Partner leaves LLP with a negative partnership account

Partner leaves LLP with a negative partnership...

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Individual joined a partnership as a junior partner and after 9 months he leaves. During his 9 months he took circa £10k a month in drawings.

I’m being told his partnership share is zero (as reported on partnership return) and they are not trying to recoup the £90k.

How would you treat the £90k CG or a D1 profit charge or other?

Thanks

Replies (33)

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By johngroganjga
03rd Oct 2013 14:54

It all comes down to why they are not trying to recoup the overdrawn balance?  If the debtor is insolvent and the debt is irrecoverable, that is one thing.  But if it has been agreed as part of the severance terms that the outgoing partner may keep his drawings then his profit share was £90k not £Nil.  The partnership return is therefore incorrect and the other partners are paying too much tax.  

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By Markhamfc1
03rd Oct 2013 15:30

The partnership accountants are suggesting they may allocate his drawings to another partners account, which seems odd to me, and will basically get him £90k tax free

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By johngroganjga
03rd Oct 2013 15:35

It's not just odd it's crazy.  It amounts to continuing partners gifting £90k out of their own pockets and getting no tax relief.  What is your role in all this?  I assumed you were the accountant.

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By Markhamfc1
03rd Oct 2013 15:46

I admit very very odd -  I

I admit very very odd -  I have nothing to do with the LLP accounts I just act for one of its partners.

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By johngroganjga
03rd Oct 2013 16:02

Looking at it from the point of view of the outgoing partner I would have though that the receipts would be taxable income in his hands in any event, regardless of how the continuing partners account for them.  To argue otherwise would be to say that he had provided his services to the firm for nine months free of charge and also received personal cash gifts from the partners in the firm, and nothing could be further from the truth than to suggest that those gifts were a token of the donors' appreciation of his generosity in providing his services to their firm without payment. Clearly absurd.

If he is going to pay tax the continuing partners should get tax relief.

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By ACDWebb
03rd Oct 2013 17:28

Is the partnership as a whole profitable?

Is there a partnership agreement that sets out profit shares?

Clutching at straws, but perhaps he gets fixed prior share & there is a net tax loss of >£90k for some reason and you cannot have partners with profits and others with losses. Unlikely I grant you, but ....

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By Markhamfc1
03rd Oct 2013 17:37

Loss last year and on target for a loss this (previously profitable). He was on a fixed share of £12k per month. So if you can't show him having a profit and the others a loss what would you do?  We are not responsible for the accounts or the partnership tax return.

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By ACDWebb
03rd Oct 2013 18:16

The TAX allocation has to be adjusted

reducing 'profitable' partners profit to nil and adjusting the loss making partners losses.

How they reflect for that adjustment in the accounts is another

 

  ABC  11Tax adj loss(10,000)   Prior share   90,000   90,000Adj loss(100,000)(50,000)(50,000)  (10,000)(50,000)(50,000) 90,000Adjust loss allocation for tax          -   45,000 45,000(90,000)Taxable / Allowable loss(10,000)(5,000)(5,000)        -  

 

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By nmprobinson
03rd Oct 2013 22:11

Loss??
How had he taken £90k if the partnership is loss making?? (Presume from brought forward bank balance).

Seems an odd situation!? Not sure we have all the facts

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By thehaggis
03rd Oct 2013 23:09

Partnership Account

If he was entitled to £12K per month, he doesn't have a negative partnership account. In strictness it is in credit by £18K (because he took £2k less in each of the 9 months).

For tax purposes, ACDWebb has got it.  His profit is reduced to nil and the remaining loss allocated between the partners.  Example 3 here  http://www.hmrc.gov.uk/manuals/bimmanual/BIM72250.htm gives a simple illustration

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By johngroganjga
04th Oct 2013 08:01

BIM72250 is a new one on me - and baffles me. it produces the absurd, and I say unfair, result in this case that the outgoing partner walks away with £108,000 tax free (£90,000 already taken, and the £18,000 balance on his account still to come) and the partners suffering the cost of this get no tax relief.  At least I suppose it's symmetrical but why do HMRC foist such counter-intuitive nonsense on us? 

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By johngroganjga
04th Oct 2013 08:38

It looks then as if the reason why the so-called overdrawn balance of the outgoing partner is not being recouped is that it is not overdrawn at all.  On the facts we now have, strictly he must have a credit balance of £18,000.  But perhaps he has agreed retrospectively to a reduction in his fixed profit share from £108,000 to £90,000.  Either way, absurd as it may seem, that sum is entirely tax free in his hands.

The explanation we have that the partnership accountants are suggesting allocating his drawings to the continuing partners is, on the face of it, nonsense but it is in fact the same as the accounting profit allocation would look if the overall result was break even and one partner had a fixed prior share of £90,000. 

    

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By Markhamfc1
04th Oct 2013 09:42

Thank you very much for your comments. £90k tax free, I'm going to have one very happy client, although it does seem crazy, and open to abuse.

 

Ironically FL memo helpline were adamant this would be taxable.

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By johngroganjga
04th Oct 2013 09:53

But check out the partnership accounts and ensure your client is credited with his fixed profit share (taking his instructions on whether he has or has not agreed a reduction from £108,000).

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By Steve Kesby
04th Oct 2013 12:13

I suspect...

... that the economic reality is that the outgoing "partner" was really an employee and the mischief is in the deeming provision that taxes members of LLPs as if they are partners in a partnership.

That particular mischief is now in the consultation process.

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By thehaggis
05th Oct 2013 00:16

@johngroganjga

I'm not sure why you have difficulty with this particular scenario.  Tax is charged on profits.If there are no profits, there is nothing to tax.

Drawing money from a capital account is what self-employed people and partners do day in day out.  If a self employed person sets up in business and makes a loss, there is no tax on any money he has withdrawn to meet his living expenses.

There may be some mischief in this particular arrangement, but we don't know the facts.

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Replying to gerrysims:
By johngroganjga
05th Oct 2013 10:11

Individual partners

thehaggis wrote:

I'm not sure why you have difficulty with this particular scenario.  Tax is charged on profits.If there are no profits, there is nothing to tax.

Drawing money from a capital account is what self-employed people and partners do day in day out.  If a self employed person sets up in business and makes a loss, there is no tax on any money he has withdrawn to meet his living expenses.

There may be some mischief in this particular arrangement, but we don't know the facts.

The difficulty is obvious when you look at the position of each partner individually. Say the firm overall breaks even and makes no profit or loss. The tax adjusted result is the same. One partner has £90,000 credited to his capital account and withdraws it in full and walks away with no tax liability. Firstly, as a taxpayer with no connection with or interest in the firm in question that offends me enormously. Why should I pay my taxes into a system that allows such ludicrous anomalies. Secondly as one of the continuing partners that suffers a debit to my capital account in respect of my share of the £90,000 loss suffered by the equity partners I am baffled and angry when my accountant tells me that HMRC say that the loss I have suffered is ignored for tax purposes and I will have to pay tax on any future profits in full without being able to deduct my loss.

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By johngroganjga
05th Oct 2013 12:36

Basil
Of course there are ways that partners can agree between themselves to compensate each other for the anomalies that result from applying HMRC's rules. The point is that they should not have to. The tax system itself should produce a result that is fair to all concerned. If that is not one of the objectives that we should expect a tax system to aspire to we are all done for. In this case there is an obvious solution the the problem, which is to make universal the principle that in partnerships the taxable result should be allocated on the same basis as the actual result.

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Replying to Chris.Mann:
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By Dave Bull
07th Oct 2013 12:23

I think we should stick to the point

johngroganjga wrote:
The tax system itself should produce a result that is fair to all concerned. If that is not one of the objectives that we should expect a tax system to aspire to we are all done for. In this case there is an obvious solution the the problem, which is to make universal the principle that in partnerships the taxable result should be allocated on the same basis as the actual result.

 

I always thought that where a poster asks for advice on a real-world matter, replies ought to be restricted to the real-world rules that will determine whether the client should declare the money as income.  Replies complaining that the tax system isn't fair stray into the the realm of philosophy rather than helpful advice to fellow AW members. Tax isn't fair, never has been and never can be, John. Let's start a different thread to discuss practicable ways to improve partnership taxation rather than clog this one up with comments that don't really address the OP's needs.

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By ACDWebb
05th Oct 2013 13:02

It's anti avoidance legislation

and as Basil says the possibility of the tax anomaly should be covered off in the partnership agreement.

If it was not there then the sainted Margaret, Private Eye, and the world at large would no doubt be up in arms about the loophole being exploited to avoid tax

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By johngroganjga
05th Oct 2013 13:51

Anti-avoidance should just catch the 1% who abuse the rules artificially, not penalise the 99% with a manifestly unfair and counterintuitive outcome. Interesting that BIM72250 doesn't say anything about anti-avoidance just that without the reallocation of losses from those who have suffered them to those who have not, the result would be "spurious". Spurious is not defined or explained.

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By Steve Kesby
05th Oct 2013 14:32

It's not some new anomoly John

It's always been the case that you can't have some partners in profit and some in loss.

Back when profits where assessed on a PYB, if the partnership made a continuation election, you could get the situation where incoming partners were taxed on extraordinary profits they didn't participate in and outgoing partners weren't taxed on extraordinary profits that they did participate in.

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By johngroganjga
05th Oct 2013 15:37

I know it's not new. I think that you mean that FOR TAX PURPOSES you can't have some partners in profit and some in loss. In the real world it happens all the time of course. The problem is the tax rule that changes the basis of allocation for tax purposes from that which the partners have agreed among themselves into something that they do not recognise and would not have agreed between themselves in a million years.

If the justification for this is that it is a price worth paying to prevent a greater evil, namely the manipulation of profit sharing arrangements to achieve a tax advantage (if that's what the problem is - I frankly don't see it) then I say the simple solution is to say that losses attributed to a partner when the firm as a whole has not suffered a loss cannot be surrendered sideways only carried forward against profits from the same trade attributed to the same partner.

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By ACDWebb
05th Oct 2013 15:47

But that is still capable of manipulation

 

Don't have a fixed share partner, employ them. if they can never share in a loss isn't that what the are effectively? it's sort of one of the things that the partnership/LLP consultation is looking at is it not?

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By thehaggis
06th Oct 2013 10:27

@John

What you are effectively asking for is tax relief for partners' (or proprietors') drawings. 

In the example above, the partnership made a loss of £10K, and £10K loss relief is available.  No loss relief is available for any partner's drawings (each partner might have drawn £90k, we don't know but it is unlikely that they have not withdrawn anything). 

Again, the bottom line is that tax is charged on profits.  As others have said here, it is not the tax system that is at fault, but the agreement between the partners that allowed one to take £90K out of the bank when the profits did not warrant it.

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Replying to johngroganjga:
By johngroganjga
06th Oct 2013 14:55

Misunderstanding

thehaggis wrote:

What you are effectively asking for is tax relief for partners' (or proprietors') drawings. 

In the example above, the partnership made a loss of £10K, and £10K loss relief is available.  No loss relief is available for any partner's drawings (each partner might have drawn £90k, we don't know but it is unlikely that they have not withdrawn anything). 

Again, the bottom line is that tax is charged on profits.  As others have said here, it is not the tax system that is at fault, but the agreement between the partners that allowed one to take £90K out of the bank when the profits did not warrant it.

With respect you misunderstand the facts here. The fixed share partner here is entitled to a prior share of £108,000. After providing him with that fixed share the equity partners suffer a loss. Those are the economic facts. What any partner has actually drawn from his capital account does not come into it. The partner who has drawn £90,000 has not taken in excess of his entitlement. He has taken £18,000 less than that. The absurdity is that for reasons best known to itself the tax systems ignores the economic facts and transfers the tax benefit of the losses away from those partners who have suffered a reduction in their wealth and gives it to the partner who has suffered no loss.

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By DMGbus
06th Oct 2013 10:56

Goodwill, capital / revenue

If a partner is allowed to leave a partnership having drawn more than his/her entitlement to his/her share of trading profits, then this excess drawing will be one of the following (none of which rank for income tax relief):

Gift / generosity of other partnersDrawback of capital previously investedLoan (if to be repaid)Goodwill payment - to either "keep the peace" / part amicably / save legal action costs or to reflect share of  / increase in goodwill not reflected in capital accounts

It has been suggested that the exiting partner has left having drawn more than profits earned thus creating a loss for the remaining partners - I see the loss as being a capital one (see bullet points above) rather than a revenue loss ranking for income tax loss relief.

If the fourth bullet point is accepted as a true reflection of the situation, then Goodwill has been acquired by the remaining partners from the outgoing partner and tax relief then becomes a capital one (CGT)  at some future date when the remaining partners leave the partnership.

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By shoshana
07th Oct 2013 13:23

Partnership/members agreement

This type of scenario is exactly why notional profits and losses should be covered by the partnership or members' agreement. This way, the partner whose notional profit is reallocated would compensate those whose losses were reduced and unavailable to set off against their income.

I had a friend (definition: a client who gets my services free!) in exactly this situation working for a reasonably large firm of lawyers - sadly for him it was not covered by the partnership agreement and I had to tell him there was nothing that could be done.

Malcolm Greenbaum

Director, Greenbaum Training and Consultancy Limited

IFRS, US GAAP, UK GAAP, UK tax and VAT

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7om
By Tom 7000
07th Oct 2013 17:17

HMRC rules

 

yep thats the link you want

http://www.hmrc.gov.uk/manuals/bimmanual/BIM72250.htm 

 

Seems to me he walks away with 90k tax free. Mind you the other 2 partners have put their hands in their pocket and had to pay him this.

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By North East Accountant
08th Oct 2013 09:06

Get that agreement right

I'm sure we all advise new partnerships, LLP's and companies to prepare a partners, members or shareholders agreement at the outset. Sadly, not many do.

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7om
By Tom 7000
08th Oct 2013 09:22

normally...

...If you had  £90k drawings and no profits and you left you would have to put it back. I have seen that a few times. It doesnt half upset the outgoing partner who says things like...why do I have to pay my salary back...

 

I think thats why HMRC rules apply as they do. You dont normally ket the other chap off scott free...

 

and why do we use the phrase scott free is another dilemma I am now thinking about

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By johngroganjga
08th Oct 2013 10:03

Numerous people are being misled by the heading to this thread, which suggests that there is an overdrawn capital account.  On fuller examination of the facts which emerge during the course of this thread, this is not a case involving an overdrawn capital account at all.

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The triggle is a distant cousin of the squonk (pictured)
By Triggle
08th Oct 2013 10:40

Probably everyone on this thread knows this already but, just for the record, here is the statutory refererence:

http://www.legislation.gov.uk/ukpga/2005/5/section/850

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