Taxation of partnerships & sole traders

BLP.18 — Taxation of Partnerships & Sole Traders

Core principle: tax transparency

A general partnership and a sole trader have no separate legal personality for tax. Profits are taxed in the hands of the individual partners/proprietor, not the business. The firm is "transparent" — it files a partnership return, but each partner is separately assessed and liable for tax on their share. (Contrast: a company is a separate taxable person paying corporation tax.)

Income tax on trading profits

• Trading profit is computed, then allocated to partners per the profit-sharing ratio in the partnership agreement (or equally under PA 1890 s.24 if silent).
• Each partner pays income tax on their slice at 20% / 40% / 45% (personal allowance £12,570) plus Class 4 NICs. (Class 2 NICs are no longer a required charge for the self-employed from 2024/25 — only voluntary Class 2 to preserve the contributions record.) Drawings are irrelevant — partners are taxed on profit share, not amounts drawn.
• A sole trader is taxed identically on the whole trading profit.
• Basis: from 2024/25 the tax-year basis applies — profits are taxed by reference to the tax year (6 April–5 April), ending the old current-year basis and overlap-relief complications.

Losses

Trading losses give relief options: set against other income of the same/prior year (s.64 ITA 2007), carry forward against future profits of the same trade (s.83), or early-trade loss relief (carry back 3 years, s.72) in the first four years.

Capital gains

Each partner is treated as owning a fractional share of each chargeable asset; a disposal of partnership assets triggers CGT on each partner individually. Rates 18% / 24%; annual exempt amount £3,000. Business Asset Disposal Relief may apply on disposal of all/part of the business: 18% rate, £1,000,000 lifetime limit (per individual).

VAT

The firm registers for VAT (treated as a single person for VAT) once taxable turnover exceeds the £90,000 threshold.

Common traps

• Drawings ≠ taxable amount. Partners are taxed on profit share even if undrawn.
• No corporation tax — never apply the 19%/25% CT rates to a partnership or sole trader.
• Salaried partners / "salaries": a partner's "salary" is an allocation of profit, taxed as trading income, not employment income.
• BADR limit is £1m lifetime, not per disposal, and the rate is now 18% (from 6 April 2026).
• NICs: the self-employed pay Class 4 on profits; Class 2 is no longer a required charge (voluntary only) from 2024/25.
• Incoming/outgoing partners: profit is apportioned by time and by the ratio applicable during each period.