There are a number of key tax and legal differences to consider when your status changes from that of an employee to becoming a partner in a partnership.
The following table highlights some of the key differences.
|EMPLOYMENT (EMPLOYEE)||SELF-EMPLOYMENT (PARTNERSHIP)|
|The individual (employee) will pay income tax and National Insurance Contributions (NIC) on their earnings received from their employer.||The partner will pay income tax and National Insurance Contributions (NIC) on the taxable profits allocated to them from the partnership.|
|Income tax The same income tax rates that apply to employment income apply to profits from a partnership.|
|You are taxed on employment income when it is paid to you during the tax year.||As a partner you are taxed on profits that are allocated to you. Currently profits assessable in a tax year are those arising in the ‘basis period’ for that year, which is normally the accounting period ending in the year, with special rules for commencement and cessation of trade. The rules around basis periods are being repealed – see ‘basis period rules’ below.|
|As an employee, you may not need to file a self-assessment tax return with HMRC. If you do need to file a self-assessment tax return (for example, if you have other sources of income, or earn over £100k in a tax year) you will need to register for self-assessment by completing form SA1. Currently, self-assessment tax returns are due each year by 31 January.||As a partner you will have to file a self-assessment tax return with HMRC. Form SA401 should be completed by an individual becoming a partner in a partnership. Currently, partnership tax returns are due each year by 31 January, however in practice they commonly need to be submitted in advance of this to ensure the individual members have the data available in time for their own self-assessment tax returns.|
|National Insurance Contributions (NIC)|
|As an employee, you are subject to Class 1 NIC. The rates for the 2023/24 tax year are: If you earn more than £242 a week and up to £967 a week, you pay 12% of the amount you earn between £242 and £967If you earn more than £967 a week, you also pay 2% of all your earnings over £967. Your contributions are deducted from your wages by your employer.||As a partner, you are subject to pay two classes of NIC, Class 2 and Class 4. The rates for the 2023/24 tax year are: Class 2 NIC is paid at a flat rate of £3.45 a week (2023/24) if your earnings are over £6,725 in the year.Class 4 NIC is paid as a percentage of your annual taxable profits – 9% on profits between £12,570 and £50,270, and a further 2% on profits over that amount (2023/24).|
|As an employee, you will have income tax and NICs withheld at source from your wages in the form of Pay As You Earn ‘PAYE’.||As a partner, PAYE will no longer apply (unless the salaried member rules for LLPs apply). Currently, self-assessment returns are due by 31 January each year, and payments on account must be made twice a year for the current tax year: On 31 January within the tax year; andOn 31 July, after the tax year ends. Individuals and partnerships will need to sign up to Making Tax Digital (MTD) if earning over £10k per year. Some partnerships will need to make sure they meet the MTD for Income Tax requirements by 6 April 2025, but full dates for all types of partnerships have not been published. MTD for Income Tax will change the filing requirements from an annual obligation to at least quarterly filings.|
Basis Period Reforms
Currently, the first year an individual becomes a partner they are subject to the opening year rules, which falls into two stages:
- The UK tax year in which a partner joins the partnership, where profits are charged to tax based on the actual income that arises between the partner joining the partnership and the end of the tax year on 5th April, and
- The following UK tax year, where a partner is assessed on 12 months’ of profit regardless of the accounting period end date. This can result in ‘overlap profits’ whereby more profits have been charged to tax than have arisen. Overlap profits are the share of the profits which have been charged to tax twice, and these are carried forward to offset against income at a later date e.g. upon cessation of trade, or the partner leaving the partnership.
After the opening year, the ‘current year basis’ is used whereby the profits assessable are the profits arising at the accounting period end date which falls within the tax year, e.g. if you have a December 2022 year end, then these profits will be charged to tax in the 2022/23 tax year.
Change to basis period rules from 2023/24
The basis period rules are being repealed, and partnership profits will instead be assessable based on profits arising within a tax year. This will have the following impact:
- From 2024/25, partnership profits will be taxed based on the profit made in that tax year.
- The tax year 2023/24 will be a transitional year with the following profits charged as follows:
- The current year basis is used, plus any profits arising between the end of that accounts period and 5 April 2024 are charged in 2023/24
- This is reduced by any overlap profit brought forward
- Any additional net profit above what would have previously been taxable under the old basis is then spread over 5 years, starting in 2023/24. You can elect to be taxed on more than this in a tax year, which might be beneficial if for example you have some of your basic rate tax band remaining.
- If the accounting period for the partnership is not changed to 31 March or 5 April, then profits will need to be apportioned each year going forwards for the partnership tax return. This presents a problem if you only have estimated profits for the second accounting period that you are apportioning.
Say you have an accounting year end of December. For the 2024/25 tax year, the profits charged to tax will be:
- 6 April 2024 – 31 December 2024: 270/366ths of your December 2024 profits, plus
- 1 Jan 2025 – 5 April 2025: 95/365ths of your December 2025 profits
It is likely that by the time you need to submit your 2024/25 tax return (by 31st January 2026) you may not have your December 2025 partnership accounts finalised.
In this scenario, unless the rules are changed, you would need to submit estimated figures in your tax return, then amend it when you know the December 2025 profits from your partnership.
Therefore, it may well be beneficial to change your year end to March in the 2023/24 tax year; if you change the year end to March 2023 then you will end up with excess profits in the 2022/23 tax year but you will not be allowed to spread them as transitional profits!
Overall, the rules are complex for basis periods and the transitional period, so we recommend seeking advice before submitting your partnership or individual tax returns.