Lossmaking partner, profitable partnership

Lossmaking partner, profitable partnership

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A partnership makes a profit for tax purposes, but applying the existing profit sharing arrangements to the taxable profits would, but for s.850(2) ITTOIA 2005, give rise to a loss in the hands of one partner. The s.850 adjustment is a trivial, automatic mechanical exercise enshrined in statute. So far, so good.

The partner who made a loss (but for S.850) is arguing that in the following year there should be a compensating reversal (profits permitting, which they will). The partner who received the benefit of a reduced profit share for tax purposes in the earlier year, by reason of the other partner's loss, is resisting that reversal. The partnership deed is silent on the matter.

S.850 certainly does not provide an automatic right to a reversal. S.850(2) only requires an apportionment of loss in the year in which a partner makes a loss. In the subsequent year the only statutory reference is S.850(1), which requires a taxation treatment to follow the profit sharing arrangements for that (later) period.

Provided that the partners agree (which at present they do not) there is plenty of scope for agreement to share the profits in whatever manner they like (possibly subject to antiavoidance rules applicable to bounteous settlements, not in point here), and they certainly have the potential to agree to a division that effectively compensates the lossmaking partner for a perceived loss of tax relief.

However, given the absence of agreement on the matter or other document imposing a restoration by reversing entry in the subsequent year, I am wondering whether general partnership law has anything to say on the matter? I can certainly see an equitable argument for the reversal, despite that there is no statutory requirement.

Any views on this?
Clint Westwood

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By wdr
07th Feb 2007 13:34

Keep tax and accounts separate, and the answer becomes clear
Look at the closing balance sheet in the year of the loss. The loss making partner has a deficit on his 'profit share account'

Now look at the next year. The profit share attributable to the previous loss making partner will go in part to make good the previous year's deficit, and for the balance will be to his credit. So the allocation of the year's profit will automatically give a reduced profit share for tax purposes to the former loss making partner-the result he wants for tax purposes.

It becomes more difficult if there is a current account credit balance on the 'loss making' partrner's account which had merely been reduced by the earlier year's loss. But a careful study of the terms of the partnership deed , and strict accounting following those rules may still give the 'right' answer.
Whether the professional costs of all this are worthwhile is a separate question.
Partenership accounting disputes are a lawyer's dream.

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By User deleted
07th Feb 2007 16:04

Any views on this?

My view is that this arrangement aint going to work - there has been an irretrievable breakdown in the relationship.

They should simply divorce.

A sad fact of modern life.

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By AnonymousUser
07th Feb 2007 12:52

I am unaware....
of any provision of the type you describe here. The profit/loss adjustment is, as you say, a mechanical adjustment for tax purposes only (as far as I know) to ensure there can never be a tax loss when there is an overall profit, and vice versa. The compensation for one partner being taxed on more than his actual profit share is, I imagine, a matter entirely for the partners to agree upon.

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By AnonymousUser
07th Feb 2007 14:05

Son of Grumpy
I don't follow your argument - surely what happens in one year has no relevance to previous or subsequent years. I don't see what difference it makes if one partner's capital account (I assume that's what you mean by profit share account) is in deficit.

If there is a profit in year 2 and that profit is split 50:50 it doesn't matter that some of the loss-making partner's profit will be used to wipe out the deficit arising from the previous year. He will still be assessed in year 2 on his whole 50% of taxable profits arising in year 2.

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By martinfoley07
07th Feb 2007 14:24

well, ...
the partners presumably are very clear on how they split the profits, and that means that is how they go about it for accounts purposes. Therefore, last year's loss will wipe out /offset this years profit for one of the partners (or something along those lines).

The tax return split is different as you say, but it would seem obvious in equity that the partner has this years profits adjusted accordingly.

(admittedly there are/will be genuine problems when one or both partners get shafted with adverse marginal tax rates as consequence of the tax share)

So no problem surely !!

Er......Fact that the partners are not agreeing the pretty obvious means either
(i) it is a VERY bad partnership and it is frankly difficult to see how it can survive something like this if the partner trying to "win" sticks at it in that manner and it can't be simply and amicably resolved. And indeed it will be a lawyer's paradise, goodbye to profits, hello to lawyer's fees
(ii) just being optimistic for a second, perhaps the partners have approached it from wrong angle and have not got their heads around the agreed/equitable accounts distrribution angle, and that calm explanaation will work? Occasionally this can mean some odd "tax equalisation" adjustments in the partnership accounts where different marginal tax rates apply betwen the years, but can be done without pain if the partners wish to act in good faith when the written agreement is silent on the matter.

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