Transitioning from Sole Trader to Partnership: A Strategic Guide

Legal recognition as a Partnership

Like a sole trader, a partnership is one of several legal structures which may be used to operate a business. Different types of business structures are available, each with their own merits. 

Converting from a sole trader to a partnership is made relatively straightforward by the lack of formalities compared to setting up a company.

In order for a partnership to be formed it must fit the below definition.

“Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.”

(s1 Partnership Act 1890)

A business seeking to convert from a sole trader to a partnership should mainly focus on meeting the above definition.

Drawbacks to forming a Partnership

Entering a Partnership can be burdensome on the individual partners because each must trust their co-partners to act for the good of the partnership business - this may not come naturally for someone accustomed to operating as a sole trader.

It may be worthwhile considering the pros and cons of alternative types of business relationships in order to determine if these are more appropriate for your particular business venture, e.g. employer-employee, principal-agent, franchisor-franchisee.

The liability among general partners is said to be “joint and several”. This means that the full amount of any outstanding debt of the partnership can be pursued against any individual partner, as well as the firm as a whole. The personal assets of each partner are at risk because of a general partner’s unlimited liability, as is the case for sole traders.

The law also works in a similar way should an individual partner commit a wrongful act or omission while conducting partnership business. All the other innocent partners are made liable for the loss or injury caused by that single partner.

Both of the above examples stress how general partners must be willing to share the risk of pooling their efforts if they are content to be sharing in the rewards.

Although not legally required, a partnership should be governed by its own individually-drafted Partnership Agreement (PA). Ideally, your PA will be drafted by a solicitor specialising in partnership law; willing and able to tailor this document to suit the needs of your business. Naturally, such a service's legal costs should be carefully considered.

Why convert to a Partnership?

Sharing is at the heart of a partnership; partners contractually agree to share the profits and losses of the partnership, the use of assets, the liability for debts and the right to make management decisions. Therefore, if you want to work alongside another individual as a joint owner-manager, this may be an attractive option for you. 

There are several benefits when two sole traders operate under a partnership instead of individually, or within a company:

• Combined general overheads;

• Ability to raise more capital for the business;

• Confidentiality of business matters;

• Tax relief for start-up losses (unavailable for companies).

Ownership of assets

As a sole trader, you are likely to own many, if not all, of the assets used by your business.

A partnership cannot legally own any of the assets used by the business, in the way that a sole trader or company can. There are two types of assets used by partnerships:

• “Partnership Property”: this is any property (including stock) brought into the partnership using partnership money to purchase it; and

• Assets personally belonging to a single partner but used within the partnership.

In the former case, each partner owns an individual share in the property. Legislation requires all “partnership property” to be used exclusively for the purposes of the partnership. This would, for instance, preclude the partners from using partnership assets at the weekends for personal use.

A formal partnership agreement should establish rules for the acquisition and use of any assets by the business to clarify the position above. In the absence of a partnership agreement, the property belonging to the partnership is assumed to be held in equal shares between each partner. 

Introduction of assets Belonging to a Sole Trader

If any sole trader forming a partnership decides to share their personal assets for use by the partnership, capital gains tax may arise.

Forming a partnership will mean the sole trader is disposing of a share in an asset - a half share, in a two-partner business - which was previously their own.

If the asset has increased in value since the sole trader acquired it for themself, the increased value attributable to the share they are disposing of is subject to capital gains tax.

For a further explanation on CGT and Partnership, please refer to guidance provided by the government: HS288 Partnerships and Capital Gains Tax (2019) - GOV.UK (www.gov.uk).

VAT and Income Tax Requirements

The partnership must also appoint one of their number to be a “nominated officer”. The nominated officer is responsible for

• Maintaining business records of the partnerships;

• Identifying each partner to HMRC;

• Producing a tax return and submitting this to HMRC.

The Partnership Tax Return will contain a statement on how the yearly partnership profit (or loss) has been divided among the partners.

In addition, each partner is required to individually register with HMRC for self-assessment. They will then be required to pay income tax and national insurance on their share of partnership profits, in the same way as if they were earning that income as a sole trader.

The threshold for compulsory VAT registration is the same for a partnership as for a sole trader - yearly VAT-taxable-turnover in excess of £85,000. A sole trader already VAT registered can transfer their registration to the newly-formed partnership using form VAT 68.

The deadline for registering the partnership with HMRC is the 5th of October in the firm’s second tax year.

Partnership Trading Name

Partnerships commonly use the surnames of all the partners as trading names.

If a partnership chooses a different name, it is legally required to set out the names of the partners on partnership stationery and on the visible front of business premises.

Author: Edward Bennet Gibbon -

Author: Edward Bennet Gibbon -

In partnership with:

DISCLAIMER

This article has been written by law students for the sole purpose of providing informative insight. The information in this article is intended for educational purposes only and does not constitute legal advice, nor should the information be used for the purpose of advising clients. You should seek independent legal advice before relying on any of the information provided in this article.

Sources

Partnership Act 1890

Companies Act 2006 cl Part 41

A Mavrikakis, Business Law And Practice (College of Law Publishing, 2021-2022)

Govuk, 'Set up a business partnership' (Govuk, 19 January 2023) <https://www.gov.uk/set-up-business-partnership> accessed 19 January 2023

Sarah Laing, 'A Winding Road? From Sole Trader To Partnership' (Tax Insider, April 2018) <https://www.taxinsider.co.uk/a-winding-road-from-sole-trader-to-partnership-ta> accessed 19 January 2023