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Trouble Ahead For Partnership Taking 100% AIA on Slowly Depreciating Assets?

A partnership is investing heavily in equipment eligible for 100% AIA. The equipment depreciates slowly and fairly evenly over 10years so 10% on cost is the rate of depreciation in the accounts. My concern is that there is therefore a large potential tax liability if the business were to close and realise the value of the equipment. The partners have been in the habit of drawing all available profit. I am thinking of suggesting that an amount equivalent to the potential liability is retained in capital accounts as a "tax reserve" but am likely to meet with protests. Of more concern is the fact that one partner may retire in a few years and could potentially escape picking up his share of the potential for future liability. Has anyone any experience or suggestions on how to handle this please? At the moment we are probably looking at about £50,000 of tax between 3 partners.


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By DMGbus
08th May 2012 21:16

Deferred tax provision

If the entity were a Ltd Co then it would be obliged to include a deferred taxation provision.

So far as I am aware a partnership has no such obligation.

In the particular circumstances I would explain the issue to the members of the partnership and ask them if they would agree to a tax provision.    Tricky thing here is that the liability is NOT one of the partnership but rather one of the individual partners so there's an arguement NOT to make the provision in the partnership accounts.

At the end of the day it's an issue for agreement between the partners and most likely NOT covered by the partnership agreement so requiring an innovative solution.  The partnership is fortunate to have a pro-active accountant who's NOT a robotic box-ticker, but rather is forward thinking and switched on to helping his clients.

Thanks (1)
09th May 2012 14:17

But what are they worth?

While the assets may be slowly depreciating what would they actually be worth if they were sold - and would the amount of cash realised be sufficient to pay any tax due?

It is common for assets that last a long time to be depreciated slowly, but in reality the 'second hand' cash value will vary considerably to what the economic life to the existing partnership is worth.

The cash realised on any future sale should be sufficient to pay the tax on the disposal, as after all the tax charge will be a percentage of the realised sale price.

before worrying further I would look at that.





Thanks (1)
By John R
09th May 2012 17:28

Valuation memorandum

A deferred tax provision would cover this quite nicely. Although there is no requirement for such a provision either under company law or GAAP (as it is not a partnership liability), it could be suggested that it would be good practice to include one. You are correct in assuming that the last surviving partner will pick up the tab in the absence of contrary agreement - there can be no balancing adjustment when a partner merely retires as there is no disposal by the partnership.

A better alternative may be to suggest that the partners all sign a new partnership agreement or at least a memorandum to the effect that in the event of a partner leaving the partnership, his share of capital will be based on the market value (or possibly book value) of fixed assets at the time, discounted for the amount of any income tax and class 4 NI that the retiring partner would have suffered at that time had all the assets been sold. The calculation of the discount will have to be spelt out perhaps something like "at the appropriate rate of income tax and national insurance that would be due on the notional balancing charge that would arise on disposal as shall be decided by the partnership accountant". Obviously, it is not for an accountant to come up with such wording and the partners should be advised that a solicitor should be instructed.

It will be far better to get this sorted now while the partners are friends as, in my experience, any goodwill between partners and ex partners rapidly disappears after a retirement.

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