Partnerships: a contractor’s overview

December 13, 2017

Writing for Contractor UK, BKL tax partner David Whiscombe discusses the attractions of partnerships and limited liability partnerships to independent professionals choosing a structure through which to operate a business.

When independent professionals choose a structure through which to operate a business, it’s easy to overlook the attractions of partnerships or their very close relatives Limited Liability Partnerships (LLPs).

First up — partnerships. Unlike limited companies, these are not legal entities in their own right: the legal definition is that a partnership is “the relation that subsists between persons carrying on a business in common with a view of profit”.

In tax terms, partnerships are “transparent” — each partner is taxed on his or her share of taxable profit in much the same way as a sole trader, and given relief for his or her share of tax-adjusted loss (though there are some counter-avoidance rules which can operate to restrict tax relief for tax losses incurred in a partnership, especially where there’s a whiff of tax avoidance involved).

Also unlike companies, most partnerships aren’t required to file accounts or other financial or organisational information on the public record at Companies House, so offer a greater degree of confidentiality than companies (for completeness, I should add that this doesn’t apply to some special forms of partnership, but you’re unlikely to come across those very often). Partnerships do have to file tax returns with HMRC however, disclosing what taxable profit the partnership has earned and how it’s allocated between the partners.

In regard to allocation of profit, there is pretty much complete flexibility. Profit has to be allocated between partners for tax purposes in the same proportions as commercial profit is allocated between them — but partners can choose to allocate profit in whatever way they see fit and HMRC won’t be able to intervene (except in one particular set of circumstances which is fairly easily avoided).

So if you do all the work of the business but you are in partnership with a ‘significant other’ who does literally nothing in the business, you can still legitimately allocate profits between the two of you in whatever way is tax-efficient. Contrast that with the issues over “wife’s wages” and the like where it’s always necessary (with a limited company) to show that what you’ve paid out doesn’t exceed the going rate for the work actually done. You can even introduce children into the partnership, though minor children as partners are best avoided.

The big commercial drawback with partnerships is this: every partner is personally liable for all the liabilities incurred in the course of the partnership business. Unlike a company, you can’t liquidate a partnership, leave a liquidator to sort out the mess, and start up afresh. You (and every other partner) are liable down to your last pound. Actually, that’s not strictly true: there are such things as “Limited Partnerships” in which partners who agree not to take any part in the management of the business have limited liability, leaving at least one (and usually only one) “managing partner” to run the business and to have unlimited liability.

Limited Partnerships are common in the field of investment management, but much less common as trading vehicles. But where it’s desirable to have a transparent income-sharing structure where some of the partners need to take no part in the business, it may be useful.

Limited Partnerships are not to be confused with Limited Liability Partnerships (“LLPs”). LLPS are in some ways a half-way house between partnerships and companies. Like companies, they have a legal identity that is separate from that of their members: they can enter into contracts, they can sue or be sued and, if it all ends in tears, they can be liquidated with the liability of members to contribute to losses being limited to the agreed amount of capital. And most of the regulatory rules that apply to companies also apply to LLPs, including the requirement to file accounts and details of ownership at Companies House.

However, for tax purposes LLPs are almost always treated as if they were partnerships and as if the members were partners; and the same flexibility in allocating profits applies. Although LLPs were originally designed in response to pressure from large professional partnerships demanding a suitable business vehicle, their attractiveness in combining tax-transparency and limited liability has made them the vehicle of choice for a wide range of businesses.

Lastly and even more relevant to contractors, it’s occasionally thought that using a partnership or an LLP is a simple way to sidestep the IR35 rules and the similar new(ish) provisions regarding off-payroll working in the public sector. Sadly, not so. Although when you mention “intermediary” to most people they immediately think of companies, a partnership or LLP can also be treated as an “intermediary” for these purposes and is vulnerable in substantially the same way as a company if a contract is entered into via the partnership which would have been an employment contract if it had been entered into directly with the “worker” personally. In fact, IR35 can be even more problematic for partnerships than for companies, especially if the partnership accounts are drawn to a date other than April 5^th. It’s quite possible for the “deemed employment payment” to fall into a different accounting period than the actual income from the offending contract, which can give rise to all kinds of complication.

And, strange to say, a partnership can even in the right (or wrong) circumstances fall to be treated as a “managed service company,” falling within the MSC rules. You’d have thought that the first requirement for something to be treated as a “managed service company” would be that it would have to be a company — but, as with so many appearances in the tax system, it isn’t so.

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