Partnerships: Unlimited or limited?

• A partnership exists when two or more persons commence in business together with a view to making a profit. See When does a partnership exist?
• A partnership must be run on a commercial basis.
• A business is defined as a trade, occupation or profession.
• There are three types of partnership in the UK, each defined by a different partnership act.
  • A conventional partnership is not a separate legal entity from its owners. It is unable to hold land and property in its name therefore its partners may hold that in trust.
  • A Limited Partnership (LP) is a partnership governed by the 1907 Limited Partnership Act. It is not to be confused with a Limited Liability Partnership (LLP).
  • An LLP is a corporate version of a partnership. It is usually taxed transparently but it may hold land and property in its name. Partners in an LLP are known as members.

Partnerships are transparent for tax purposes. This means that each individual is taxed as an individual, as opposed to the partnership being taxed as a body distinct from its owners.

• Partnerships are subject to special rules for tax, including a raft of targeted anti-avoidance measures.
  • See Partnerships with mixed membership and Salaried members: When is a partner taxed as an employee?

Certain groups are unable to form partnerships and these include:

• Charities.
• Not-for-profit organisations.

When a company is a partner in a partnership it is taxed on its profits according to Corporation Tax rules.

There are three different types of partnership defined in partnership law:

The conventional partnership

This type of partnership is defined by the 1890 Partnership Act as "Partnership is the relation which subsists between persons carrying on a business in common with a view of profit".

• The expression “business” includes every trade, occupation, or profession.
• The receipt by a person of a share of the profits of a business is primâ facie evidence that they are a partner in the business.
• Interests in land:
  • A joint tenancy, tenancy in common, joint property, common property, or part ownership does not of itself create a partnership whether the tenants or owners do or do not share any profits.
  • The sharing of gross returns does not of itself create a partnership, whether the persons sharing such returns have or have not a joint or common right or interest in any property from which or from the use of which the returns are derived.

Many of the conventional partnership's key features are similar to those for a sole trader.

• Partners are responsible for their own and each other's debts.
• Partners are taxed on all the profits, although their share of the profits will vary by agreement.

There are some significant differences.

• If the partnership makes a loss, partners Sideways loss relief and CGT loss relief claims are subject to additional rules which may restrict the relief available. See Partnerships: Losses.
• Individual partners may rent property to the partnership for use in its business.

The Limited Partnership (LP)

This type of partnership is governed by the 1907 Limited Partnership Act. It is not to be confused with a limited liability partnership (LLP).

Key features

• At least one partner must have unlimited liability and they are referred to as a 'general partner'. The general partner(s) are liable for all the debts and obligations of the firm. 
• A limited partner's liability is capped. In the event of business failure (unless there was fraud or something similar) they will only lose the capital contribution that they may have made to join the partnership.
• The common set-up is that the limited partner will provide initial funding. It is not permitted to participate in management or bind the partnership.
• Where a limited partnership is not registered, it will be treated as a conventional partnership and all the partners will have unlimited liability. 
• If the partnership makes a loss, partners Sideways loss relief and CGT loss relief claims are subject to additional rules which may restrict the relief available. See Partnerships: Losses.

The Limited Liability Partnership (LLP)

This trading vehicle is a cross between a conventional partnership and a company. It has the best features of each. LLPs are governed by the 2000 Limited Liability Partnership Act and the 2006 Companies Act.

• For a LLP to be incorporated, two or more persons associated with carrying on a lawful business with a view to profit must have subscribed their names to an incorporation document.
• 'Business' includes every trade, profession and occupation.
• The LLP Act does not mention interests in land.

Key features

• An LLP is a separate legal entity to its members (the partners).
• LLPs have designated partners who are the equivalent of company officers.
• LLP accounts are filed with Companies House.
• Partners have limited liability unless:
  • The LLP becomes insolvent and the partners knowingly allowed this to happen, in which case they may be required to repay their profits of the previous two years.
  • A partner is found to be at fault at a time when they are acting under their own personal capacity.
• An LLP is normally taxed transparently as if it were a conventional partnership, there are occasions when an LLP can become opaque and is then treated as a company, these are when it is not trading with a view to a profit or when it is in liquidation.
• If the LLP makes a loss, partners Sideways loss relief and CGT loss relief claims are subject to additional rules which may restrict the relief available. See Partnerships: Losses.
• LLPs are subject to substantial tax anti-avoidance legislation. See Partnerships with mixed membershipand Salaried members: When is a partner taxed as an employee?

Limited or unlimited partnership?

The LLP is the favourite type of partnership for most individuals who are conducting a trade or business because it affords the partners the protection of limited liability.

A 1907 Act limited partnership (LP) is useful for estate planning. An LLP has to file its accounts with Companies House, but a Limited Partnership does not. LPs have long been the favourite vehicle for private equity and investment funds. It has the flexibility to allow for various partnership interests. An LP can also be useful when one partner wishes to have limited liability as they move to taking a back seat in the business.

If you are looking for a flexible trading vehicle in general terms, then consider a conventional unlimited partnership or an LLP. If you are looking at fund or asset management then perhaps consider a limited partnership.

Do we need a partnership agreement?

Partnerships are not required to have a formal agreement between members. However, partnerships are relationships and any relationship may go wrong. It is sensible to have a Partnership agreement in place to determine (the following list is an absolute minimum):

• Profit share.
• Capital contributions.
• How to deal with the arrival and departure of a partner.
• Succession.
• Death of a partner.
• Divorce of a partner.
• Partnership assets (especially for Business Property Relief (BPR) for Inheritance Tax (IHT)).

In the absence of a specific agreement, partnerships are governed by a default regime set out in the legislation, which regulates the interactions between partners. However, this default regime includes several provisions that may be undesirable. For this reason it is normally recommended to have a formal agreement. 

See Partnership agreements: What should be considered?

See Partnerships agreements: A cautionary tale

Tax planning and partnerships

Family partnerships are a useful tool in estate planning and can also be very tax-efficient in terms of income and capital taxes,

Useful guides on this topic

Will I pay less tax if I trade in partnership??
Will I pay less tax if I trade via a partnership or a LLP compared to if I trade via a company or as a sole trader?

A new partnership? Start here...
This freeview 'At a glance' guide is essential reading for anyone thinking about starting up a new partnership.

When does a partnership exist?
When does a partnership exist? Why does it matter? What are the implications for different taxes?

Partnerships: Losses at a glance
What are the loss relief options for individual members of a partnership? What restrictions apply? What is the definition of capital contribution?

LLP v Company: which will save me tax?
Different types of trading structures all have their own tax advantages and disadvantages. What are the key issues if you run a Limited Liability Partnership (LLP)? Should I run an LLP instead of a company? Does an LLP save tax?

Partnership agreements: What should be considered?
Partnership agreements can be invaluable to clarify everyday matters and settle disputes within a partnership. What sort of things should be discussed for inclusion in a partnership agreement? Why are they important?