Partnerships are the only business entities that can be formed by oral agreement, created automatically when two or more persons engage in a business ‘with a view’ (to making) ’a profit’. ‘Persons’ include artificial persons as well as individuals and as such a partnership could comprise an individual, a company and even a trust.

Unless the partners agree terms (written or otherwise), the Partnership Act 1890 applies to all unlimited partnerships. Under the Act, profits and losses are shared equally, and partners are jointly liable for the partnership's debts and any loss or damages arising from the wrongful acts or omissions of any partner. The Act also imposes a clause that states that partnerships will be automatically dissolved from the date of death or bankruptcy of any partner, unless a partnership agreement is in place that states otherwise.

The partnership's activities are treated as being carried on by the individual partners and not by the partnership itself (as the partnership is not a separate legal entity). As such, for income tax purposes a partnership has no legal existence distinct from the partners themselves (this is not the case in Scotland where a partnership is a legal person). As such, each partner is taxed on their share of profit as an individual. The effect of this provision ensures that an individual is treated as commencing their business when they start to trade, even if that was before they became a member of the partnership. Similarly, the cessation of their business does not necessarily occur when the partnership is dissolved but may cease if a partner dies.

Limited liability partnerships (LLPs) have similar tax status as ordinary partnerships but with the benefit of each partner only being liable for the amount of capital invested. Therefore, LLPs benefit from the same protection as a limited liability company.

The importance of an agreement

Under the provisions of the Partnership Act 1890 (relevant when no agreement is in place), on the death of a partner, the partnership changes such that it will be required to sell its assets to pay off any creditors and distribute the funds between any remaining partners and the deceased's estate. For inheritance tax (IHT) purposes, the value of the partnership share forms part of the deceased's estate as a transfer of value would have been made. However, there may be no IHT charge as business property relief may apply. The value of a partnership interest without an agreement that states otherwise is the market value. The deceased person's estate is also entitled to the share of the profits made since death attributable to their share of the partnership, or to interest at 5% per annum on the value of their share until the share is paid out. The choice between which of the two the estate receives lies with the personal representatives.

For income tax purposes, even if a partnership agreement is in place, the income tax position of the partner's estate will be the same as if a sole trader ceases trading, being taxed on any profits made from the end of the accounting/basis period in the previous tax year to the date of cessation.

Contents of a partnership agreement

In practice, most partnership agreements contain provisions allowing for the continuation of the partnership after the death of a general partner, confirmation of what happens to the partnership interests and whether the partners' heirs can sell the interest to another. Invariably, the agreement also allows for the deceased partner’s share to be bought by the remaining partners. The agreement should also include details as to how the deceased partner's share of the partnership should be valued, procedures on how to pay out the deceased partner’s capital, a requirement to remove their name from all partnership materials and contracts, and the practicalities of paying the deceased partner’s share.t