Partnership Profit Split % Differing from Asset Ownership %

Partnership Profit Split % Differing from Asset...

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I am a management accountant so not an expert on tax or HMRC. I was hoping bounce some ideas of anyone willing to help (while waiting for my actual accountant to return from holiday!) on an idea I had in terms to a new property development I have been working on.

My business partner and I already own the land and are hoping to get planning permission soon. I live over 100 miles from the development (block of flats that will be rented out) so the development will be run by my business partner, his wife and my father on a daily basis. We have come up with a profit split we are all happy with but I am not sure if it is viable since it hinges on if a partnership can be set up whereby the partners agree a split/share of rental profits that is different to the share of ownership of the land/development. I was thinking it might be possible as of the two partners that are not owners of the land; one is providing funds to enable the build and the other would be helping with running it.

Proposal;

  1. Set up a new partnership (separate from mine and my business partners current portfolio partnership).
  2. New development to sit within this new partnership
  3. New partnership to have 4 Members; Me, my father, business partner, business partners wife. My father will be investing a large amount to enable the build and the wife will help with the running of the development.
  4. Draw up partnership agreement for profit share 10%, 40%, 25%, 25% respectively
  5. Due to lender requirements land ownership deeds to remain unchanged (50/50 between two of the partners) - is this ok with HMRC or would the same % profit split need to be mirrored with Land Registry?

A limited company structure was considered but not preferred if this route can work due to the problem of extracting profits.

Any feedback would be much appreciated, im pretty much assuming I have got this all wrong! :)

Replies (10)

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Stepurhan
By stepurhan
02nd Apr 2014 14:38

Commercial justification

In theory, profit splits can be whatever is agreed between the partners.

The problem you have here is the family and business relationships. Without equal interests in the assets, HMRC are likely to assert that the profit-sharing arrangements are an artificial scheme to save tax. This is likely to be more of a problem for the husband and wife, as they are both likely to benefit from the whole of the 50% profit assigned to them. However, the fact that each of the two 50% owners end up with 50% of the profit in their family is suspect regardless.

So you need to come up with a commercial reasoning for the split. Work done in running the partnership and supplying funds are likely to be good starting points for justifying this split. Essentially, you want to demonstrate that four independent individuals coming together to run the same business would arrive at the same profit split figures.

Consulting your accountant on the details is likely to be wise.

Thanks (1)
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By executiveuk
02nd Apr 2014 16:43

Solution

Thanks Stepuran, this gives me more clarity around what HMRC would be looking at.

I think from my dads point of view his large investment (without which the build could not be undertaken) should be a good enough justification for his share.

But I see the point about my business partners wife and how it could be questioned that just being involved in running the place may not equate to a 25% share in other commercial settings.

If we would have done this split if forced to go down the Limited company route (with everyone being shareholders) anyway, then I guess registering the asset/Land registry in these %s as 'tenants in common?' is probably the easiest way to make sure HMRC would not challenge?

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By tonycourt
02nd Apr 2014 16:55

While I agree.....

....with Stephuran's view of what HMRC would like plus we know the government is working on ways to achieve this, it's not currently the situation. HMRC begrudgingly accept that, for example, a husband and wife partnership can allocate profits as they see fit irrespective of commercial justification BIM72065.

It sounds too good to be true, but it is. Make the most of this "loophole" as it probably won't last much longer (in my view).

 

 

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Stepurhan
By stepurhan
02nd Apr 2014 17:07

Marshall an argument

The more you tie the actual asset ownership to the profit split, the harder it is for HMRC to attack.

But just because HMRC want to disagree with you is no reason to roll over and take it. tonycourt is quite correct that, in theory, husband and wife should be taxed separately and profit splits should be unassailable. That doesn't mean that HMRC won't try to attack the situation as artificial anyway (with varying degrees of success) and any arrangement entered into now needs to be up to withstanding "loopholes" like this. Put together a solid argument now for the commerciality of the profit splits, and HMRC are more likely to leave you alone in favour of easier targets.

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By executiveuk
02nd Apr 2014 23:35

Thanks

Great advice, much appreciated.

I have put together the following reasoning of how we arrived at our %s which I think should also act as justification should HMRC question why profit share differs from asset ownership;

40% : My father will be investing a large amount in the build, without which the development could not progress. He will also be involved in the day to day running of the development. Incentive for this investment is a share of rental profits.25% : Business Partners wife will work on the running of the development full time. Since we will be dependent on achieving maximum occupancy to be profitable we think a profit share is the suitable motivator since she will also be responsible for finding tenants.25% Business Partner: will be involved in the day to day running of the business and also as a professional lettings agent will act as consultant and leverage his experience.10% Me: will be hands off and does not plan to be involved in the day to day running. Main interest in this development is capital appreciation rather than rental income. Recognises this cannot happen without the investment and motivated partners; so accepts a lesser share of rental profits to enable the build to actually happen via investment from father and dedicated partners responsible for running the development.

 

Not sure if the tax man can be described as reasonable, but does this sound reasonable?

 

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Stepurhan
By stepurhan
03rd Apr 2014 08:51

Sounds good

It would be an argument I'd be happy to run with if HMRC came calling.

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By blok
03rd Apr 2014 11:10

.

In the situation you set out - as far as I am aware - there is currently no legislation that HMRC can use to reallocate profits between partnership of this type.  Also - HMRC would have very little apetite to take up this sort of fight.

I agree that the above is very much belts and braces, but what you set out in your OP sounds very commercial and arms length to me. 

As an aside - you could consider allocating a fixed profit share to certain partners.  It is very common for partnerships to have different Capital and revenue sharing ratios.

 

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Stepurhan
By stepurhan
03rd Apr 2014 12:12

Paranoid, me?

There are various bits of legislation HMRC could claim are relevant, the settlements legislation being the most obvious one. I prefer to have commercial justification from the outset so there isn't an opening for HMRC to start a time-wasting enquiry, even if their reason for opening such an enquiry clearly has no basis in current law.

With the current appetite for anti-avoidance legislation, often with retrospective effect, pre-emption is often wise regardless.

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By blok
03rd Apr 2014 12:29

.

I'm not saying you are paranoid, It's maybe that I'm too relaxed, I don't know - but certainly the settlements legislation won't apply where partners can clearly justify their keep.

HMRC will not want another arctic systems extending to partnership level. 

I can't see them taking this on until they have some legislation to fall back on, which they dont at the moment.

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Stepurhan
By stepurhan
03rd Apr 2014 12:35

You're not out to get me then?

I was self-mocking. I didn't think you were accusing me of anything.

Having seen HMRC pursue undoubtedly spurious cases in the past, I am maybe a bit OTT on these things. Provided it doesn't create a lot of extra work, it never hurts to strengthen your position to avoid enquiries even starting.

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