Introduction
In the previous chapters, we have dealt with the income tax rules for sole
traders. We now see how those rules are adapted to deal with business
partnerships.
On the one hand, a partnership is a single trading entity, making profits as a
whole. On the other hand, each partner has a personal tax computation, so the
profits must be apportioned to the partners. The general approach is to work
out the profits of the partnership, then tax each partner as if they were a sole
trader running a business equal to their slice of the partnership (for example
25% of the partnership).
This concludes our study of the different types of UK income to be included in
an income tax computation. In the following chapter we will turn our attention
to the overseas aspects of income tax.
Study guide
| Intellectual level | ||
| 1 | Income and income tax liabilities in situations involving further overseas aspects and in relation to trusts, and the application of exemptions and reliefs | |
| (a) | The contents of the Paper F6 study guide for income tax and national insurance, under heading: | 2 |
| | B3 Income from self employment |
Exam guide
A question involving any aspect of unincorporated businesses may deal with a partnership rather than a sole trader. The principles are exactly the same, whether you are considering incremental income, possible claims for capital allowances or loss reliefs. Just remember that profits are apportioned to partners in the profit sharing ratio for the period of account after allocating interest on capital and/or salaries.
This chapter is revision of the partnership rules covered in Paper F6.
There are no changes in 2015/16 from 2014/15 in the material you have already studied.
1 Assessment of partnership to tax 6/11
FAST FORWARD
A partnership is simply treated as a source of profits and losses for trades being carried on by the individual partners. Divide profits or losses between the partners according to the profit sharing ratio in the period of account concerned. If any of the partners are entitled to a salary or interest on capital, apportion this first, not forgetting to pro-rate in periods of less than 12 months.
1.1 Introduction
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A partnership is a group of individuals who are trading together. They will agree amongst themselves how the business should be run and how profits and losses should be shared. A partnership is not treated as a separate entity from the partners for tax purposes (in contrast to a company where shareholders and directors are taxed separately from the company). Most partnerships have unlimited liability of the partners for the debts of the partnership.
It is possible to set up a limited liability partnership (LLP) where the liability of the partners for debts of the partnership are limited. A LLP is a legal person in its own right (similar to a company). However, limited liability partnerships and their partners are generally taxed on the same basis as unlimited partnerships, as described in the rest of this chapter.
1.2 Computing partnership profits
A partnership is treated like a sole trader when computing its profits. Partners’ salaries and interest on capital are not deductible expenses and must be added back in computing profits, because they are a form of drawings.
Where the partners own assets (such as their cars) individually, a capital allowances computation must be prepared in respect of the assets the partners own (not forgetting any adjustment for private use). The capital allowances must go into the partnership’s tax computation.
1.3 Allocating partnership profits between partners
Once the partnership’s profits for a period of account have been computed, they are shared between the partners according to the profit sharing arrangements for that period of account.
Steve and Tanya have been in partnership for many years. For the year ended 31 October 2015, taxable trading profits were £70,000. Steve is allocated an annual salary of £12,000 and Tanya’s salary is £28,000. The profit sharing ratio is 2:1.
Allocate the trade profit to each partner for the year ended 31 October 2015.
|
Allocate the profits for the year ended 31 October 2015. |
|||
| Total | Steve | Tanya | |
| £ | £ | £ | |
| Profit | 70,000 | ||
| Salaries | 40,000 | 12,000 | 28,000 |
| Balance (2:1) | 30,000 | 20,000 | 10,000 |
| Total | 70,000 | 32,000 | 38,000 |
1.4 Tax position of individual partners
Each partner is taxed like a sole trader who runs a business which:
- Starts when they join the partnership
- Finishes when they leave the partnership
- Has the same periods of account as the partnership (except that a partner who joins or leaves during a period will have a period which starts or ends part way through the partnership’s period) Makes profits or losses equal to the partner’s share of the partnership’s profits or losses.
| Partners are effectively taxed in the same way as sole traders with just one difference. Before you tax the partner you need to take each set of accounts (as adjusted for tax purposes) and divide the trade profit (or loss) between each partner. Then carry on as normal for a sole trader – each partner is treated as a sole trader in respect of their trade profits for each period of account. |
Exam focus point
2 Change in profit sharing ratios
The profits for a period of account are allocated between the partners according to the profit sharing agreement. If the salaries, interest on capital and profit sharing ratio change during the period of account the profits are time apportioned to the periods before and after the change and allocated accordingly. The constituent elements are then added together to give each partner’s share of profits for the period of account.
Sue and Tim have been in partnership for many years. For the year ended 31 December 2015, taxable trading profits were £50,000. Sue is allocated an annual salary of £10,000 and Tim’s salary is £15,000.
The profit sharing ratio was 1:1 until 31 August 2015 when it changed to 1:2 with no provision for salaries.
Allocate the trade profit to each partner for the year ended 31 December 2015.
Allocate the profits for the year ended 31 December 2015.
Total Sue Tim
£ £ £
Profit 50,000
1 January – 31 August (8 months) 33,333
Salaries (8/12 £10,000/£15,000) 16,667 6,667 10,000
Balance (1:1) 16,666 8,333 8,333
| 1 September – 31 December (4 months) | 16,667 | ||
| Salaries | Nil | – | – |
| Balance (1:2) | 16,667 | 5,556 | 11,111 |
| 16,667 | |||
| Total | 50,000 | 20,556 | 29,444 |
33,333
Note. Since the profit sharing arrangements changed part way through the period of account, the profits and salaries for the period of account must be pro-rated accordingly.
| 3 Change in membership of partnership | 6/12 |
| The commencement and cessation rules apply to partners individually when they join or leave. |
FAST FORWARD
When a trade continues but partners join or leave (including cases when a sole trader takes in partners or a partnership breaks up leaving only one partner as a sole trader), the special rules for basis periods in opening and closing years do not apply to the people who were carrying on the trade both before and after the change. They carry on using the period of account ending in each tax year as the basis period for the tax year ie the current year basis. The commencement rules only affect joiners, and the cessation rules only affect leavers.
However, when no one same individual carries on the trade both before and after the change, as when a partnership transfers its trade to a completely new owner or set of owners, the cessation rules apply to the old owners and the commencement rules apply to the new owners.
Daniel and Ashley have been in partnership for many years preparing accounts to 31 December each year and sharing profits in the ratio 2:1.
On 1 June 2015, Kate joined the partnership. From that date, profits were shared Daniel 50% and Ashley and Kate 25% each.
The partnership profits for the year ended 31 December 2015 were £72,000 and for the year ended 31 December 2016 were £90,000.
Compute the partnership profits taxable on Daniel, Ashley and Kate for 2015/16 and 2016/17 and the overlap profits for Kate on commencement.
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Allocation of partnership profits |
||||
| Total | Daniel | Ashley | Kate | |
| y/e 31.12.15 | £ | £ | £ | £ |
| 1.1.15 – 31.5.15 | ||||
| Profits (5/12) 2:1 | 30,000 | 20,000 | 10,000 | n/a |
| 1.6.15 – 31.2.15 |
Profits (7/12) 50:25:25 42,000 10,500
| y/e 31.12.16 | ||||
| Profits 50:25:25 90,000 45,000
Taxable partnership profits for 2015/16 and 2016/17 |
22,500 | 22,500 | ||
| Daniel | Ashley | Kate | ||
| £ | £ | £ | ||
| 2015/16 | ||||
| CYB y/e 31.12.15 41,000 | 20,500 |
| First year – actual basis | |||
| 1.6.15 – 31.12.15 | 10,500 | ||
| 1.1.16 – 5.4.16 | |||
| 3/12 £22,500 | 5,625 | ||
| 16,125 | |||
| Daniel | Ashley | Kate | |
| £ | £ | £ | |
| 2016/17 | |||
| CYB y/e 31.12.16 | 45,000 | 22,500 |
Profit allocation 72,000 10,500
Second year – 12 months to 31.12.16 22,500
Overlap profits
Kate has overlap profits for the period 1.1.16 to 5.4.16 of £5,625..
Maxwell, Laura and Wesley traded in partnership for many years, preparing accounts to 30 September.
Each partner was entitled to 5% interest per annum on capital introduced into the partnership. Each partner had introduced £60,000 of capital on the commencement of the partnership. From that date, profits were shared in the ratio 50% to Maxwell, 30% to Laura and 20% to Wesley.
On 1 May 2015, Wesley left the partnership. From that date profits were shared equally between the two remaining partners and no interest was paid on capital. The partnership taxable trading income for the year to 30 September 2015 was £120,000. Wesley had overlap profits on commencement of £5,000.
Compute the partnership profits taxable on Maxwell, Laura and Wesley for 2015/16.
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Allocation of partnership profits |
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| Total | Maxwell | Laura | Wesley | |
| £ | £ | £ | £ | |
| 1.10.14 – 30.4.15 | ||||
| Interest 7/12 £60,000 5% each | 5,250 | 1,750 | 1,750 | 1,750 |
Profits (7/12) 50:30:20
| Total | Maxwell | Laura | Wesley | |
| £ | £ | £ | £ | |
| 1.5.15 – 30.9.15 | ||||
| Profits (5/12) 1:1 | 50,000 | 25,000 | 25,000 | n/a |
| Profits allocated for year
Taxable partnership profits for 2015/16 |
120,000 | 59,125 | 46,175 | 14,700 |
| Maxwell | Laura | Wesley | ||
| £ | £ | £ | ||
| 2015/16 | ||||
| CYB y/e 30.9.15 | 59,125 | 46,175 |
| Final year | |||
| 1.10.14 – 30.4.15 | 14,700 | ||
| Less overlap relief | (5,000) | ||
| 9,700 |
Exam focus The tax treatment of a new partner was tested in June 2012 Question 4(b) Tetra. The examiner point commented that ‘This question required knowledge of the opening year rules, the allocation of profits between partners and the calculation of national insurance. It was done well. Common errors included the treatment of the partner’s salary as employment income rather than trading income and the failure to adjust the profit for the partners’ salaries before splitting the remainder between the partners.’
| 4 Loss reliefs for partners | 6/09 |
FAST FORWARD
Partners are entitled to the same loss reliefs as sole traders and make independent loss relief claims.
Partners are entitled to the same loss reliefs as sole traders. Partners may claim loss reliefs in different ways.
Partners are entitled to early trade losses relief for losses in the four tax years starting with the year in which they are treated as starting to trade and they are entitled to terminal loss relief when they are treated as ceasing to trade. This is so even if the partnership trades for many years before the partner joins or after they leave.
Loss relief against general income and carry forward loss relief is also available to partners.
When a partnership business is transferred to a company, each partner can carry forward their share of any unrelieved losses against income from the company.
Mary and Natalie have been trading for many years sharing profits equally. On 1 January 2016 Mary retired and Oliver joined the partnership. Natalie and Oliver share profits in the ratio of 2:1. Although the partnership had previously been profitable it made a loss of £24,000 for the year to 31 March 2016. The partnership is expected to be profitable in the future.
Calculate the loss accruing to each partner for 2015/16 and explain what reliefs are available.
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We must first share the loss for the period of account between the partners. |
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| Total | Mary | Natalie | Oliver | |
| £ | £ | £ | £ | |
| y/e 31.3.16 | ||||
| 1.4.15 – 31.12.15 | ||||
| Total £24,000 9/12 | (18,000) | (9,000) | (9,000) | |
| 1.1.16 – 31.3.16 | ||||
| Total £24,000 3/12 | (6,000) | (4,000) | (2,000) | |
| Total for y/e 31.03.16 | (24,000) | (9,000) | (13,000) | (2,000) |
Mary
Mary has ceased trading and may instead claim terminal loss relief. The terminal loss will be £9,000 (a profit arose in the period 1.1.15 – 31.3.15 which would be treated as zero) and this may be set against her taxable trade profits for 2015/16 (£nil), 2014/15, 2013/14 and 2012/13.
For 2015/16, Mary has a loss of £9,000. She may claim relief against general income of 2015/16 and/or 2014/15 and may extend the claim to capital gains.
Natalie
For 2015/16, Natalie has a loss of £13,000. She may claim relief against general income of 2015/16 and/or 2014/15 and may extend the claim to capital gains. Any loss remaining unrelieved may be carried forward against future income from the same trade.
Oliver
Oliver’s loss for 2015/16 is £2,000. He may claim relief for the loss against general income (and gains) of 2015/16 and/or 2014/15. As he has just started to trade he may claim relief for the loss against general income of 2012/13, 2013/14 and 2014/15. Any loss remaining unrelieved may be carried forward against future income from the same trade.
Chapter roundup
| | A partnership is simply treated as a source of profits and losses for trades being carried on by the individual partners. |
| | Divide profits or losses between the partners according to the profit sharing ratio in the period of account concerned. If any of the partners are entitled to a salary or interest on capital, apportion this first, not forgetting to pro-rate in periods of less than 12 months. |
| | The commencement and cessation rules apply to partners individually when they join or leave. |
| | Partners are entitled to the same loss reliefs as sole traders and make independent loss relief claims. |
Quick quiz
- How are partnership trading profits divided between the individual partners?
- Janet and John are partners sharing profits 60:40. For the years ended 30 June 2015 and 2016 the partnership made profits of £100,000 and £150,000 respectively. What are John’s taxable trading profits in 2015/16?
- Pete and Doug have been partners for many years sharing profits equally. On 1 January 2015 Dave joins the partnership and it is agreed to share profits 40:40:20. For the year ended 30 June 2015 profits are £100,000. What is Doug’s share of these profits?
- What loss reliefs are partners entitled to?
Answers to quick quiz
- Profits are divided in accordance with the profit sharing ratio that existed during the period of account in which the profits arose.
- £40,000.
2015/16: y/e 30 June 2015
£100,000 40% = £40,000.
- £45,000
Pete Doug Dave
Ye 30 June 2015 £ £ £
1.7.14 – 31.12.14 6m 100,000
£50,000 50:50 25,000 25,000
1.1.15 – 30.6.15 6m £100,000
£50,000 40:40:20
- Partners are entitled to the same loss reliefs as sole traders. These are loss relief against general income, early years trade loss relief, carry forward loss relief, terminal loss relief, and loss relief on transfer of a trade to a company.
| Number | Level | Marks | Time |
| Q10 | Introductory | 25 | 49 mins |
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