Chapter 13 Sole traders and partnerships Flashcards
13.2 The Sole trader
A sole trader needs to inform HMRC they are self-employed and check whether they need to register for VAT. Anticipated taxable sales above the VAT registration threshold in the first 30 days would trigger VAT registration. All businesses are obligated to keep accounts but sole traders do not need to file accounts. The sole trader has no legal identity separate from the individual, a sole trader is fully responsible for the business’s liabilities and all their personal assets are at risk as they have unlimited liability for the debts.
Sometimes for tax purposes they are separate from the business, when the sole trader takes stock for trading purposes, it is treated as being sold for market value. Where apparatus is owned in a private capacity and is transferred into their trade, it is treated as acquired by them for trade purposes so capital allowances can be claimed and are treated as having sold for market value.
Losses incurred in the first four years of trade can be carried back three years of their business and offset against other income tax the trader had, like employment income, creating a repayment of income tax.
13.3 Starting up in business
The following issues need to be considered when starting up a business:
• Employment law – new staff need a written statement of terms within 2 months of being employed. Employer’s need liability insurance as it is a legal requirement. The trader is responsible for deducting employee’s tax and national insurance under the PAYE system
• How business premises will be operated
• Contract law – need to consider terms and conditions in contracts. A professional person may need to consider professional indemnity insurance, this might be a requirement if they belong to a professional body.
• Financing – for a new business a lender might require a personal guarantee from a third party to get a bank loan, a sole trader would not need this as they have unlimited liability.
• Business name – must comply with the rules of the Companies Act 2006
• Franchise or licence contracts
• VAT registration – there are two tests for determining compulsory registration but voluntary registration is available. VAT schemes like the flat rate scheme and the annual VAT accounting helps small businesses with VAT
• National insurance contributions and tax – self-employed people pay class 2 and 4 NIC if they exceed thresholds. A self-assessment is required by 31 January following the tax year. Tax can be paid in one instalment on 31 Jan following the tax year or in two payments on account, on 31 Jan and 31 July following the tax year. There are annual maxima tests for individuals with two types of employment. Self-employed individuals using independent contractors will be subject to the construction industry scheme and need to deduct income tax for sub-contractors. Companies pay corporation tax and class 1 primary NIC.
• International trade – must declare all commercial goods imported to HMRC, along with payment of applicable customs and duties and import VAT, if VAT registered, they can claim back import VAT. Sales and supplies of goods within the EU require additional administration and reporting for statistics.
• Records – legal requirement. Sole traders or partner do not need to publish accounts or have an audit but must have sufficient records to satisfy HMRC. A company must publish annual accounts and may need an audit.
13.4 Business premises
If a business is operated from their own home and has a mortgage, the written consent of the building society or bank as secured lender to the home is required. If the home is rented, the Small Businesses, Enterprise and Employment Act 2015, the trader may be able to persuade a landlord not to include a prohibition against business use in the tenancy agreement. Planning permission from the local authority may be needed, depending on the type of trade conducted. The title deed of the property and land register should be checked to see any restrictive covenants. The terms of insurance policies checked to ensure the business’ assets are protected. Business rates may be payable.
A trader may rent separate premises, the terms of a lease should be checked by a professional. The original tenant under a lease entered into before January 1996 is invariably liable, even when transferring the lease to an assignee. If the lease is entered into since January 1996, the original tenants and any assignee continue to be liable only if they enter into an authorised guarantee agreement.
13.5 Partnership (General Partnership)
The key statute for partnership law is the Partnership Act 1890, which defines a partnership as the relation that exists between persons carrying a business in common with a view of profit. A partnership is a contract and the relation between the persons is a contractual relationship. It must be formed expressly (orally or in writing) or may be implied from the conduct of the parties. Once a partnership is formed and commences business, HMRC must be notified.
A partnership can involve two or more persons, two or more companies or a mix of individuals and companies. If a partnership has two individuals but one dies, the business may continue as a sole trader and there is no longer a partnership. The ability to enter into a partnership contract is governed by the ordinary law of contract.
A partnership is a non-juristic person but has no legal identity separate from the persons that form it. Persons entered into a partnership are collectively known as the firm. For tax purposes a partnership is an unincorporated body of persons, in Scots law a partnership has a separate legal identity. Persons who form a club or society cannot form a partnership as they are not carrying on a business.
A business commences when the taxpayer begins operational activities (dealing with activities that are expected to make profits). Carrying on negotiations to enter into contracts is not operational activities in itself. The business must be carried on in common, meaning the persons must carry on a joint business venture and the partners must act in common, having a say in the management. A partner not involved in the day-to-day operation is a sleeping partner.
The business must be carried on with a view to profit, a not-for-profit organisation cannot be run as a partnership. If the partnership intends to make profits but suffers a loss, it is still a partnership. The test is applied to the intention.
A partnership can exist without a written partnership agreement and a name for the firm. A partnership must be distinguished from the following:
• Mere joint of ownership of property
• The sharing of gross returns by persons
• The receipt of a share of profits
• Persons (the promotors) who intend to form a company and work together towards that end are not partners
• The executors of a deceased sole trader
• A senior employee of a partnership who is held out by a partnership to the public as being a partner but who receives a salary rather than a share of profits, is not a partner
13.6 Partnership – terms of agreement
The terms of a partnership contract are derived from a number of sources, they are governed by the PA 1890 except to the extended that the partners agree among themselves. A written agreement is not legally required, but the advantages of having one are:
• It fills in the details which the PA 1890 does not cover, the nature of the business, the name and the bank account
• Overrides the terms otherwise implied by the PA 1890 which may be inappropriate to the specific partnership
• Bespoke clauses can be included in the agreement
The partnership agreement should ideally cover the following matters:
• The firms name, the place of business and the nature of business
• The date of the partnership commencement and the duration
• The proportions in which capital is provided and if interest is paid before profits are divided
• The way in which profit is shared and provisions for partners drawings
• Meetings of partners and the management of business
• Restrictions of partners activities
• The admission and retirement of partners
• The effect of death or retirement of partners
• The keeping of books of account, the preparation for financial statements and provision for tax
• An indemnity for each partner against the liabilities incurred
• Dispute resolution
13.7 Partnership – relations of partners with third parties
Forming contracts with third parties – a third party will want to assurance if they make a contract with one partner, they will be able to enforce the contract against all other partners. Each partner is an agent of the firm, each partner is a principal regarding the other partners. The partners may be bound by a contract of another partner and also liable for the crimes and torts of one partner.
A partner’s power to make contracts on behalf of all the partners is determined according to the rules of the law of agency. A partner may have:
• Express authority – partner explicitly given the power to conclude a contract
• Implied authority – partners do not have a specific power to conclude a contract they have implied authority however to conclude contracts that relate to the business of selling and buying goods and services, receive payments from debtors and give receipts to them and to engage with employees.
• Apparent authority – where a person is not a partner but is held out as one by the firm, and the third party believes the person is a partner, that contract is binding.
Unless the partnership agreement provides otherwise, the PA 1890 provides the authority of a partner to make contracts as follows:
• Every partner is an agent
• A partner will bind other partners to a contract if they are concluding a contract for the business of the partnership
• If the party does not have authority to bind the partnership, the partnership is still bound to the contract if the third party did not know the partner did not have the authority to make the contract
If the partners have agreed to restrict the power of a partner to bind the firm, the firm is not bound to anything done in contravention of the restriction with respect to persons who knew of the arrangement.
Incurring liabilities to creditors – each partner has unlimited joint and several liability to creditors for the debts of the business. The partners may be sued for any of the debts of the business and personal assets can be used to pay the debts. If a single partner is sued, they have a right of recovery from the other partners, for a share of the debts. It is only the debts of the business for which partners are liable. There are rules concerning new partners and retiring partners regarding their liabilities to creditors:
• New partners are liable for debts incurred after they become a partner, not for debts incurred before them unless they agree to become liable
• Retiring partners continue to be liable for outstanding debts incurred while they were partners, unless the creditor agreed to release them from liability. They are also still liable if the third party did not receive notice of their retirement. The liability is passed to their executors when they die.
13.8 Partnership – relations between partners
Partnership property – must be used in accordance to the partnership agreement. Property is partnership property if it was brought into the partnership by the partners who formed the partnership or was bought with partnership money.
Property is co-owned between all the partners and each partner has an interest in the whole of the property. On dissolution the partner still has a right to their share of the proceeds of the sale of property after payment of all debts. Partnership property must be distinguished from personal property, this is important for tax purposes on the disposal of property. For tax purposes each partner is regarded as owning a fractional amount in each asset according to their asset sharing ratio.
To secure partnership borrow, a partnership may grant a mortgage or fixed charge over partnership property. A general partnership is not able to grant a floating charge. A creditor of a partner in their private capacity cannot take partnership property in satisfaction of the debt. On dissolution, the property is used to pay outstanding debts before recourse is had to the private property of the partners.
Rights and duties between partners – partners must observe a duty of good faith, the 1890 PA adds further duties to this:
• Bound to render true accounts and full information to each other on all matters impacting the partnership
• Must account for profit they make using the firm’s property, name or trade connections without the consent of the other partners
• Must carry on business on their own account unless they agree to the contrary, but a partner must account for any profit made in business of the same kind as, or competing with the firm
13.8 Partnership – relations between partners (2)
Partners may fix and vary their mutual rights and obligations by express or implied agreement. Subject to the agreement, PA 1890 implies the following terms:
• All partners entitled to access the partnership books
• All partners take part in the management of business
• Decisions taken by majority vote of the partners. On deadlock the views in favour of the status quo prevail, but unanimity is required in relation to fundamental matters relating to the firm.
• Capital and profits and losses are shared equally, unless otherwise agreed
• Partners not entitled to remuneration for acting in the partnership business
• No interest is paid on capital contributed by a partner
• Partners entitled to interest at 5% per annum on loans made by them in excess of their original capital investment
• Partners are indemnified by the firm for any liability incurred or payment made in the course of the firm’s business
• A partner cannot be expelled by a majority of partners unless the majority have the power to do so under the agreement
Dealing in partnership interests – an individual’s collective rights under the contract is known as the partnership interest. The interest comprises of three key rights:
• The right to any surplus arising from the sale of partnership property on dissolution
• Right to a share in profits
• Right on the dissolution to the working capital they have contributed
A partner’s interest is from the perspective of each partner an item of private property, but not one in which they are necessarily free to deal.
Dissolution of a partnership – various ways it can come to an end include death, bankruptcy of a partner, an agreement between the parties, every time there is a change in membership there is a dissolution of the current partnership and commencement of another. Where a partnership comes to an end the property is distributed in the following order:
• Paying off external debts – if there are insufficient debts, the partners must bear the deficiency in accordance to the profit-sharing ratio
• Repaying the partners any advance made over and above their capital contribution (loans)
• Repaying the partners’ capital contributions
• Anything left over is then repaid to the partners in the profit-sharing ratio
13.9 Closing the business down
Sole traders and partnerships may decide to close down their business at any time and need to understand the various legal and tax implications, for example:
• They need to make redundancy payments to employees and provide them with necessary forms
• Rent may have to be paid for the premises until the leases can be assigned
• Payments might have to be made to terminate supply agreements early
• Closing year rules apply for income tax purposes
• They must notify HMRC for de-registration from VAT within 30 days. VAT may be due on assets owned by the business at the end of de-registration
13.10 Limited Partnerships
Under the Limited Partnerships Act 1907 it is possible to have a limited partnership in which:
• at least one partner has full, unlimited liability, but
• one or more individual partners have limited liability for the debts beyond the extent of the capital they have contributed.
The limited partners may not:
• take part in the management of the business
• withdraw their capital
• bind the partnership in a contract with a third party without losing the benefit of limited liability
• dissolve the partnership by notice and their death does not dissolve the partnership
13.11 Limited Liability Partnerships (LLPS)
The Limited Liability Partnerships Act 2000 allows for this. The key features are that:
• the partnership is a corporate body with a separate legal identity and unlimited liability for its debts
• the liability of the individual partners is limited to the amount of their capital contribution
The LLP is still treated as transparent for tax purposes despite being a corporate body. So, partners are still taxed according to the same rules that apply for a general partnership. Each partner pays income tax on trading profits and pays their own class 2 and 4 NICs.
The corporate personality of an LLP is ignored for tax purposes only where the LLP carries a business with a view to profit, an LLP set up to hold investments retains its corporate nature even for tax purposes.
To form an LLP, a registration procedure must be followed which requires an incorporation document, a statement of compliance and a fee to be sent to company’s house. The name must end with LLP. An LLP is simply run and owned by its members.
The rights and duties of partners are usually be set out in a partnership agreement, in absence of this they are set out in the Limited Liability Partnerships Regulations 2001. LLPs must have two designed members who must take responsibility for the compliance aspects of running an LLP by:
• filing certain notices with company’s house
• signing and filing accounts
• appointing auditors if appropriate
• in the event of insolvency proceedings, providing a statement setting out the affairs of the business
The separate legal entity of an LLP is primarily liable for the debts and obligations of the firm’s business. The members usually do not face personal liability, but there can be exceptions. Each member is an agent of the LLP and has the power to bind the LLP. But the LLP is not bound where the member does not have authority and the third party is aware that they do not have authority or does not know or believe them to be a member of the LLP.
The LLP has perpetual succession, where a partner has died or wound up, the partner ceases to be a member but the LLP continues in existence. If the LLP has one partner, it can continue for 6 months before being wound up, the remaining partner is responsible for the debts.
An LLP is wound up under similar provisions to company liquidation provisions. Partners of a general partnership can incorporate into an LLP and is generally done with no tax consequences. Transferring a property could have adverse SDLT consequences but there is a specific exemption from SDLT where a property transferred from an ordinary partnership into an LLP if certain conditions are met.
