Partnership vs a Limited Company
The main difference between a partnership and a limited company is that the liability of a company’s shareholders is limited to the amount of the unpaid amount on the shares that they own. Partners on the other hand, can not restrict their liability (unlimited liability) and therefore can be held personally responsible for any unpaid debts the partnership incurs.
Joint and Severally Liable
This is potentially very dangerous as partners are joint and severally liable for partnership debts.
Thus if one partner engages in an activity which results in large debts, all partners, regardless of whether or not they had prior knowledge of the activities would be equally liable to make good any shortfall in funds from their personal assets.
The internal workings of a partnership are usually governed by a deed. This agreement is the equivalent of the memorandum and articles of association belonging to a company.
The partnership deed will set out procedures and rules relating to capital maintenance, profit shares of individual partners, the admission of new partners and the resignation of existing ones.
The partnership act does not provide a comprehensive set of rules and procedures on the governance of a partnership and therefore, without a partnership deed many important aspects of the business, such as disputes and working practices will not be covered and may therefore result in inconsistent and perhaps unfair decisions being taken.
Partnership and Limited Company Tax
One further difference between a partnership and a limited company is the way in which each is taxed. A company pays tax on its profits and directors are taxed on what they receive in remuneration from the company.
A partnership on the other hand is not taxed in its own right as a company is (a partnership is not a separate legal person). Instead each of the partners are taxed on their share of the profit, irrespective of how much or how little they have taken out of the business.
The following is a simply example:
Although both entities are effectively taxed on £500,000 with in the company, the tax is split between the company and the directors. The company will pay corporation tax at 21% on the retained £250,000 whilst the directors will be taxed at income tax rates (up to 40%) on the £250,000 paid to them.
The partners however will be taxed fully at income tax rates and may therefore have a much higher tax bill.