Tax Tips For Entrepreneurs – 9. Agree The Split Of Partnership Profits And Losses
The legal definition of a partnership is the relationship that subsists between persons carrying on a business in common with a view to profit.
In a simple partnership the partners share profits and losses in accordance with a pre-agreed profit-sharing ratio. A partnership is not a separate legal entity and partners are jointly and severally liable for the debts and losses of the partnership.
Normally, one would want the partnership agreement to be crystal clear on the split of profits. However, where the partnership comprises a husband and wife or civil partners, it may be advantageous to have a more loosely worded agreement to provide some flexibility in profit allocation to allow profits to be split in a way that minimises their combined tax liability. This could be achieved by a clause in the agreement which provides for profits to be determined in such a ratio as is agreed by the partners.
Agree The Split Of Posses
William and Ann are husband and wife and are in partnership together. As their other income fluctuates, they decide to keep the partnership agreement loose as to the share of profits and agree the split each year depending on their other income. In year 1 William has other income of £20,000 and Ann has no other income. The profits of the partnership are £50,000 and are allocated £35,000 (70%) to Ann and £15,000 (30%) to William to equalise income and minimise tax liabilities. In year 2, neither has any other income and profits from the partnership are £70,000. They agree to split the profits equally. The absence of a set profit sharing ratio in the agreement provides the flexibility to allocate profits in a tax-efficient manner.