Formation of a Sole Trader: The process involves choosing a business name (ensuring it doesn't infringe on trademarks), registering for relevant taxes (like income tax and VAT), and obtaining necessary local licenses. No formal legal documentation is required to start.
Drafting a Partnership Agreement: While not legally mandatory, a written 'Deed of Partnership' is essential to override default legal rules. This document should specify profit-sharing ratios, capital contributions, decision-making processes, and procedures for partner withdrawal.
Financial Reporting: Owners must maintain accurate records of all income and expenses. At the end of the tax year, they calculate profit using the formula:
Dissolution Procedures: Partnerships may dissolve automatically upon the death or bankruptcy of a partner unless a prior agreement exists. Sole traders simply cease trading and notify tax authorities.
| Feature | Sole Trader | Partnership |
|---|---|---|
| Ownership | Single individual | 2 to 20 individuals (usually) |
| Control | Absolute and immediate | Shared; potential for conflict |
| Capital | Limited to owner's wealth/loans | Pooled resources from multiple partners |
| Liability | Unlimited personal liability | Joint and several unlimited liability |
| Continuity | Ends with owner's death/retirement | Dissolves unless agreement states otherwise |
Identify the Liability Type: In exam scenarios, always check if the business is described as 'unincorporated.' If it is, the answer regarding debt must emphasize that personal assets (cars, houses) are at risk.
Default Partnership Rules: If a question mentions a partnership without an agreement, assume the law dictates equal profit sharing and equal management rights, regardless of how much capital each person contributed.
The 'Agency' Trap: Be prepared for questions where one partner makes a bad deal. Remember that the firm is usually bound by that deal if it was related to the business's normal activities.
Taxation Clarity: Always state that these owners pay Personal Income Tax on profits, not Corporation Tax, as the business is not a separate legal entity.
The 'Separate Entity' Myth: Students often mistakenly believe that because a business has a name like 'John's Plumbing,' it is a separate person. It is not; 'John's Plumbing' is simply an alias for John himself.
Capital vs. Profit Share: A common error is assuming profits must be shared based on capital contribution. In reality, partners can agree to any ratio (e.g., 70/30) regardless of who put in more money.
Liability for Past Partners: Partners may remain liable for debts incurred while they were in the firm even after they leave, unless they provide proper notice to creditors.
