In a business partnership, profits and losses don’t belong to the partnership as a separate entity — they’re allocated directly to the individual partners. Whether you’re a self-employed individual or a company partner, you are taxed on your share of the profits, regardless of whether you’ve physically received the money.
But what happens when a partner disagrees with their profit allocation or hasn’t received what the partnership statement says they did?
Let’s break down how profit sharing works, when disputes can arise, and how to handle disagreements with HMRC.
🤝 Understanding How Partnership Tax Works
A partnership is not a separate legal entity, so the tax responsibility falls on each individual partner. This means:
- No tax or National Insurance is paid by the partnership itself
- Each individual partner pays Income Tax (or Corporation Tax, if the partner is a company) on their share of the profits
- The profit share is usually agreed through a Partnership Agreement or, by default, shared equally under the Partnership Act 1890
📊 Profit Sharing Ratios (PSRs)
By default, profits and losses are split equally, unless the partners have agreed otherwise in a written partnership agreement.
- Partnerships can set any ratio they like for dividing profits — and this can be changed each year, so long as it’s agreed before the year ends
- PSRs cannot be altered retrospectively to reduce tax liabilities once the financial year has ended
- However, adding flexible wording to the agreement (e.g. “as the partners shall from time to time decide”) allows for more adaptability within the tax year
🔄 Why Would a Partnership Change the PSR?
There are several reasons to update the profit-sharing ratio:
- One partner contributes more time, effort, or capital
- A new partner joins or an existing one leaves
- Tax planning considerations
If the PSR is changed mid-year, profits must be time apportioned and allocated accordingly.
🚫 Disputes Over Profit Share Allocation
Disagreements can arise if a partner believes:
- They did not receive the amount shown in the partnership tax return
- The profit shown does not reflect actual activity or contributions
Unfortunately, for tax purposes, HMRC treats the partnership return as conclusive — this means that all partners must declare the profit allocation shown, even if there’s a dispute.
This was confirmed in the cases of Morgan v HMRC and Self v HMRC [2009], where former partners tried to challenge the profit allocations recorded on the partnership return.
📝 How to Declare a Disputed Profit Share
If a dispute can’t be resolved before the Self Assessment filing deadline, here’s what to do:
- Report the amount of profit you believe is correct on your return
- In the ‘white space’ (additional information) section:
- Declare the amount shown on the partnership return
- Include an adjustment (either a deduction or addition)
- Provide an explanation of the dispute and why the partnership’s figure is incorrect
- Declare the amount shown on the partnership return
According to HMRC’s guidance (Enquiry Manual EM7522), this approach will not be treated as an incorrect return if your calculation deducts a genuinely disputed amount.
📌 Key Takeaways
✅ You’re taxed on your share of the profits, even if you don’t receive them
✅ Disputes must be raised before filing, but white space declarations can be used
✅ Partnership returns are legally binding for tax purposes, unless successfully challenged
✅ A written agreement with flexible PSR wording offers greater protection and clarity
💬 Final Thought
Disagreements in partnerships are not uncommon, but having a clear, flexible profit-sharing agreement, and good communication can help avoid unnecessary tax complications. If you’re unsure how to proceed, especially when HMRC is involved, it’s worth seeking advice from a qualified accountant.
Partner note:
s 24 Partnership Act 1890
Morgan v HMRC and Self v HMRC [2009] UKFTT 78 (TC)
s 12ABZB TMA 1970 (inserted by FA 2018)
EM7522
