What Is the Right Way to Divide Profits and Losses in a Partnership in the UK?

Summary

• Partnerships do not require a formal written agreement, but without one, the Partnership Act will apply by default, which may not reflect how the business actually operates.
• A well-drafted partnership agreement should document how profits and losses are divided, partner responsibilities, capital contributions, and processes for partners joining or leaving.
• Drawings are treated as income and subject to income tax when withdrawn by a partner from the partnership.
• This article is a plain-English guide to dividing profits and losses in a business partnership in Australia, written for business owners and partners.
• The content is produced by LegalVision, a commercial law firm that specialises in advising clients on partnership agreements and business structures.

 

Tips for Businesses

Document profit and loss arrangements in a written partnership agreement before trading begins. Agree on a drawing structure that reflects each partner’s contribution. Review the agreement if the business changes. Keep clear financial records to support accurate tax reporting each year.

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On this page

• Allocating Profits
• Drawings vs Profit Share
• Losses Within a Partnership
• Importance of a Partnership Agreement 
• Tax Considerations within the UK
• Key Takeaways
• Frequently Asked Questions

 A partnership is where two or more individuals agree to work together toward a common goal with the view to making a profit. While it is best practice to formalise the arrangement in writing, it is important to note that there is no legal requirement to have a formal contract recognising a partnership. Being a part of a partnership means each person (referred to as a ‘partner’) is liable for losses as well as gaining a share in business profits. Whether you are a traditional partnership (general partnership) or a limited liability partnership (LLP), all individual partners must understand how profits and losses are divided in a partnership. This article explores how a well-drafted partnership agreement can help you document the details of dividing profits and losses in a partnership. 

Allocating Profits

You can allocate profits to individual partners in a number of different ways, including:

• splitting the profits equally;
• dividing the profits in accordance with the amount of work each partner brings to the business; and
• deciding upon a fixed amount for certain partners and percentage shares for others.

How you decide to share your profits is important to how your business operates. Therefore, it is vital to ensure all partners agree on a chosen method of splitting business profits. The best way to do this is to incorporate terms into your partnership agreement. 

Drawings vs Profit Share

A common feature of partnerships is for each partner to take drawings. Drawings are essentially a salary and involve taking goods, services or money from the business partnership to a partner’s personal accounts. It is also important to note that profit generated by a partnership will be subject to income tax when a partner withdraws it from the business. 

You should draft terms for drawings into the partnership agreement, as they will differ depending on how you decide to divide profits. For example, if a partner’s profit is a fixed figure salary, their monthly drawings will be a maximum of one-twelfth of their salary. In contrast, if another partner earns 25% of all profits made, their monthly drawings will be decided within the partnership agreement. Likewise, any additional profits owed will be paid at the end of the year.

Losses Within a Partnership

You should also agree on dividing business losses and document this in your partnership agreement. In the same way as profits, if there is no written agreement, all partners will have to share equally in the losses from the business. This could cause huge difficulties in situations where different partners have contributed varying amounts of capital to the business, which could result in unequal burdens for the losses.

Importance of a Partnership Agreement 

Partnership agreements are important tools for governing the relationships between partners. Without one, situations like the division of profits and losses will refer to the Partnership Act, which may not accurately reflect how the business operates. 

A formal partnership agreement will cover most situations arising in the course of business, including:

• how each partner’s share of profits and losses is divided;
• how to resolve conflicts within the partnership;
• capital contribution of each partner;
• responsibilities of each partner;
• method for amending the partnership agreement;
• circumstances where new partners can join the partnership; and
• process for partners retiring or leaving the partnership.

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Tax Considerations within the UK

Within the UK, all types of business partnerships are known as being tax transparent, meaning the partnership itself is not liable to pay tax to HMRC. However, partners are responsible for paying taxes on their profits or capital gains each financial year. Partners may also be able to claim tax relief on their losses. Therefore, it is important to seek the advice of a professional to correctly calculate what you owe and avoid legal trouble.

Key Takeaways

Partnerships are a type of business structure involving two or more individuals working in a business to make a profit. Within your partnership agreement, you can document the process for dividing profits and losses. Absent clear wording in an agreement, the Partnership Act will automatically apply. 

LegalVision provides ongoing legal support for partnerships through our fixed-fee legal membership. Our experienced corporate lawyers help businesses manage contracts, employment law, disputes, intellectual property and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.

Frequently Asked Questions