Partnership profit allocation anomaly?

Partnership profit allocation anomaly?

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I can't see how HMRC's rules on partnership profit allocation work in practice. I must be missing something simple.

Here's the scenario: two partners, A and B; partnership profit £4,000 (PY £170,000); commercial profit sharing arrangement in place results in a £12,000 profit (PY £50,000) for A (a 20% taxpayer this year) and a £8,000 loss for B (a 40% taxpayer this year). HMRC require A to report a profit of £4,000 and B a profit of £nil. Given that A has drawn his full entitlement of £12,000 from the business, I don't see how it is equitable that A pays tax on only £4,000 and B loses the opportunity to claim loss relief on the £8,000 debited to his partnership current account. Even if A were to gift B his "tax saved" of £1,600 (20% of £8,000), B is still not compensated for the £3,200 by which he has lost out. How is this ever fair? Does anyone know how these matters are normally dealt with to achieve a more equitable tax burden?

Replies (4)

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By ACDWebb
12th Jul 2011 10:06

There is only £4000 profit

A may have drawn £12k but there is only £4k available and A presumably now has an overdrawn current account?

The tax "saving" of the hoped for allocation of £12k & (£8k) is a red herring

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By neileg
12th Jul 2011 11:17

Profits and losses

The partnership is a legal entity and is taxed on its profit of £4k. Of course the amount of tax is determined by the partners own circumstances but as ACDWebb says, you only pay tax on the profits actually earned. I have in the past dealt with complex partnerships where the tax on the notional profit or loss is charged/credited to the partners. But the allocation between partners is a matter for them not for HMRC. The anomoly stems from the way profits are allocated, not from the tax system.

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By Ian W Brown
12th Jul 2011 12:00

Postings to current accounts

Thanks for the reply ACDWebb.  I think I'm getting the way thing work a bit clearer now.

Just for clarification, the £4,000 partnership profit was posted to current accounts in accordance with the profit share arrangement in place: Cr £12,000 to A and Dr £8,000 to B.  No current account was overdrawn.

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By Ian W Brown
12th Jul 2011 12:15

Tax adjustments between partners

neileg has, I think, pointed me in the way I need to go.  Many thanks.

"the tax on the notional profit or loss is charged/credited to the partners. But the allocation between partners is a matter for them not for HMRC." 

So far as A and B are concerned, A has received the tax reliefs (at his rates) of  B's loss (the £8,000 Dr to his current account).  I think neileg is saying that they can always sort it out between them just like they came to the profit share arrangement in the first place.  In simple terms (ignoring NIC and personal allowances), debit A's current account with £1,600 (20% of £8,000) and credit  B's current account with £1,600.  B will be much happier and A shouldn't mind paying 20% on the full £12,000 received.

Much appreciated.

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