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Introduction of a partner

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A husband/wife partnership propose to introduce an employee as a partner. A reduced profit share in these circumstances normally constitutes a disposal for CGT purposes.  Am I correct to assume that business gift/holdover relief can be used to defer the gain?   Suppose the new partner is entitled to a future profit share but not a share of the existing capital of the business - does this mean that a CGT position does not arise as a consequence of the partnership change?

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paddle steamer
By DJKL
24th Nov 2019 14:12

What is currently in the balance sheet that is being disposed off?

Is revaluation of the balance sheet taking place?

Are there issues re a transfer to an employee?

Is there any consideration?

https://www.gov.uk/government/publications/partnerships-and-capital-gain...

"Point to remember
Transfers of interests between partners take place at balance sheet value unless actual consideration is paid."

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RLI
By lionofludesch
24th Nov 2019 14:45

The new partner could do with a bit of legal advice.

He has no entitlement to the assets yet is liable for partnership debts.

I would not be accepting this deal and I would be advising the existing partners to insist that the employee takes proper advice before signing up.

It's a bad deal.

Why not just pay him a bonus based on the firm's profits ?

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Replying to lionofludesch:
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By John Stone
24th Nov 2019 15:14

Yes- I've already made the point to the client that the employee may prefer a steady salary to a share of uncertain profitability. That said - my basic queries were (1) whether the gain resulting from a reduced partnership change can be deferred by Holdover Relief and (2) whether such a gain is negated altogether by fixing the new partner's share in the capital at the date of his appointment at 0%.

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Replying to John Stone:
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By lionofludesch
24th Nov 2019 15:29

If I were the HMRC officer, I'd raise an eyebrow at the suggestion that it was a gift, as I would at the proposal that the new partner was a partner given that it was asserted that he had no share in the assets and a 0% share of profits.

Never mind the tax position for the time being - look first at the credibilty of the deal.

What does the employee think ? Is he likely to be sucker enough to accept the deal offered ?

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Replying to lionofludesch:
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By John Stone
24th Nov 2019 15:53

First of all- thanks for your time on this - particularly on a Sunday afternoon. But surely if an existing partner surrenders share of the business for zero payment - it is a gift - and a business gift at that qualifying for business gift (Holdover) relief. In my alternative scenario - the capital share was zero but there would be a positive profit share (not zero as you imply). AsI said - I agree that the person is likely to favour the status quo but I am being asked about the CGT position and that is the focus of my query.

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By lionofludesch
24th Nov 2019 16:10

There may be no payment but that doesn't mean that there's no consideration.

I believe you mentioned 0% at some point, so I'm slightly fogged by your response here. If you meant that he'd had no profits at the point of transfer, I would suggest that that is always the case for a new partner. What he is receiving is the expectation of future profits.

The bottom line is that I'm not convinced that he is a partner.

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Replying to lionofludesch:
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By John Stone
24th Nov 2019 19:06

Lion I've re-read my posts and there's no ambiguity. The scenario I described was an agreed share in future profits but no entitlement to the capital existing at the time of the appointment.

If,on the other hand, the new partner was entitled to his agreed share of both income and capital for zero payment - then that surely meets the usual definition of a gift - and a business gift at that.
If there is a partnership agreement setting up one or other of these scenarios - there is surely a partnership!

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paddle steamer
By DJKL
25th Nov 2019 10:53

But reverting to your original question, is there a chargeable gain assessable?

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By John Stone
25th Nov 2019 11:26

There are very few chargeable assets in the balance sheet. Goodwill is not included but undoubtedly exists. So is it taken into account in assessing disposal proceeds?

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Replying to John Stone:
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By lionofludesch
25th Nov 2019 11:33

Eh ?

At the end of the day, if it's not been converted into cash or transferred to someone, it has no value.

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paddle steamer
By DJKL
25th Nov 2019 11:51

So I repeat my first post,

"Point to remember
Transfers of interests between partners take place at balance sheet value unless actual consideration is paid."

So is there any balance sheet value re goodwill here?

Also see worked example:

https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg27640

And in general:

https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg27600p

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Replying to DJKL:
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By John Stone
25th Nov 2019 12:04

No - there's no goodwill in the balance sheet.
I can't assess any gain yet as the revised partnership shares are not yet decided. My input for now was just to warn the current partners that a CGT position might arise from the introduction of a new partner. I hoped to be able to say that Holdover Relief might save the day.

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Replying to John Stone:
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By lionofludesch
25th Nov 2019 12:20

John Stone wrote:

No - there's no goodwill in the balance sheet.
I can't assess any gain yet as the revised partnership shares are not yet decided. My input for now was just to warn the current partners that a CGT position might arise from the introduction of a new partner. I hoped to be able to say that Holdover Relief might save the day.

How much is this goodwill likely to be worth ?

I'm fogged here - because did you not say that the new partner is to have no right to assets ? So how can there be any transfer of goodwill ? Or any other asset for that matter.

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Replying to lionofludesch:
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By John Stone
25th Nov 2019 12:33

I'm sorry you keep being 'fogged'. I have described two scenarios in my posts. 1. New partner entitled to a share of capital and income. Query -Does Holdover Relief apply to relieve any gain arising? 2. New partner entitled to a share of future profits only. Query - Does this mean there is no gain in the first place?

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Replying to John Stone:
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By Tax Dragon
25th Nov 2019 12:40

What am I missing? Hasn't DJKL fully answered both questions?

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Replying to Tax Dragon:
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By John Stone
25th Nov 2019 12:55

No.

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Replying to John Stone:
paddle steamer
By DJKL
25th Nov 2019 13:27

Why do you think there is an assessable chargeable gain on goodwill when there is no goodwill asset recognition within the partnership accounts nor consideration paid by the new partner to the existing partners?

You really ought to look at the example I linked to from HMRC.

If old partners want to recognise existing goodwill valuation in the accounts, Dr Goodwill, Cr capital accounts, there is a different answer, but as you appear to be describing matters I am struggling to spot either existing partner having a chargeable gain vis a vis goodwill.

Why do you think there is a gain?

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Replying to DJKL:
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By John Stone
25th Nov 2019 14:37

Thanks for your help on this. As the only recorded assets are stock, debtors, bank and a few old vans - a gain looks unlikely. But for future reference, if a gain did arise, do you think that Holdover Relief could be utilised in these circumstances?

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Replying to John Stone:
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By Tax Dragon
25th Nov 2019 14:59

Gifts to employees (which is what you are in essence suggesting - I think) may have other implications.... such as (as Lion intimated) they tend not to be gifts.

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By Tax Dragon
25th Nov 2019 13:42

John Stone wrote:

No.

Is the new partner the daughter, perhaps? If so, and if you think that relevant to the answer, why do you not disclose the relationship in the question?

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Replying to Tax Dragon:
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By John Stone
25th Nov 2019 15:31

The new partner is not the daughter. So I did not consider it relevant. I did not disclose it because it is not the case.

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By lionofludesch
25th Nov 2019 15:45

There's still the question of whether it constitutes part of the employee's remuneration deal.

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Replying to lionofludesch:
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By John Stone
25th Nov 2019 16:32

Lion - Looks like I might need to look into this too. Are you able to refer me to any reading or case-law on it?

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By lionofludesch
25th Nov 2019 16:45

Sorry, no. It's just my gut feeling.

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By Tax Dragon
25th Nov 2019 17:15

John Stone wrote:

any reading...?

TCGA, s17(1)(b). SP D12 (again!) – paras 7 and 8. And the commentary at the links DJKL gave you.

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Replying to Tax Dragon:
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By John Stone
26th Nov 2019 08:22

Thanks for that TD. So,asI understand things, if the new partner is not an employee, goodwill not in the balance sheet can be ignored. However, if he was an employee prior to his appointment, s17 TCGA puts a market value on goodwill. Or does it put market value on the whole business including the value of net assets not normally subject to CGT?

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By Tax Dragon
26th Nov 2019 09:07

In the normal course of commercial transactions, an incoming partner might buy in to the partnership. If you have a situation where there is an element of 'gift', I would wonder why that was. If it's a daughter, s18 invokes s17. If it's an employee, then is the 'gift' remunerative?

We all seem a bit fogged about what you're asking, because you haven't answered the "why?"

But to answer the s17 question... partnerships are transparent for CGT and an incoming partner may get a share of every partnership asset. S17 would, presumably, apply to every asset or to none of them. (But so what? S17 is no more than a bit of tax fakery. If something isn't chargeable to CGT, it doesn't matter what the deemed consideration is.)

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Replying to Tax Dragon:
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By John Stone
26th Nov 2019 11:19

So just to conclude (hopefully) - If a longstanding employee (but not a relative) is admitted as a partner with no payment, the partners reducing their partnership shares would be deemed to have disposed of their respective shares of the (unrecorded) goodwill at market value. Have I got this right?

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By Tax Dragon
26th Nov 2019 11:55

With an employee, I think it's going to be hard to argue that the 'award' of the goodwill is not a reward for services.

If it is a reward (you persist in not disputing that) then I think a) s17 applies b) there's no holdover relief, because there is actual consideration - albeit not cash - and c) it's taxable on the employee - like any other reward, it's earnings.

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Replying to Tax Dragon:
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By Tax Dragon
26th Nov 2019 12:02

I'd just add... I know I picked out paras 7 and 8 before, but do read all of SP D12.

And make sure it's the latest version.

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Replying to Tax Dragon:
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By lionofludesch
26th Nov 2019 12:03

Tax Dragon wrote:

With an employee, I think it's going to be hard to argue that the 'award' of the goodwill is not a reward for services.

If it is a reward (you persist in not disputing that) then I think a) s17 applies b) there's no holdover relief, because there is actual consideration - albeit not cash - and c) it's taxable on the employee - like any other reward, it's earnings.

Great summary of the issues.

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Replying to lionofludesch:
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By John Stone
26th Nov 2019 13:36

I'm confused now. You say s17 applies. That is capital gains legislation. But you conclude that the matter would be taxed as earnings.

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By lionofludesch
26th Nov 2019 13:43

John Stone wrote:

I'm confused now. You say s17 applies. That is capital gains legislation. But you conclude that the matter would be taxed as earnings.

CGT for the existing partners.

Income Tax for the new one.

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Replying to lionofludesch:
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By Tax Dragon
26th Nov 2019 14:12

lionofludesch wrote:

CGT for the existing partners.

Income Tax for the new one.

There is after all a disposal AND an acquisition…

It might fail to get there, but the tax system is aiming for the position that might have arisen had cash been moving around – a cash bonus taxed as employment income and cash being used to buy the goodwill.

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Replying to Tax Dragon:
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By John Stone
26th Nov 2019 14:21

But supposing the partnership agreement specified that the new partner is entitled to x% of future profits but 0% of the capital of the business pertaining at the date of his appointment. Doesn't this result in nothing being taxable as a consequence of the partnership change?

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By Tax Dragon
26th Nov 2019 14:41

If there is no disposal to tax and no acquisition to tax, then do you really need us to tell you there's no tax?

That said, I question your thesis. Is goodwill part of "the capital of the business"?

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Replying to John Stone:
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By lionofludesch
26th Nov 2019 14:55

John Stone wrote:

But supposing the partnership agreement specified that the new partner is entitled to x% of future profits but 0% of the capital of the business pertaining at the date of his appointment. Doesn't this result in nothing being taxable as a consequence of the partnership change?

You say that goodwill isn't currently on the business accounts. So I infer that "the capital of the business" represents undrawn profits, together with sums advanced by the partners - but nothing for goodwill.

I wouldn't fancy your chances at a Tribunal.

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Replying to lionofludesch:
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By John Stone
26th Nov 2019 15:46

OK - Replace the word'capital' with 'goodwill' in the partnership agreement.

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By lionofludesch
26th Nov 2019 15:54

John Stone wrote:

OK - Replace the word'capital' with 'goodwill' in the partnership agreement.

Good luck.

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By Tax Dragon
26th Nov 2019 16:02

If the new partner cannot share in any capital proceeds, including for the sale of goodwill, then I can see the OP's point. I would get a solicitor involved with the drafting of the agreements (and advising on what is and is not possible) rather than just changing the odd word here and there :-)

Getting legal input may help to focus minds on the real issues.

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Replying to Tax Dragon:
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By lionofludesch
26th Nov 2019 16:13

Happen as may be, Drags, but, for me, the problem is the more restrictions are placed on the new partner's participation, the less he looks like a genuine partner.

He's looking a lot more like an employee whose remuneration is set by a percentage of the business profits.

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By Tax Dragon
26th Nov 2019 16:25

Doubtless one of the things that talking with the legal type might focus minds on is what happens when the pie is smaller - or, Heaven forfend, negative. Minimum wage and all that.

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By John Stone
26th Nov 2019 16:26

'I can see the OP's point'. Noone has ever said that before! Anyway - Many thanks TD and Lion for your inputs. Greatly appreciated.

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RLI
By lionofludesch
26th Nov 2019 11:03

If this new partner is genuinely unconnected, I'd consider incorporating.

For commercial reasons.

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