class 2 and Class 4 National Insurance contributions.

Class 2 contributions are a flat rate payment of £2.50 per week, payable either monthly or every six months by direct debit. Many firms arrange the payment on behalf of partners, which are then debited from the partners' current accounts.

For 2011/12 Class 4 contributions are nil on profits under £7,225, 9% on profits between £7,225 and £42,475 and 2% on profits above £42,475.

Class 4 contributions are paid to the HMRC at the same time as the tax liability, as shown above.

In your first year as a partner you will probably have already paid some Class 1 contributions on your earnings prior to admission. Any overpayments must be claimed from NICO and this should be reviewed at the end of your first tax year as a partner.

Keeping records

As a self-employed taxpayer you are required to retain any business related records for a longer period than personal ones. Business related records must be retained for five years from the 31 January filing date for the tax return.

For example, for a 2011/12 tax return filed on or before 31 January 2013, you must keep your business records until 31 January 2018. In most cases the partnership will hold and retain these business records.

Failure to retain records for this period could result in a penalty of up to £3,000.

Understanding your position

The above is a summary of the main tax implications which will apply on being admitted into partnership. Many firms will have their own arrangements with regard to tax provisions and payment of monthly drawings. It is imperative that you understand how these impact upon your personal position and take advice where necessary.

Tax returns

A partnership is required to submit an annual tax return that declares the firm's profits, with details of the taxable profits allocated to each partner.

The partnership return will include all expenses of the firm and any expenses incurred by the individual partners in the performance of their business. All expenses incurred on business activities must be claimed via the firm, otherwise no tax relief will be available.

The partnership return must be submitted by 31 October, or 31 January if filed online, following the year of assessment. The penalties levied on each partner for failure to comply with these regulations are £100 plus a possible further £10 for each day the failure continues beyond three months (up to a maximum of £900), with further £300 penalties after six months and again after twelve.

The partnership return will include only your income earned through the partnership and your share of proceeds on the sale of a capital asset. You will therefore be required to submit a personal tax return reporting both partnership income in accordance with the partnership return, and other non-partnership income (such as bank interest and dividends). Your return will also include details of your allowable tax deductions such as pension contributions, Gift Aid and interest on a loan for the provision of partnership capital.

Although the partnership income is reported in accordance with the firm's year-end, your non-partnership income will continue to be reported on a fiscal year basis (i.e. 6 April to the following 5 April).

Your personal return must also be submitted by 31 January following the end of the year of assessment. Failure to comply will result in an initial penalty of £100 plus a possible further £10 each day the failure continues beyond three months (up to a maximum of £900), with further penalties of the greater of 5% of the tax due or £300 after six months and again after twelve.

These late filing penalties are separate form the interest and penalties for late payment of tax.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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