Although a partnership agreement doesn't have to be in writing, it's always a good idea to outline the exact terms in a document. In doing this each partner's rights and liabilities are clear. You should also set out the terms for changing and dissolving the partnership, which is important for taxation purposes.

Tax of partnerships

Partners are treated as self-employed by HM Revenue and Customs (HMRC) for tax purposes.

For more information, see Tax covering sole traders.

Each partner must include in their own self-assessment tax return their share of profits from the partnership. Each partner is responsible for paying their own income tax and Class 4 National Insurance contributions.

The partnership itself has to fill in a Partnership Tax Return showing the partnership's income and expenses for the tax year. This includes a Partnership Statement, which shows how profits or losses have been divided among the partners. The partners must use the profits allocated to them on the Partnership Tax Return on their own Self Assessment tax returns.

You should choose one of the partners to fill in the Partnership Tax Return and send it to HMRC. This person is known as the 'nominated partner'. They should also give all the other partners copies of the Partnership Statement to help them complete their own personal tax returns.

Although the nominated partner has responsibility for the Partnership Tax Return, if the return is submitted late or incorrectly, all partners will be jointly responsible for any interest and penalties.

Changes in the composition of partnership

When a new person joins an existing partnership, they'll be assessed on income tax for their first year on the basis of profits made during that tax year, i.e. from the date of their joining the partnership to the following 5th April.

In the second tax year, income tax will generally be assessed on the basis of the normal rule, i.e. on the profits of the 12-month accounting period that ends in the second tax year.

For more information, see Income tax for sole traders.

Capital Gains Tax on disposals

Capital gains tax arises when you sell or give away a capital asset whose value has increased during your period of ownership, resulting in a chargeable gain. Capital assets may include, for example, premises, fixed plant and machinery and goodwill.

How to work out chargeable gains

If one of the chargeable assets owned by the partners is sold, the first step is to divide the capital gains among the partners. It's as if the partners have separately sold their individual interests in that asset. The capital gains are divided according to the capital profit sharing ratio found in the partnership agreement. If there is no profit sharing ratio, the capital gains must be shared equally.

For more information, see Capital Gains Tax for sole traders.