Partnerships and self-employed NIC

1 The partnership computation

In this TX lecture: The opening-year and terminal loss relief for individual partners, and the extension of trading loss relief against gains, are not examined in FTX.

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2 Introduction

A partnership is a single trading entity, but for taxation purposes each individual partner is effectively treated as trading in his own right and is assessed on his or her share of the tax adjusted trading profit of the partnership.

It is essential to understand therefore that it is not the partnership itself that is assessed upon its tax adjusted trading profit, but it is each individual partner who will be assessed on his or her share of that tax adjusted trading profit.

Partners are assessed on a tax year basis - the same as sole traders.

3 Trading income

1. The default method of calculating the trading profit of the partnership is the CASH BASIS although the partnership can elect for the ACCRUALS BASIS to apply.

2. The partnership’s tax adjusted profits or loss for an accounting period (after capital allowances for the partnership) is computed in the same way as for a sole trader.

3. Partners’ salaries and interest on capital debited on the statement of profit or loss are not deductible as expenses as these are simply an allocation of trading profit by the owners of the business. These must be added back in the adjusted profits computation.

4 Allocation of the trading profit or trading loss

1. The adjusted trading income or trading loss is divided between the partners according to their profit sharing arrangements in force during the accounting period.

2. Partners may firstly be entitled to salaries and interest on capital (known as 'prior appropriations of profit'). The balance of any trading profit (or loss) remaining will then be allocated in the profit sharing ratio (PSR).

5 Partnership capital allowances

1. Capital allowances are deducted as normal in calculating the tax adjusted trading profit.

2. If assets are used privately by the partners, then as for a sole trader only the business proportion is included in the capital allowances computation.

6 A change in the profit sharing agreement

If the profit sharing agreement is changed during a period of account, the profit must be time apportioned before allocation under the different agreements.

• Time-apportion the partnership’s profit where a profit-sharing agreement changes. Apply salaries/interest allocations to each sub-period, then share the remainder in that sub-period’s ratio.

• A new partner is assessed on their allocated share from joining; a departing partner only on their share up to departure. Continuing partners’ shares change with the agreement. Each is assessed on the tax-year basis.

• Allocate the partnership’s capital allowances before dividing profits. Do not deduct partner salaries twice; they are allocations of profit, not business expenses.

7 Partners’ losses

Allocate a partnership loss under the partnership agreement, just as profit is allocated. Each partner may use their own share under s 64 against current/prior total income or s 83 against future profits of the same trade. The partners need not choose the same claim. Opening/terminal loss and gains extensions are excluded.

8 Self-employed earners

8.1 Class 4 contributions

Class 4 NIC applies to the self-employed individual’s taxable trading profits, not to an employee’s wages. It is normally due where the individual is aged 16 or over and below State Pension age at the start of the tax year.

The rates are given to you in the tax tables at the front of the exam - use them!

Class 4 uses assessable trading profits, including the annual given transition amount under the FTX examination model. Unlike Class 1 it is an annual profits computation, not a weekly/monthly cash-wages charge. Class 4 has no employer element and no employment allowance; Class 2 is excluded.