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partnership - capital account showing negative

has the partner effectively been paid too much ie a loan has been created? Can it be removed eg classify as bonus (and then becomes part of the partner's tax calculation?

many thanks in advance for any clarification


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What is the issue?
There seems to be a confusion here, between a balance sheet position , a profit share argument and tax.

Can we dissect the question?
We start of with a balance sheet statement. At the end of a period partnership accounts are prepared, based presumably on the prior agreed division of profit.
We now find that one of the partners has drawn more than the aggregate of his opening capital account and his agreed profit share?

That has no bearing on tax liabilties[which follow the agreed profit shares as allocated], and has no other tax consequences unless funded by bank borrowing. If the aggregate partnership capital is negative, then a proportion of bank intetest claimed may be disallowed.

Suppose the partners now agree to change the allocation of profit so as to eliminate the overdrawn capital account of the one overdrawn partner.

That is a private matter amongst them , ,and of no concern to anyone else. The result is that the allocation of profits is now changed, and the tax liabilty-which is of course an indivdual and not a partnership liabilty-follows the amended partnership profit sharing arrangements.

You will need then to look at the partnership agreement and may need to annex a memorandum showing what has been done.

Is there a CGT or IHT consequence? In practice I suspect the answer will be 'no', but whatever variation to the original agreement may be noted in a memorandum should make clear who is to bear any such liability.

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Should pay back into partnership
When an individual partner's capital account becomes overdrawn this is usually because partners' drawings from the partnership have exceeded the profit share &/or credit balance brought forward. Share of losses can also cause the overdrawing.

The individual partner should pay into the partnership the overdawn balance, unless the partnership agreement states otherwise.

The other partner(s) might voluntarily choose to be generous to the overdrawing partner and suffer a debit on their own Capital account(s)to fund a credit to the overdrawn partner. Another way of correcting the overdrawing is to adjust the profit share ratio in favour of the overdawn partner.

Unlike a limited company there's no s419 tax charge nor a benefit in kind of a beneficial loan. However tax deduction for loan interest paid might be put in jeopardy by overdrawn capital, just as it can be with a sole trader.

If the overdrawn partner is insolvent then case law (Garner v Murray if I remember correctly) states that the other partners suffer a debit to make good the overdrawn partner's debit, in a certain ratio.
I forget which ratio it is: it is one of 2 things either the profit share ratio or capital account credit balance ratio. The reason I forget which it is isthat the last time I heard of the case was in studies back in 1974 and in practice have never met this situation since.

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What doe the partnership agreement say?
The action to be taken should be covered in the partnership agreement, if one exists. Normally it would put the onus on the partner to bring his account back in line with the amount of his share of capital required to fund the business.
Also note, that if the partner had previously taken out personal borrowing to fund his capital invested in the business, then he has now forfeited the right to claim interest on that loan, as it will be deemed repaid out of the drawings taken out of the business.

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