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Where Taxpayers and Advisers Meet
Partnerships - Tax Planning Tips
01/11/2001, by Mark McLaughlin CTA (Fellow) ATT TEP, Tax Articles - General
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Tolley's Practical Tax by Mark McLaughlin ATII TEP

10 topical tax planning tips are covered in this article.Partnerships are the business equivalent of matrimony, albeit an alliance recognised in law (Partnership Act 1890) if not in religion. Here are some planning points aimed at helping the tax aspects of such business relationships run more smoothly and predictably than many marriages!

1. Fair enough?

Has the partnership profit been calculated for tax purposes on a basis that gives a 'true and fair view', subject to specific adjustments provided by tax law? Following changes introduced by FA 1998 (s 42 and Sch 6), partners may be subject to an additional ('catching up') tax charge arising from a change of basis. Professional partnerships in particular have been affected following their withdrawal from the cash basis, although any resulting tax under Schedule D Case VI may be subject to spreading over 10 years. In some cases, it could be beneficial to accelerate the catching up charge by election (ICTA 1988, Sch 6 para 5), such as where a partner has unused losses or allowances in a tax year. In addition, the charge invariably qualifies as relevant earnings for pension contribution purposes.

2. A refreshing change

Partners may wish to consider the effects of a change in the partnership accounting date on the utilisation of overlap relief (if applicable), the incidence of taxable profits and the timing of income tax and Class 4 national insurance payments in relation to those profits.

3. Don't be personal!

In appropriate cases, examine new and existing contracts between partnerships and their clients, and review working relationships involving the individual partnership members. Could any engagements be caught by the IR35 legislation concerning the provision of personal services through an intermediary? (FA 2000, Sch 12 para 4).

4. Tax-efficient borrowings

Individual partners can obtain tax relief for interest on a loan (but not an overdraft) to buy a partnership interest, or broadly to contribute capital to the partnership, or to make advances to it for business purposes, or to pay off another qualifying loan (ICTA 1988, s 362). Could those partners refinance their partnership capital, paying off other personal loans that do not attract tax relief? Beware the anti-avoidance provision of ICTA 1988, s 787, which operates to deny tax relief where the sole or main benefit of the loan arrangement is to obtain relief for the interest payments. This legislation was considered in Lancaster v IRC ([2000] STC (SCD) 138), although the subsequent House of Lords decision in MacNiven v Westmoreland Investments Ltd ([2001] STC 237) might provide encouragement where the interest is physically paid.

5. Doing a disservice

Does a service company operate alongside the partnership? The service company's terms of engagement should be considered carefully, particularly where a close company is involved and the partners are director shareholders. Credit allowed to the partnership by the service company could constitute a beneficial loan to the individual partners, as the definition of 'loan' is extended to include 'any form of credit' (ICTA 1988, s 160(5)(a)). A partnership debt may also have tax implications for the service company, where it is effectively a loan to participators (ICTA 1988, s 419(2)(a)), and the credit period exceeds six months (ICTA 1988, s 420(1)) (Grant v Watton (HMIT); Andrew Grant Services Ltd v Watton; Watton v Grant ((1999) STC 330)). Prepayments by the partnership to the service company might provide the solution.

6. Share and share alike

Consider the composition of the partnership, and the timing of partnership changes. In the early years of a business, it may be worthwhile comparing the total tax and national insurance liabilities of one 'partner' employing another, with the total liabilities if the business operated as an equity partnership. The employed individual could subsequently be admitted as an equity partner as the business grew. For capital gains tax purposes, there are various occasions of charge relating to partnerships, which are indicated in Statement of Practice D12 (as extended by SP 1/79 and SP 1/89). For example, an upward revaluation of partnership assets could trigger a capital gains tax charge for one or more partners upon a subsequent change in profit sharing ratios, such as when partners join or leave. A downward adjustment to original asset values (or no revaluation at all!) may be appropriate in those circumstances.

7. Once bitten...

It is not uncommon for a partner in marriage to become a business partner, invariably for reasons of tax efficiency. Could the Inland Revenue challenge the allocation of partnership profits between husband and wife if one spouse played little or no active role in the business? It is interesting to note the Revenue's comments on husband and wife partnerships in the Inspector's Manual at paragraph 263 'We cannot challenge the apportionment of profits, as we can a wage, by reference to the value of the partners' contribution to the firm's activity'. It goes on to say:

'It is sometimes overlooked that there is no need for the spouse to contribute capital; or to participate in management; or in a trading context at least, to be capable of performing the main activity of the business. Indeed to be a partner one need not take an active part in the business at all'.

The reference to 'trading' is significant, as the admittance of an untrained and unqualified spouse into a professional partnership can be problematic for various (tax and non-tax) reasons. In addition, the Revenue might argue that the settlements legislation (ICTA 1988, Part XV) applies to any husband and wife business in which the incoming partner receives a disproportionate profit share compared to his or her contribution to the partnership's business. An enhanced profit share could be considered to represent an element of 'bounty' received from the other spouse. Caution should therefore be exercised when undertaking tax planning in this area.

8. Limited help

Trading partnerships wishing to take advantage of Limited Liability Partnership (LLP) status should consider the potential restriction in 'sideways' loss relief (e.g. under ICTA 1988, s 380) for individual partners. Sideways loss relief is restricted to the greater of the amount of the partner's capital contribution and the amount of his or her liability on a winding up (ICTA 1988, ss 118ZC-ZD). However, this restriction does not apply in the case of LLPs carrying on a profession.

9. Happy landlord?

Does one of the partners own the business premises personally? Consider the adverse affect of any rent charges to the partnership on a claim to retirement relief, which remains available until 5 April 2003 (TCGA 1992, Sch 6 para 10). However, note that charging rent does not have an adverse affect for the purposes of business asset taper relief (CG 17940a).

10. The ties that bind

Does the partnership agreement contain a clause operative on a partner's death binding a deceased partner's personal representatives to sell, and the surviving partners to buy, his or her partnership share (i.e. a 'buy and sell' agreement)? For inheritance tax purposes, an interest in a partnership potentially qualifies for 100% business property relief (IHTA 1984, ss 104-105). However, relief is denied if a binding contract for sale exists at the date of death (IHTA 1984, s 113 and Statement of Practice 12/80). If a buy and sell agreement exists, consider replacing it with, for example, an option for the existing partners to acquire the business interest following death instead.

And remember...

If these planning points do not help the business relationship to flourish, partners can always take comfort in the knowledge that partnerships are easier, less traumatic and less expensive to escape than marriages...aren't they?

About The Author

Mark McLaughlin is a Fellow of the Chartered Institute of Taxation, a Fellow of the Association of Taxation Technicians, and a member of the Society of Trust and Estate Practitioners. From January 1998 until December 2018, Mark was a consultant in his own tax practice, Mark McLaughlin Associates, which provided tax consultancy and support services to professional firms throughout the UK.

Mark is now a consultant with The TACS Partnership,  an independent tax advisory firm that provides high quality, independent advice on all UK taxation matters.

He is a member of the Chartered Institute of Taxation’s Capital Gains Tax & Investment Income and Succession Taxes Sub-Committees.

Mark is Chief Contributor to McLaughlin’s Tax Case Review, a monthly journal published by Tax Insider.

Mark is the Editor of the Core Tax Annuals (Bloomsbury Professional), and is a co-author of the ‘Inheritance Tax’ Annuals (Bloomsbury Professional).

Mark is Editor and a co-author of ‘Tax Planning’ (Bloomsbury Professional).

He is a co-author of ‘Ray & McLaughlin’s Practical IHT Planning’ (Bloomsbury Professional) 

Mark is also co-author of ‘Incorporating and Disincorporating a Business‘ (Bloomsbury Professional).

He is Editor and co-author of ‘HMRC Investigations Handbook‘ (Bloomsbury Professional).

Mark has also written numerous articles for professional publications, including ‘Taxation’, ‘Tax Adviser’, ‘Tolley’s Practical Tax Newsletter’ and ‘Tax Journal’, which provides free information and resources on UK taxes to taxpayers and professionals, and TaxationWeb’s sister site TaxBookShop.

Mark is a Director of Tax Insider, and Editor of Tax Insider, Property Tax Insider and Business Tax Insider, which are monthly publications aimed at providing tax tips and tax saving ideas for taxpayers and professional advisers. He is also Editor of Tax Insider Professional, a monthly publication for professional practitioners.

Mark is also a tax lecturer, and has featured in online tax lectures for Tolley Seminars Online.

Mark co-founded TaxationWeb (www.taxationweb.co.uk) in 2002.

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