Taxation of partnerships & sole traders

BLP.18 — Taxation of Partnerships & Sole Traders

Core principle: tax transparency

For the charge on partnership trading profits, the firm is normally transparent: calculate and allocate the profit, then charge each partner on that partner's share, not on drawings (ITTOIA 2005 ss.848-850). Individual partners pay income tax; corporate partners can pay corporation tax (CTA 2009 ss.1258-1259, 1262). A sole trader is the individual proprietor, not a separate company.

Do not confuse tax treatment with legal personality. An English/Welsh ordinary partnership has no separate legal personality; a Scottish firm does (PA 1890 s.4). A profit-seeking LLP is generally transparent for these taxes despite being a body corporate, subject to the statutory conditions and cessation rules (ITTOIA s.863; TCGA s.59A). The partnership still has return obligations and can have VAT and employer-tax liabilities; transparency does not mean that it has no tax obligations.

Income tax on trading profits

• Compute tax-adjusted trading profit, then allocate it under the profit-sharing arrangements in force for the relevant period. The default is equal shares if there is no contrary express or implied agreement (PA 1890 s.24). Statutory rules can override an allocation, including mixed individual/company partnership rules; an agreement is not a universal tax-avoidance permission.
• Drawings do not determine the charge. Profit left in the business still belongs in the partner's allocated trading income. Personal allowances and reliefs are considered later in that individual's computation.
• Main income-tax rates for 2026/27 are 20% / 40% / 45%; apply the relevant territorial rules, rather than assuming these describe every Scottish/Welsh taxpayer's non-savings income (FA 2026 s.2; ITA 2007 ss.6, 10). In an England computation, the basic-rate band is £37,700 of taxable income. The standard personal allowance is £12,570, subject to entitlement and a £1 reduction for each £2 of adjusted net income above £100,000; it is exhausted at £125,140 (ITA ss.10, 35). Do not give the full allowance to every partner regardless of other income.
• A sole trader starts with the whole trade's profit. A partner starts with the allocated share. Allowances, other income and the applicable rates determine the actual liability.

Tax-year basis and transition

From 2024/25, income-tax trading profits are assessed on the tax-year basis, 6 April to 5 April, not the old accounting-year basis. If accounts do not coincide with the tax year, apportion/aggregate the relevant periods; daily apportionment is the default, with a reasonable alternative used consistently permitted (ITTOIA ss.7-7A). Late-March/early-April accounting-date rules can avoid small apportionments (ss.7B-7D).

The reform did not make transition profits disappear. Remaining 2023/24 transition profits, after the applicable overlap-relief calculation, are normally spread across 2023/24 to 2027/28. Earlier taxation can be elected; permanent cessation brings the remaining balance into charge. Thus a 2026/27 computation may still include a transition-profit amount (FA 2022 Sch.1 paras.61, 70-73). Do not cite repealed ITTOIA s.852 as the current provision creating a notional trade for every partner.

Partners' salaries and LLP salaried members

• A genuine partner's agreed priority share called a salary is an allocation of trading profit, not an employee wage or a deduction from that profit. The title is not decisive: someone called a salaried partner may instead be an employee on the actual facts (HMRC PM132050). Fixed remuneration alone is not a conclusive status test.
• For an individual member of a profit-seeking LLP within s.863, all three conditions in ss.863B-863D must be met for the salaried-member income-tax treatment in s.863A: A, at least 80% of expected remuneration for services is disguised salary; B, the mutual rights/duties do not give significant influence over the LLP's affairs; C, the qualifying capital contribution is less than 25% of the expected disguised salary for the relevant tax year.
• Disguised salary includes fixed amounts, amounts varying without reference to overall LLP profits/losses, and amounts not in practice affected by them. Apply the statutory testing times, capital definition, part-year/new-member adjustments and anti-avoidance rules; do not infer employee status merely from the word salary (ss.863B-863G). These are LLP rules, not a replacement test for every ordinary partner.
• BlueCrest [2026] UKSC 18: significant influence must derive from enforceable rights/duties, including qualifying delegated authority, and concern the LLP's affairs as a whole. Control is unnecessary ([81]). Influence from strong performance, high contribution to profits, personal qualities or client relationships is excluded unless it comes from the member's formal, legally enforceable role ([77]-[78]); influence over one part of the business is not enough ([94]). The qualifying influence is likely to be managerial or strategic, not an absolute prerequisite ([95]). Condition B was remitted to the FTT ([137]). Remuneration tied to an individual's/team's performance did not cease being disguised salary merely because total LLP profits capped payments ([128]-[134]).

National Insurance

For ordinary UK self-employed trading profits in 2026/27, subject to applicable age/status exceptions:

• Class 4: 6% on profits over £12,570 up to £50,270, then 2% above £50,270 (SSCBA 1992 s.15). No Class 4 is due merely because there is a small positive profit below the lower limit.
• Class 2: at or above the £7,105 small-profits threshold, contributions are normally treated as paid, without a payment obligation. Below that threshold eligible self-employed people may pay voluntarily at £3.65 per week to protect their record (s.11; SI 2026/231 regs.1, 3). Saying only "voluntary Class 2" misses the treated-as-paid route. Check the separate rules for employment, overseas work and special occupations.

Trading losses

• General-income relief (ITA s.64): claim against income of the loss year, the preceding year or both; if both, specify which year first. Commerciality and other statutory restrictions apply. The claim deadline is normally the first anniversary of the normal self-assessment filing date for the loss year.
• Early-trade losses (ss.72-74): losses in the first tax year of the trade or the next three tax years can be carried back against income of the three years before the loss year, earliest first. Commerciality and restrictions, including the spouse's earlier conduct of the same trade, matter. The claim deadline follows the same anniversary rule.
• Cap (s.24A): specified income-tax reliefs, including s.64 and s.72 relief, share an aggregate annual limit of the greater of £50,000 and 25% of adjusted total income, subject to the statutory exclusions. Amounts relieved against profits of the same trade/business are excluded from this cap. Adjusted total income is defined in s.24A(8); it is not simply turnover or drawings.
• Carry forward (ss.83-84): unrelieved losses can be claimed against the earliest available future profits of the same trade, not freely against any future income. Do not relieve the same loss twice. Under s.71, an unused s.64 loss may also qualify for CGT treatment under TCGA ss.261B-261C, subject to those conditions.
• Terminal relief (ss.89-91): permanent cessation can allow qualifying losses from the final 12 months to be relieved against profits of the same trade for the final tax year, then the three previous tax years latest first. This is not a general three-year relief against all income.

Capital gains

Tax on gains from partnership assets is assessed on the partners separately (TCGA s.59). For individual partners, their shares of gains enter their own CGT computations, with their own reliefs, losses and AEA entitlement. Profit-sharing and capital-sharing ratios need not be identical; establish the relevant interests rather than automatically using the income ratio. Corporate partners' gains are within corporation tax, not individual CGT rates.

For individuals in 2026/27, main CGT rates are 18% / 24% and AEA is normally £3,000, subject to entitlement. BADR can apply on a qualifying disposal of the whole/part of the business or partnership interest, at 18% for disposals on or after 6 April 2026, subject to the £1m lifetime limit. It requires a claim and the relevant ownership/activity conditions; not every sale of a business asset qualifies. See BLP.14 for computations and relief conditions.

VAT

The firm's taxable supplies are considered together, not by giving each partner a separate threshold. Registration can be in the firm's name (VATA s.45). For a UK-established business, the £90,000 tests concern taxable supplies over the past 12 months tested at month-end, or expected supplies in the next 30 days alone. The retrospective test has a limited exception if HMRC is satisfied next-12-month taxable supplies will not exceed £88,000. Notification/effective-date rules differ between the two tests. Non-UK-established businesses have separate rules. See BLP.16, not a blanket "register whenever annual turnover exceeds £90,000" rule.

Common traps

• Drawings, retained profit and a genuine partner's salary allocation do not replace the allocated-profit starting point.
• Transparency is not no tax: identify an individual or corporate partner, the type of receipt, and the relevant tax.
• Calculate allocations for the periods during which the relevant rights apply; do not assume membership length is always irrelevant or every allocation is a simple time fraction.
• Check allowances, relief caps, transition profits and NIC thresholds before calculating the final liability.

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