TXF6 UK
Syllabus B. Income Tax And Nic Liabilities B3. Income from self-employment

B3j. Partnerships and limited liability partnerships

Syllabus B3j)

Partnerships and limited liability partnerships

i) Explain and compute how a partnership is
assessed to tax.
 ii) Explain and compute the assessable profits
for each partner following a change in the
profit sharing ratio.
 iii) Explain and compute the assessable profits
for each partner following a change in the
membership of the partnership.
 iv) Describe the alternative loss relief claims
 that are available to partners.

What is a partnership?

A partnership is a single trading entity, but for taxation purposes each partner is treated individually.

Allocation of the trading profit or trading loss

  1. The trading income or trading loss is divided between the partners according to their profit sharing arrangements.

  2. Partners may firstly be entitled to salaries and interest on capital. 

    The balance of any trading profit (or loss) will then be allocated in the profit sharing ratio (PSR).

Illustration 1

Peter has been in partnership with Paul for many years.

The partnership's tax adjusted trading profit is £120,000..

The partners share profits equally.

  • Required:

    What will Peter's and Paul's share of tax adjusted trading profit be?

Solution

  • £120,000 x 1/2 = £60,000

  • Peter and Paul will both have £60,000 profit.

A change in the profit sharing agreement

If the profit sharing agreement is changed during a period of account, the profit must be time apportioned before allocation under the different agreements.

Illustration 2

Peter has been in partnership with Paul and Claire.

Paul resigned as a partner on 1 January 2019.

The partnership's tax adjusted trading profit for the year ended 5 April 2019 is £120,000.

The partners have always shared profits equally, and continued to do so after Paul resigned.

All partners have overlap profits of £5,000, which they incurred on the start of trading.

  • Required:

    What will Peter's share of tax adjusted trading profit be for the year ending 05/04/2019?

    What will Paul's share of tax adjusted trading profit be for the year ending 05/04/2019?

Solution

Tax adjusted trading profit for Paul:

6/4/2018 - 31/12/2018

£120,000 x 9/12 x 1/3 = £30,000
Less:
Overlap profits (£5,000)
Tax adjusted trading profit for Paul £25,000

Note Overlap profits are deducted from total profits when a person ceases to trade.

  • Tax adjusted trading profit for Peter: 

    6/4 2018 - 31/12/2018

    £120,000 x 9/12 x 1/3 = £30,000

  • 1/1/2019 - 5/4/2019

    £120,000 x 3/12 x 1/2 = £15,000

  • £30,000 + £15,000 = £45,000 profit for Peter

Illustration 3

Canda and Panda are in partnership.

The trading income was £18,000

Profits are shared between Canda and Panda in this ratio 3:2, after paying a salary of £3,000 to Panda. 

Calculate Canda's share of residual trading profits.

Solution:

£18,000 - £3,000 = £15,000 * 3/5 = £9,000

If the question had asked for her total profit share then she would have been entitled to her salary of £3,000 plus the residual profit share of £9,000, giving a total income from the partnership of £12,000.

Illustration 4

Doug and Rob are in partnership. 

The trading income for the year ended 30 September 2018 was £18,000

  • Up to 30 June 2018 profits were shared between Doug and Rob 3:2, after paying salaries of £3,000 and £2,000 per annum.

  • From 1 July 2018 profits were shared 2:1 after paying salaries of £6,000 and £4,000 per annum.

  • Required

    Show the allocation of trading profits for the Accounting Period ended 30 September 2018.

Solution:

Total Doug Rob
£ £ £
1/10/2017 to 30/6/2018
(Income £18,000 × 9⁄12 = 13,500)
Salaries (9/12) 5,000 x 9/12 = 3,750 3,000 x 9/12 = 2,250 2,000 x 9/12 = 1,500
Profit shared (3:2) 13,500 - 3,750 = 9,750 9,750 x 3/5 = 5,850 9,750 x 2/5 = 3,900
Profit + salary 13,500 8,100 5,400
1/7/2018 to 30/9/2018
(Income £18,000 × 3/12 = 4,500
Salaries (3/12) 2,500 1,500 1,000
Profit shared (2:1) 2,000 1,333 667
Profit + Salary 4,500 2,833 1,667
Total allocation 18,000 10,933 7,067

Partnership capital allowances

  1. Capital allowances are deducted as an expense in calculating trading profit.

  2. If assets are used privately, the business proportion is included in the partnership’s capital allowances computation.

Illustration 5

Peter has been in partnership with Paul.

The partnership's tax adjusted trading profit is £120,000. this figure is before taking account of capital allowances.

Capital allowances for the period are £20,000.

The partners share profits equally.

  • Required:

    What will Peter's and Paul's share of tax adjusted trading profit be?

Solution

  • £120,000 - £20,000 = £100,000
    £100,000 x 1/2 = £50,000

  • Peter and Paul will both have £50,000 profit.

Commencement and cessation

  1. The rules for commencement and cessation are the same as for a sole trader.

  2. The profit is allocated between the partners for accounting periods and then the assessment rules are applied.

  3. Each partner is effectively taxed as a sole trader on his/her share of the adjusted trading profit

  4. Continuing partners will be assessed using CYB

  5. When a new partner joins a partnership, he is treated as commencing a new trade and hence the opening years rules apply

  6. When an old partner leaves a partnership he is treated as ceasing a trade and hence the closing years rules apply

  7. Each partner has his own overlap profit available for relief.

As long as there is at least one partner common to the business before and after the change, the partnership continues.

Illustration 6

Ann and Beryl have been in partnership since 1 July 2016 making up their accounts to 30 June each year. On 1 July 2018 Clair joins the partnership.

The partnership’s trading profit is as follows:
£
Year ended 30 June 2017 12,000
Year ended 30 June 2018 14,000
Year ended 30 June 2019 24,000
Profits are shared equally.

1) Show the amounts assessed on the individual partners for all relevant tax years of assessment.

Profits will be allocated between the partners as follows:
Total Ann Beryl Clair
£ £ £
y/e 30/6/2017 12,000 6,000 6,000 -
y/e 30/6/2018 14,000 7,000 7,000 -
y/e 30/6/2019  24,000 8,000 8,000 8,000

2) Compute each partner’s trading income as though they were a sole trader

Ann and Beryl will both be assessed as follows, based upon a commencement on 1 July 2015:
£
2016/17 (Actual) 1 July 2016 to 5 April 2017 £6,000 × 9/12 4,500
2017/18 (CYB) Year ended 30 June 2017 6,000
2018/19 (CYB) Year ended 30 June 2018 7,000
2019/20 (CYB) Year ended 30 June 2019 8,000

They will both carry forward overlap profits of £4,500.

Clair will be treated as commencing on 1 July 2018, and will be assessed on her share of the partnership profits as follow:
2018/19 (Actual) 1 July 2018 to 5 April 2019 £8,000 × 9/12 6,000
2019/20 (CYB) Year ended 30 June 2019 8,000

She will carry forward overlap profits of £6,000

Partnership losses

  1. Losses are allocated between partners in the same way as profits.

  2. Loss relief claims available are the same as for sole traders.

  3. A partner joining the partnership may claim under opening years loss relief, for losses in the first four tax years of his membership of the partnership. 

    This relief is not available to existing partners.

  4. A partner leaving a partnership may claim under terminal loss relief. This relief is not available to partners remaining in the partnership.

Illustration 7

John, James and Paul are in partnership making up their accounts to 5 April. 

During the year, Paul left the partnership and George joined in his place.

During the year, the partnership made a trading loss of £40,000.

  • Required:

    State the loss relief claims that will be available to the partners.

Solution

Paul will be entitled to terminal loss relief since he has actually ceased trading.
George will be entitled to claim opening years relief since he has actually commenced trading.
John and James will not be entitled to either of the above reliefs. 
All the partners will be entitled to relief against total income of the current or previous tax year and against gains. 
All the partners except Paul will be entitled to carry forward relief.