What is a Partnership?

Partnerships are defined by section 1 of the Partnership Act 1890 as “the relation which subsists between persons carrying on a business in common with a view of profit”. Many family run businesses, particularly farming businesses, are operated as partnerships.

What is a Partnership Agreement & why do I need one?

Whilst it is possible to operate a partnership without any formal documentation in place, many businesses choose to govern themselves by entering into a Partnership Agreement, which is a legally binding document that sets out the rights, obligations, and responsibilities of partners within a partnership business. It defines things such as how the profits will be shared amongst the partners, who has authority to make decisions affecting the partnership, as well as what happens should a partner decide to retire from the partnership.

Informal arrangements and the organic way in which family-owned businesses operate and run sometimes mean that they don’t always consider having a legal document in place to formalise these details. However, there are advantages in having this legal documentation in place.

Pitfalls of undocumented partnerships

Unintended consequences

Without a written partnership agreement, the is governed by the Partnership Act which can cause unintended, and potentially pretty dire, consequences for the family. Under this antiquated but still legally binding act, the partnership is dissolved when a partner dies or retires, rather than it being passed on to the next generation. As the Partnership Act takes precedence over any Will, this can potentially result in the sale of the assets of the partnership, or indeed the whole business, even if there is a valid Will leaving it to the next generation. Rather a sobering thought for those without a Partnership Agreement in place. 

Restrictions on borrowing

Another issue which is more commonplace these days, is that many banks require a Partnership Agreement to be in place for them to be willing to lend. This is because an agreement helps the lender to understand how the business works, and to ensure that the loan is properly authorised. Leaving the partnership to the mercies of the Partnership Act can create ambiguities and potential disputes, which makes it difficult to assess the risk involved with lending. A Partnership Agreement also ensures the continuation of the business after a partner dies or retires (provided there are at least two partners left after the death or retirement), which protects the bank’s investment.

Providing certainty for the future with a Partnership Agreement

A legally binding partnership agreement brings clarity and certainty to situations which may arise in the future which could potentially not be considered otherwise. They include:

• Continuity of the partnership and the business following death or retirement;
• How a partner’s share is distributed and to whom;
• How to pay for this share;
• Detail of how the business assets and buildings are owned and by whom;
• How to value partnership assets;
• How decisions are made and what restrictions there are on things that partners can do.

Tax relief and Partnership Agreements

A frequently overlooked advantage of having a Partnership Agreement in place is with regard to tax relief.  For instance, farming partnerships which have a Partnership Agreement can benefit from tax relief which might not be available to those without one.

There are two main types of tax relief available via a partnership agreement, one of which only applies to farm businesses:

Business Property Tax Relief

It is possible to claim full relief from inheritance tax for a property which comes under a Partnership Agreement.  However, the relief is only 50% for personal property which is being utilised by the partnership. 

Agricultural Property Tax Relief

This is also applicable at 100% for property belonging to the partnership but only covers property which is used for agricultural purposes and not for buildings which are purely residential or used for other non-agricultural purposes. It is also not applicable for development potential value for agricultural land.

Clarity from a Partnership Agreement

By having a formal partnership agreement drawn up, the detail of what belongs to the partnership is clearly set out to avoid any future confusion or conflict.  It has the added advantage of being able to take advantage of tax relief only available to property or assets defined as being legally held within a partnership agreement.

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