Partnership guide

Partnership Agreements

People starting up in partnership often ask whether it is really necessary to have a formal partnership agreement. The answer is definitely 'Yes'.
Basically, the agreement should set out the rules governing how the partnership operates, and should cover the main ´What happens if ...´ situations. If there is no agreement, there will be a large element of uncertainty, and applying the underlying law, such as the Partnership Act 1890, may well lead to unwanted results.

It is usually best to have a partnership agreement drawn up by a solicitor, but before you reach that stage you should think about exactly what you want the agreement to cover. In particular, you should consider:

Running the business

Financial matters

Special circumstances

Limited Liability Partnerships

An LLP is a form of legal business entity that gives the benefits of limited liability but allows its members the flexibility of organising their internal structure as a traditional partnership. They are intended for businesses which carry on a trade or profession, and are particularly attractive to larger professional partnerships.

LLPs are in law regarded as 'bodies corporate' and are subject to aspects of company law, but for tax they will generally be treated as 'partnerships'. The members provide working capital and share any profits. Members who are individuals will be liable to pay income tax under the Schedule D rules, and self-employed Class 2 and Class 4 National Insurance contributions. Members who are companies will be liable to pay corporation tax on their share of profits.

Although, the liability of the members will normally be limited, the firm itself, and any negligent members, will be liable to the full extent of their assets.

LLP disclosure requirements are very similar to those of a company, including the filing of annual accounts (audited where necessary). There are also similar rules for the filing of annual returns, and notifying changes in members' details or the location of the Registered Office. However, the LLP agreement remains confidential.

Every LLP must have at least two, formally appointed, Designated Members, who carry responsibilities similar to those of a Company Secretary.

The name of an LLP is used in a similar way to that of a company, and is displayed in the format ANOther Limited Liability Partnership, or ANOther LLP, and there are similar restrictions on the use of similar or sensitive names.

Choosing your Accounting Date

Q: Can I select any date for my accounting year end?

A: The choice of a year end accounting date is for the business owner to decide.

The rules still allow businesses a free choice of accounting date. Under the current year basis, the taxable profit for a particular tax year is determined by the accounts that end in that year.

Thus, for 2006/07 tax, accounting dates will vary between 6 April 2006 and 5 April 2007. So what is the best date to choose?

Sometimes, compelling commercial reasons relating to the nature of the trade will dictate the most appropriate accounting date. Otherwise (as in many tax matters), there is no easy answer - it all depends on the particular circumstances. There are several basic considerations:

Overlap relief
The system is designed so that, over the life of a business, tax is paid on no more and no less than the cumulative profits of the business. However, unless your accounting date falls between 31 March and 5 April (inclusive), there will be some element of double counting, or overlap, in the first full tax year on the current year basis.

Overlap relief will be held in reserve for use when the business ceases (or on an interim change of accounting date). One concern is that, because of inflation, overlap relief will be worth less in future years than it is at present.

Bunching of terminal profits
The converse of the overlap situation is the 'bunching' effect of profits when a business ceases. The assessment for the final tax year will be based on the profits right back to the accounting date in the previous tax year. The earlier in the tax year the accounting date falls, the longer will be the period of account relating to the final assessment.

Thus a cessation date of, say, 31 December means that the final tax assessment will be based on a period varying in length between 9 months (5 April accounting date) and 21 months (6 April accounting date). This effect may be lessened to some extent by overlap relief, but the overall distortion is illustrated in the example set out below.

Partnerships
Partners are each deemed for tax to have an individual business so the points already mentioned for new businesses and those ceasing apply equally to partners joining or leaving a continuing partnership.

Pattern of profits
If profits do not vary significantly from one year to the next, the accounting date will not affect the assessable profit for each tax year.

Where profits show a trend, the rule of thumb is that (all other things being equal) it is beneficial to have an accounting date early in the tax year if profits are rising, and late in the year if profits are falling.

External factors
Of course, all other things are not equal, and in evaluating the advantages and disadvantages of particular accounting dates there are a number of factors to be considered, including:

Timing of payments on account
It is as well to remember that the date for the first payment on account falls over two months before an accounting date of 5 April, but nearly ten months after an accounting date of 6 April. Thus, with an accounting date later in the tax year, you could pay too much tax on account where profits are falling, and this is a further factor affecting cashflow.

Conclusion
Using a 5 April (31 March) accounting date leads to the simplest application of the current year basis of assessment. However, it does mean that the timetable for tax payments and returns is very tight, and there is therefore an increased risk of incurring penalties. Also there is now less time to allow for tax and business planning relating to tax issues.

If you expect your profits to show an overall upward trend, there are clearly cashflow advantages in having an accounting date at or shortly after the beginning of the tax year. In these circumstances, it is important to ensure that you make proper provision for the increased liability that will occur when the business ceases.

Benefits in Kind & Expenses Payments

Benefits in kind are assessed on all directors and employees whose salary and benefits combined are £8,500 or more.

Remuneration by way of benefits is often attractive to employees, especially if they are paying the higher rate of income tax, because the benefit may either be tax free or subject to less tax.

A benefit that is not taxable is not automatically exempt from national insurance contributions

(NICs).
An employer is required to complete form P11D in respect of each employee earning £8,500 or more (including benefits) and all directors. Form P9D is required to record benefits received by other employees. Benefits for NIC purposes must be included on the deductions working sheet column 1A 'earnings on which employee's contributions payable'. (This should not include Class 1A NIC benefits on company cars and car fuel). Comprehensive records should be kept in relation to all benefits and expenses payments.

Non-taxable benefits
There are several benefits that are not normally taxable, even when an employee is within the P11D category. These can be substantial. The most significant are:

Small interest free loans
No tax is payable on 'cheap' or interest free loans to employees of up to £5,000.

Employee benefits
Tax efficient benefits can assist your company's profitability by ensuring that employees receive the maximum benefit from the money spent on their remuneration, thereby helping to retain key staff members.

Most, but not all, benefits are now caught by tax legislation. Most benefits are also caught for national insurance. Every employer operating PAYE schemes should obtain a copy of Employer's Further Guide to PAYE and £s (CWG2) - and should read it carefully.

Cars
When company cars are used for private motoring, the taxable benefit is normally calculated as a percentage of the list price. If an employee is also provided with fuel for private use in the car he or she is taxed on the same percentage applied to a standard value regardless of the value of the fuel used. NICs may be due on the fuel, depending on the method of purchase. Class 1A NICs must also be paid by the employer. National Insurance Planning - and don't forget that VAT is payable based on a special scale charge for fuel provided for private use.

Vans
If a company van is made available for private use (including travel between home and work) a standard taxable benefit applies. This benefit includes fuel for private use.

There is no charge for employees who have to take their van home and are not allowed other private use. There is also no charge for use of a commercial vehicle of more than 3.5 tonnes gross weight, so long as the employee's use is not wholly or mainly private.

Expenses payments
These also need to be disclosed on forms P11D. However, the employees then need to put in claims on their own tax returns or tax codes for expenses incurred in the performance of duties.

Where an employee is not required to complete a tax return, form P87 should be used instead.

How to save yourself work
Most employers can obtain a dispensation in respect of certain expenses payments, which could avoid the need to complete P11Ds in some cases. Application can be made at any time. Check with us for details.

Tax and the Company Car

The system for taxing those who use company cars has remained fundamentally unchanged for some years, save for stepped changes in the emissions thresholds. The basis of the charge is to tax a figure calculated by multiplying the car's list price by an emission-based percentage, with a 3% surcharge on diesel powered cars.

The taxable value of the benefit continues to be up to a maximum of 35% of the list price of the car when first registered. The list price includes car tax (if applicable), Value Added Tax and delivery charges, and is subject to an upper limit of £80,000.

Cars emitting CO2 at or below a specified level are taxed on 15% of the list price. This is the usual minimum charge and will apply up to an emission level of 144g/km.

Cars running solely on diesel fuel are subject to a 3% supplement, unless the car meets the Euro IV standard. Special rules apply to cars running on electricity, electricity and petrol, gas or petrol and gas, which are generally seen as more environmentally friendly.

Cars with higher levels of CO2 emission are taxed on a graduated scale rising to a maximum (for both petrol and diesel) of 35% of the car's price. The detailed figures are shown in the Appendix. These figures apply to all company cars, including second cars.

Cleaner Diesels
When the current system was introduced, it included a discount of 3% for diesel powered cars compliant with the Euro IV emissions standards to encourage earlier take-up of 'cleaner diesels' and effectively cancelling the 3% surcharge on all diesel company cars.

The Government is satisfied with the take-up of cars that are Euro IV compliant and the 3% discount has therefore been withdrawn from 6 April 2006 for cars first registered after 31 December 2005. It will, however, continue to be given for Euro IV compliant cars registered upto and including that date.

CO2 emission information
For all cars first registered from at least November 2000, the definitive CO2 emissions figure for tax purposes will be recorded on the Vehicle Registration Document (V5). Under an agreement with HM Revenue & Customs, the Society of Motor Manufacturers and Traders (SMMT) is providing a CO2 emissions enquiry service on their website at www.smmt.co.uk for cars first registered from January 1998.

Older cars
Cars first registered before January 1998, for which there are no reliable CO2 emissions data, are taxed according to their engine size, as follows:

Engine Size (cc) Percentage of car's price charged to tax

0 - 1400 15%
1401 - 2000 22%
2001 and more 32%

Fuel scale charges
Where the employer pays for any fuel used privately by the employee, there is an additional scale charge based on the CO2-based car benefit percentage applied to a standard value of £14,400.

Employee contributions
Where the employee is required, as a condition of the car being made available, to pay for the private use of a car the value of the benefit is reduced accordingly (on a pound for pound basis). Capital contributions of up to £5,000 made by employees towards the cost of the car and/or accessories, when the car is first made available, will continue to reduce its price for tax purposes.

By contrast it is "all or nothing" for the fuel scale charge, which remains at the full value unless the employee pays for all private fuel!

HM Revenue & Customs has published baseline rates which will be accepted either for employers re-imbursing employees for the cost of fuel for business mileage, or for employees re-imbursing employers for the cost of fuel for private mileage. Alternative rates may be negotiated, for example when it is necessary for the performance of his or her duties that an employee uses a four-wheel drive vehicle, a higher rate per mile might be agreed due to the typically higher fuel consumption of such vehicles.

Tax payable
These standard charges are subject to income tax at basic or higher rate (depending on the employee's rate of pay). The tax is usually collected under the PAYE system by appropriate adjustment of the employee's tax code.

For the benefit to be attractive, the employee must pay less in extra tax than it would cost him to run his own car out of his taxed income.

Tax free benefits
Car Parking
The provision of a car parking space at or near the employee's place of work is not an assessable benefit.

Pool Cars
There is no tax for using a pool car. This is one where private use is merely incidental to the business use, and it is not normally used by one employee to the exclusion of all others.

Please note: A pool car must not normally be kept overnight at or near an employee's home.

"Lower Paid" Employees
The provision of a car for an employee (NOT a director) who is paid at a rate below £8,500 per year (including the value of benefits) does NOT attract any charge to income tax. Nor is there any charge on fuel for private use provided to such employees.

Special Consideration for Sole Traders

If your spouse is employed in your business (but not as a partner), it can be very tax efficient to provide them with a car, as long as they earn well below £8,500. The use of the car can be tax-free in their hands, and the business will get full tax relief on all the expenses connected with the car, provided you can demonstrate the car is necessary for business purposes.

Business use of an employee's own car
It is quite normal practice for employees to be reimbursed at a reasonable mileage rate for business use of their own cars.

A statutory system of tax and national insurance free mileage rates applies for business journeys in employees' own vehicles, as follows:

Cars and vans
On the first 10,000 miles in the tax year 40p per mile
On each additional mile above this 25p per mile
Motor cycles 24p per mile
Bicycles 20p per mile

It is no longer possible to make a claim for tax relief based on actual receipted bills, nor claim capital allowances or interest on loans related to car purchases.

Unless the employee is reimbursed at a rate higher than the statutory mileage rate, the payments do not need to be reported on a P11D.

Company vans
There is no taxable benefit where employees have to take their company vans home and are not allowed any other private use. Otherwise, the taxable benefit for the private use of a company van and fuel, if supplied, is £500 or £350 (vans less or more than four years old) per annum, until 5 April 2007.

With effect from 6 April 2007 the taxable benefit for the unrestricted use of company vans will be £3,000 (with no reduction for older vans) plus a further £500 of taxable benefit if fuel is provided by the employer for private travel.

The maximum tax payable on the use of a company van will therefore increase from April 2007 from £200 to £1,400 p.a., and the employer's Class1A NIC payable will increase from £64 to £448 p.a.

Tax saving check list

1. Keep adequate records of business mileage.
2. Always check your tax code to see that the correct benefit is being applied.
3. Sole traders and partners should consider the potential tax advantages of providing their spouse with a company car.
4. If you have low private mileage, you may be better off if you pay for all your own private fuel.
5. If you have high business mileage, it may be better to use your own car and claim "mileage" from your employer.
6. Encourage your employer to apply for a P11D dispensation.
7. If you are on the borderline of "lower paid", think about setting up a contribution for the use of the car, to keep on the right side of £8,500.
8. Tax - free parking is a must!

Interest and Tax Payments

HM Revenue & Customs charges interest on underpayments of tax, and pays interest (repayment supplement) on overpayments. The rate of interest paid on overpaid tax is lower than the rate charged on underpayments, and interest rates are adjusted frequently in line with commercial interest rates.

Detailed calculation of interest and supplement are not shown on Statements of Account, so it is worth checking when these items are large.

Income Tax and Capital Gains Tax - self assessment
Interest is charged on underpaid payments on account and balancing payments from the due date to the date of payment. Repayment supplement is paid from the date of overpayment to the date the repayment is issued. The interest or supplement is based on the final amount of tax and Class 4 national insurance contributions, taking into account all later adjustments.

Interest is also payable on late-paid penalties and surcharges (but not on interest!).

For individual taxpayers interest charged by the Revenue is not tax-deductible, but neither is interest paid by the Revenue taxable income.

Corporation Tax - self assessment
Similar principles apply with regard to corporation tax. However, interest rates are not necessarily the same as those applying to income tax and capital gains tax. In addition, there are different rates of interest for companies required to make quarterly payments of corporation tax.

In contrast to the position with personal taxpayers, under corporation tax self assessment interest charged is allowed against company profits and interest received is treated as taxable income.

Raising Finance for Your Business

If you are thinking of expanding your business, or starting a new one, you will need to raise finance. This requires careful planning and good professional advice. It is generally wise to spread your commitment over a number of finance sources. This will give you greater flexibility in the long term. Some of the more common sources are:

Most lenders will require some form of security. No amount of security will make a bad plan good, but it does demonstrate commitment from your side and provide insurance for the lender. As one banker recently said 'If they're not prepared to take a risk, why should we?' Generally acceptable forms of security include:

Again, you might consider using more than one form of security. If the lender requires personal guarantees you should proceed with great caution. Try to ensure that any such guarantees are limited in amount, if not in time. You should also consider insuring the risk. You will almost certainly be required to present a comprehensive and convincing business plan to show how you are going to service the loan. In essence, this must demonstrate that you will be able to meet the new commitment through sustained growth in your business.

In all three areas - choosing a finance source, securing the finance, and preparing a business plan - you will benefit greatly from our professional advice. Why not arrange to meet with us and take advantage of our in-house expertise and extensive network of contacts? We might even be able to help you refinance your existing commitments to your advantage.

UITF Abstract 40

Prior to 2000, there were three bases to choose from when preparing accounts of professional firms. The first, and most popular among firms of Solicitors, was the Cash Basis whereby income and expenditure was only recognised when it was either received or paid.

The second basis was commonly referred to as the Conventional Basis which differed from the Cash Basis only to the extent that bills issued but not settled at the year end were taken into account. This basis found favour with many professional firms.

The third basis was the Accruals Basis which extended the Conventional Basis by recognising accrued and prepaid expenditure and also work in progress, ie incomplete work, at cost. This was not widely adopted by professional firms.

In 2000, the Inland Revenue via an earlier Finance Act, imposed the full accruals basis and everyone in business thereafter had to identify and account for work in progress at cost. In professional partnerships generally this meant staff costs inclusive of relevant overheads and excluding any element of partner cost. In limited companies directors take the place of partners and their time will be included, but any profit element will be excluded.

In 2003, by way of an interpretation of FRS5 issued in the 1990's, the Accounting Standards Board (ASB) issued Practice Note G on Revenue Recognition. This caused much debate and the widely held and publicised view was that little if anything had changed.

In March 2005 the ASB through its sub-committee known as the Urgent Issues Task Force issued UITF abstract 40 in which it spelled out quite clearly the basis of recognising income in respect of incomplete work for all service providers. The result is that for all accounting periods ending after 22nd June 2005 the accounts of all service providers have to recognise work in progress at full selling price. This applies to sole traders, partnerships, limited liability partnerships and limited companies.

There are some instances whereby pieces of incomplete work can be omitted from the year end valuation and the simplest to explain is where the outcome of the piece of work is 'at risk'. An example of this is a 'no win no fee' arrangement. If the work in question is incomplete at the year end and this case has not been won by that date then there is no right to any of the income.

Apart from these few instances, all incomplete work will require to be valued at full selling price. It is of no consequence if there is no contractual right to issue a bill for the incomplete work at the year end. It is sufficient that there is a right to expect to be paid for the work when it is completed. Therefore if a piece of work is, say, 50% complete at the year end then 50% of the expected final sales value has to be recognised regardless of whether or not a bill can be issued at that date for this amount.

Up until this time this incomplete work would have been valued at cost and in professional practices this would mostly exclude partner input. It would also exclude profit on the staff cost element. Therefore the change means a recognition of the previously excluded profit element as well as the partner input value. For many, this will represent a significant uplift in value.

The accounting rules state that in the year of change the whole year has to be measured on the same basis. The consequence of this is that the work in progress at the start of the year in which the change takes place has to be revalued on the new basis. The introduction of this revalued amount at the start of the accounting period creates an uplift adjustment of the difference between the new revalued amount and the previous value based on cost. This uplift adjustment is a one-off adjustment to move to the new basis and creates an exceptional one-off tax bill. Gordon Brown, in his pre-Budget Statement, has stated that legislation will be introduced to allow the tax cost arising from this uplift to be spread over at least three years.

What does this mean for you?
For many businesses there is the immediate consequence of the large tax charge arising out of this one-off uplift adjustment. Every year thereafter, because work in progress is now being valued at selling price, there is every likelihood that year on year profits will be greater thus giving rise to increased annual tax bills. All of this means pressure on cash flow and for many, there will be the need to arrange additional long term funding.

However, tax is only one concern arising out of this change. There are the strategic concerns for business continuity through succession. This increased value of work in progress will be added to the Balance Sheets thereby increasing the value of the capital in the business. The consequence is that on retiral the owners of the business, in the case of partnerships, will be seeking a full release of their investment that is now greater and in the case of limited companies a higher disposal price for their shares. This puts more pressure on future cash flows.

In addition, in the case of partnerships, incoming owners will be expected to introduce funds to match the existing owners and as this value is now greater then the incoming owners will require to find a greater amount of cash than previously. In the case of limited companies new management being brought into ownership will require to subscribe for shares that carry a higher acquisition value. All of this could act as a deterrent to the introduction of future owners.

If your business is that of a service provider, or if you have any questions in general, please contact us as soon as possible to discuss how this latest development might affect you.