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Are undrawn profits a "loan" for s455 purposes?

following on from a recent post along the same lines.

Corporate partner is allocated a share of revenue profits but doesn't receive them in cash terms.  This current account with the partnership is shown in the company accounts as a debtor.  The cash is annual drawn down by the individual partner, who controls the company.

The partnership is not a genuine scottish partnership therefore this http://www.hmrc.gov.uk/manuals/ctmanual/CTM61515.htm wont apply..

Q, would s455 apply?

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I don't think so

For S.455 to apply, the company needs to have made a loan or advance to the individual, and it's never had the money to do so. Alternatively the individual, via the partnership, needs to have incurred a debt to the company.

When the individual overdraws his current account, such that there's nothing left for the corporate partner to draw, has he incurred a debt to the corporate partners. I don't think so; they're partners and thems the breaks. Others may disagree of course.

But then again next year there's the GAAR, which might tax the individual's drawings as dividends from the corporate partner, which is what in substance they are. Interesting article on the GAAR in this week's Taxation, by the way.

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By BKD
22nd Feb 2013 10:15

I'd say no

Because it's not a debt, it's part of the company's capital in the partnership. I'm wondering why it's shown as a debtor in the company's accounts. Most corporate partners that I see show only the investment in the partnership - profits and losses being dealt with through the CT computations. If you are going to bring in profits and losses to the accounts, surely the matching entries are to the carrying value of the investment?

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Blimey!

Virtually simultaneous responses! I thought BKD was going to have the alternative view.

I don't agree on the accounting front though, I think not bringing the profits/losses of the partnership into the corporate partners accounts is inconsistent with FRS 9. Happy to hear alternative view on that point.

If the profits or losses are recognised, then I'd say it should mirror what the partnership accounts would show using the LLP SORP. The investment should be at cost less impairment, I'd say.

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By BKD
22nd Feb 2013 10:36

Now, now, George

We don't need to disagree on everything :)

I too would be (vaguely) interested in the accounting point. Since I don't do accounts, it's not much of an issue for me. But having skimmed through FRS9, it would appear that it does not apply in most, if not all, of the corporate partners that I deal with. which would explain the accounts.

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By blok
22nd Feb 2013 10:43

.

the accounting entries for the corporate partner in this example is credit income (reserves) debit other debtors, being amount recoverable from partnership.

(i didn't prepare the accounts)

I fail to see the rationale for teh company holding its share of undrawn trading profits as an investment?  but its been a while since I loked at frs's and teh likes.

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By BKD
22nd Feb 2013 11:00

Rationale

As George says, look at the partnership accounts. It would be unusal for those to show the undrawn profits as a creditor.

Very simple example:

Company puts in £10k of capital to partnership.

Cr Bank £10k

Dr Investment in partnership £10k

Company's share of profits for the year £25k, credited to its capital account in the partnership. What is the company's investment in the partnership worth now? Subject, again as George says, to impairment, I'd say it is £35k

So, Cr income from partnership £25k

Dr Investment in partnership £25k

 

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Careful...

... skimming through FRS 9. It's got some strange terminology.

What we call partnerships are, joint ventures or joint arrangements that aren't an entity in FRS 9, as I recall.

Profits would only be adjusted as an increase in the investment on consolidation for entities/arrangements that aren't subsidiaries, again, only from (possibly hazy) recollection.

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No, no, no

I was agreeing with the treatment blok has, that the capital account element would be an investment, but the current account element would be included within debtors, as a current asset. I accept that it's not a debtor, as such, but it is a current asset; a receivable, if you will.

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By BKD
22nd Feb 2013 11:20

Agreed

Current asset is fine - but it's certanly not a debt due from the partnership (IMO).

As for FRS9, when I said that it would not apply to most of the corporate partners that I see, that is because they don't have a sufficient interest in the 'entity' to meet the FRS9 definitions of associate and JV. At least that's what I took from my skim-read of the definitions, which I accept can be a risky thing to do.

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22nd Feb 2013 11:45

going out on a limb....

Quite happy for people to tell me i'm wrong, but i think S455 does apply.

We have a medium sized solicitor client who has been pitched one of these new fangled fancy structures - basically admitting a corporate partner who receives the majority of the profit share.

Among other 'issues' we have raised for our client - happy to share if anyone wants to know - was this very concern.

Due to cash flow restrictions / debt servicing, very rarely will over 75% of profits be able to be drawn.

Therefore, the partnership owe's the limited company for the amount of undrawn profit.

The promoter had ignored any reference to S.455 and when asked why they said it didn’t apply. The only way we could see that it doesn’t apply would be if you said cashflow taken in the first 9 mths of yr 2 was actually a repayment of the yr 1 outstanding balance, yr 3 was repaying yr 2 etc etc. However, eventually, the balance wouldn’t be cleared in 9 mths and therefore S455 applies.

We / our client, has yet to receive an answer.

Thoughts??

 

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Well, as I (and BKD) have said above

I'm of the view that the partneship doesn't owe the corporate partner its share of the profits. The amount is due to the corporate partner, but it's not a debt; it certainly couldn't be enforced as a debt.

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By BKD
22nd Feb 2013 12:05

Another way of looking at it

There is some absudity in this (but that is because it is absurd to suggest that there is a debt due to the corporate partner):

Assume that the undrawn profits do represent a debt due by the 'partnership'. Where does the credit figure sit? In the corporate partner's capital account. So, the only person that owes the company any money is the company itself.

 

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By Triggle
22nd Feb 2013 13:18

I don't think that you actually make an entry in the books of the the company for the partnership profit. As BKD and George say this would create a debtor in the company that is effectively owed to it by the company itself.

Afterall, if a company had a subsidiary company that made a profit you would not make an entry in the holding company's books for that profit itself (only unless a dividend had been declared).

The only entry to be made in the company's books would be when the company made a drawing from the partnership - the entry would be (in the company) dr: bank cr: investment income.

When the CT comp for the company is prepared any investment income from the partnership in the AP would be deducted from the accounting profit.

Two partnership tax comps would then be prepared - one for the non-corporate partner(s) and one for the corporate partners(s).

The non-corporate partnership comp would follow the IT rules. The corporate partnership comp would follow CT rules.

The corporate partnership tax comp would then be used to ascertain the profits chargeable to CT by the company. If the partnership's basis period was different from the company the adjusted profit of the coporate partner would be time apportioned to the company's AP.

The corporate partner's share of the profit is treated as being derived from a trade carried on by the company. It is, however, a separate trade from that carried on by the company itself and if losses were incurred by the partnership or the company they could not be set against profits arising in the other.

By not making an entry in the company's books for the "unpaid profit" s455 is irrelevant.

s1259 & 1260 CTA2009 & CTM36510 & 36520

http://www.hmrc.gov.uk/manuals/ctmanual/ctm36510.htm

 

 

 

 

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By blok
22nd Feb 2013 14:08

.

Triggle wrote:

I don't think that you actually make an entry in the books of the the company for the partnership profit. As BKD and George say this would create a debtor in the company that is effectively owed to it by the company itself.

Afterall, if a company had a subsidiary company that made a profit you would not make an entry in the holding company's books for that profit itself (only unless a dividend had been declared).

 

I think you make a wrong anaolgy to compare a corporate group structure where there is definitive legal separation to that which exists between a partnership and its partners.

Keeping this simple, If I decide to leave profits in partnership in which I am a member, and I prepared a personal balance sheet, I would be including my current account as an asset of mine.

 

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By BKD
22nd Feb 2013 14:27

Assets

blok wrote:

Keeping this simple, If I decide to leave profits in partnership in which I am a member, and I prepared a personal balance sheet, I would be including my current account as an asset of mine.

 

No problem with that concept, but there are many types of assets - debt being just one.

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By johnt27
22nd Feb 2013 13:23

s455 may be due if

This is an issue we have seen in the past and based on legal counsels opinion this was the advice we received.

If you have a corporate partner in a normal partnership and the company has a debt owing back to the partnership this will be caught under the s455 legislation. The way to avoid this is to treat the company's share of capital as an investment in it's accounts.

Of course as others have said if you have both capital and current accounts then the treatment will differ so you need to review the partnership agreement.

If your partnership is actually an LLP then you won't have a s455 problem as HMRC can't absolutely determine that the company is lending money to the human members and not the LLP itself as a seperate legal entity.

However with LLPs you will fall foul of the disguised remuneration rules if for example the corporate partner receives the majority of profits and the remaining partner/partners create large overdrawn accounts through drawings.

Both Abbeytax and ICAEW have some useful guidance on this area https://www.icaew.com/~/media/Files/Members/Advisory-helplines/corporation-tax-faq-archive.pdf

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By BKD
22nd Feb 2013 13:41

Contradictory

johnt27 wrote:

If your partnership is actually an LLP then you won't have a s455 problem

The guidance that you link to says, as I would expect, exactly the opposite.

There is an apparent inconsistency that whereas s455 does not apply to most loans to Scottish general partnerships because they are separate legal entities, the same logic does not apply to LLPs. But this is because the legislation specifically says that everything done by an LLP is to be treated as done by its members. Which gives the absurd, though legislatively correct, result that a loan to a Scottish LLP is caught.

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Eh?

S.863(1) ITTOIA 2005 seems to start with the words "For Income Tax purposes...". S.455 tax is, of course, Corporation Tax.

I'm struggling to see the partnership as a "relevant arrangement" for Part 7A of ITEPA as well.

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By johnt27
22nd Feb 2013 14:20

Section numbers were so last year....

To fall foul of Part 7A I believe you need to have 3 parties to a transaction (as I said I'm only going on legal opinion sought):

1. LLP

2. Company

3. Director/Member of above

Where an arrangement to divert profits is made as would be the case if say someone used an EBT/loan arrangement this would appear to look very similar to what I described previously.

If however you don't use an LLP then unless you are Scottish your partnership isn't deemed to be a seperate legal entity and so 7A doesn't apply.

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Aha!

S.1273 says the same thing for Corporation Tax purposes. That still doesn't square with a Scottish partnership though.

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22nd Feb 2013 14:02

confused.com #1

i didnt think the original question related to a 'scottish partnership'??

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By blok
22nd Feb 2013 14:09

.

zeofiles wrote:

i didnt think the original question related to a 'scottish partnership'??

as a matetr of fact this is a scottish partnership, but I am proceeding, for teh purpose of this post that it is not a genuine one.

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@blok

TYPE SLOWER!!!

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22nd Feb 2013 14:14

As an example

Sorry for reinventing the wheel, but

A firm of solicitors, admits a new partner - a limited company that has been formed exclusively for this purpose and has no other trade.

In year one the corporate partner's profit share is £250k.  However, they only 'draw' £200k from the partnership.

Do the Ltd company books show;

Income  Cr £250k

Bank Dr £200k

Debtors Dr £50k

or is it

Income Cr £200k

Bank Cr £200k

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By BKD
22nd Feb 2013 14:36

To reply to zeofiles' example

Take your pick

Re the first 'solution' I think a more correct presentation would be

Cr income £250k

Dr bank £200k

Dr other current assets £50k

 

I have also seen accounts reflect only the payments from the partnership, per your second solution.

In either case, the "income" from partnership should be added back in the CT comp and then taxed on the basis of profits earned in the period (which may well be the same thing in the case of #1)

A third treatment is to not reflect the partnershipincome at all in the accounts (subject to George's comments above re compliance with accounting standards).

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By Triggle
22nd Feb 2013 15:06

But if a drawing was made by the Corporate partner on the partnership the funds would be transferred to the company bank account and would then have to be accounted for in the company somehow?

As I say, I think this is the only entry in the company's books that you have to make.

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By BKD
22nd Feb 2013 15:16

Yes, Triggle

P&L typically shows "Distribution (or drawings) from partnership". As I say, ignored for CT purposes.

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22nd Feb 2013 15:24

@triggle

A genuine question, not a criticism:-)

Is the income to the limited company the amount drawn or its total profit share?  Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?. (Therefore, in the above example its option 1) 

The taxable income is the full amount isn’t it?

 

 

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By Triggle
22nd Feb 2013 16:05

*

zeofiles wrote:

A genuine question, not a criticism:-)

Is the income to the limited company the amount drawn or its total profit share?  Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?. (Therefore, in the above example its option 1) 

The taxable income is the full amount isn’t it?

 

As I see it, for accounting purposes any amounts transferred from the  partnership to the company (its drawings from the partnership) would be treated as income from the partnership in the company's books.

However, I agree, for tax purposes the company pays CT on its full tax adjusted profit from the partnership.

As BKD says, the amount included as income from partnership in the accounts is deducted from the profits in the company's CT comp and replaced by the figure calculated in the partnership Corporate partner's tax comp.

My approach is, however, predicated on the fact that you would not accrue for the profit of the partnership in the company's books. If you did you would be providing a debtor in the books of X Ltd which is due to X Ltd from X Ltd.

If you did reflect the full partnership share of profits in X Ltd's accounts anyone looking at the partnership accounts and the company accounts side by side would see the same profit reported twice.

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By BKD
22nd Feb 2013 15:33

Taxable income

Is the income to the limited company the amount drawn or its total profit share?

It is of course the total profit share. But that has nothing to do with what entries appear in the company's accounts.

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By BKD
22nd Feb 2013 15:34

As an aside ...

... to the OP, why do you have concerns about whether the partnership is genuine or not?

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22nd Feb 2013 16:08

@ BKD, sorry think i have confused you. Yo clarify

is the income [as in the amount shown in the P&L] to the limited company the amount drawn or its total profit share? Under the accruals basis it should be the full amount shouldnt it unless the expectation is that it won't all be received?

Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?.

 Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?. Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?.  Under an accruals basis is should be the full amount shouldn’t it unless the expectation is that it wont be received?.   

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By blok
22nd Feb 2013 16:10

.
One other points - unless corporate partner recognises the income in its accounts, the shareholders will be unable to pay themselves divis.

Bkd. I mentioned that this isn't a genuine Scottish partnership because it then can't hide behind the separate legal entity argument and is more aligned to your English partnerships. I believe that to be the case. Also it meant a wider audience.

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By BKD
22nd Feb 2013 17:09

Scottish or not

blok wrote:
One other points - unless corporate partner recognises the income in its accounts, the shareholders will be unable to pay themselves divis. Bkd. I mentioned that this isn't a genuine Scottish partnership because it then can't hide behind the separate legal entity argument and is more aligned to your English partnerships. I believe that to be the case. Also it meant a wider audience.

Is it otherwise a genuine partnership? If it is:

Loans to a partnership of which company is a member

There are also doubts about the application of ICTA88/S419 to loans to a partnership whose members include the company itself. The loan cannot reasonably be viewed as a loan to the other partners.

You should not contend that such loans are within the charge to ICTA88/S419 if there is a genuine partnership and you are satisfied with the bona fides of the arrangements.

Remembering that

The possibility of invoking ICTA88/S419 (5) should not be overlooked.

So, even if the undrawn profits were a debt (which they are not), the above words should provide at least some comfort.

 

To zeofiles - if you're asking me what figures should appear in the accounts then you're asking the wrong person. I'm interested only in the tax analysis (perhaps I should have held my tongue earlier regarding the accounting treatment).

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By blok
25th Feb 2013 19:33

.

BKD wrote:

So, even if the undrawn profits were a debt (which they are not), the above words should provide at least some comfort.

 

Hi

I take no comfort from the manual because the partnership is not a genuine one.

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By BKD
25th Feb 2013 20:10

Care to elaborate?

blok wrote:

Hi

I take no comfort from the manual because the partnership is not a genuine one.

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By blok
22nd Feb 2013 16:16

.
I also seem to recall that under the 1890 act, upon dissolution, an overdrawn partner does have an obligation to repay the partner in credit.

I don't have access to the act at the moment to check that.

If therefore, the Partnership agreement is silent or non existent, the inference is that this money should find its way back to corporate.

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PA 1890

See BIM72505. Section 39 is what you're thinking of, but then see S.43.  It's implicit from S.43 that what is owed by/to the partner isn't a debt until the partner retires or dies.

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By blok
26th Feb 2013 10:35

.

elaborate

The issue I have is that the arrangement with the corporate partner has no commercial justification.  On its facts, its is a sham designed to avoid income tax. Therefore the client would not be able to hide behind the let out afforded to Scottish partnerships.

 

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By blok
26th Feb 2013 10:42

.

having read the whole thread again -

the initial question was whether the undrawn profits was a loan.

I tend to agree with George and BKD that the undrawn profits are just that and there is no legislation that exists to transform this into a loan and therefore s455 couldn't apply.

I would be intrested to find out more about counsel's opinion though.  John27's point seems to hinge on "if we have a loan".  Did counsel specifically address the point about whether he felt that undrawn profits constituted a loan?

On the accounting side, I do struggle to draw a distinction between current and capital accounts.  To my mind these are one of the same for teh company.

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By BKD
26th Feb 2013 11:04

Apologies for labouring the point

But the Scottish aspect is a red herring.

As for capital accounts, I always thought that capital was capital - either fixed or current. Neither can be said to constitute debt.

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By blok
26th Feb 2013 11:29

.

why do you think it a red herring?

HMRC would appear to accept the legal interpretaion that a Scottish partnership is a seperate entity and therefore s455 can not apply because a loan is not then made to a participator. (if a loan was in existence).

I understand the point you make about capital / current accounts, which does appear to be an accounting presentation point.  I have lost track of what the consensus of opinion was on that.

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By BKD
26th Feb 2013 11:57

I think it is a red herring, because ...

Whether it is a Scottish partnership or not, it is the treatment of a partnership of which the company is a partner that matters.

http://www.accountingweb.co.uk/anyanswers/question/are-undrawn-profits-loan-s455-purposes#comment-603413

 

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Yes but...

... blok's suggestion is that the limited company as a partner is a red herring if the company is, in fact, nothing more than a sham.

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By blok
26th Feb 2013 12:17

.

CTM61515''s  first two paragraphs provides two entirely seperate "reliefs" from s455, where (i) the partnership is genuine Scottish partnership and or (ii) the partnership (any) is a genuine one and teh company is a member.

The summary is therefore that so long as the partnership is a genuine one s455 should not apply. 

I was wrongly consdiering the position where teh company was not a member and only the first paragraph would apply.  Of course in my example both the first and the second paras would appear to be in point, although neither apply because of the "genuine" issue.

So I now understand where you are coming from.

 

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