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Partnership ceased and debit capital account

Partnership ceased and debit capital account

Partnership has ceased trading and one partner has drawn more than his share of profits, leaving him with a debit balance on his capital account which won;t get carried forward.
What is the usual treatment for tax purposes?
Off the top of my head it would seem equitable, as it's the final year of trading, to increase his share of profits to equate with the drawings so that he pays more income tax. Someone suggested it's his capital account so it's a capital gain and covered by the the annual allowance. So no tax to pay on it. Seems like a good wheeze.
Stumped. What's the real answer?
Thank you.


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16th Jul 2009 19:22

I would expect . . .
I would expect the tax treatment to follow the facts of the matter (but I am no tax guru!).

So my starting point would be to ask whether the ex-partner will be asked to repay the debit balance on his capital account. I assume the answer is, "No" (but if it is "Yes" then I think the tax position is obvious!).

I presume the debit balance did not arise as a result of dishonesty by the ex-partner (e.g. theft). If it did then I think the loss resulting from that dishonesty is not allowable for tax (in contrast to theft by an employee which would normally be regarded as an allowable expense).

There is an argument for saying that the debit balance should be written off and the write off should be regarded as a non-trading (and non-tax-allowable) expense.

An alternative view would be to seek some agreement between the continuing partner and the ex-partner on the terms of his departure from the partnership. If an agreement is reached that the ex-partner is not to be asked to repay the debit balance and the profit shares for the period prior to his departure are to be adjusted to attribute to him just sufficient profit as to reduce his capital account to zero on his leaving, then the tax consequences will flow from that. I do not think it unreasonable for the partners by agreement to adjust the distribution of profits between them after the end of the accounting year but before the partnership accounts have been signed off - although a strict view might regard that as improper.

On the other hand, if a value is placed on his share of partnership goodwill and he disposes of that goodwill to the continuing partners (resulting in a zero balance on his capital account on his departure), then tax consequences will flow from that.

But if the business as a whole has ceased trading then it is difficult to see that there is genuinely value in goodwill. That being the case, I cannot see that the ex-partner has made a capital gain.


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16th Jul 2009 20:15

It's really got nothing to do with tax.

The partners are taxed on their share of the partnership profit.

The final balance sheet of the partnership should show that there are no assets and the debit balance on one partners account will equal the credit balance on the other partner's. So effectively the partner with the overdrawn capital account personally owes the money to the other partner.

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By Anonymous
16th Jul 2009 21:38

..........the OP and first responder seem to be barking up all sorts of trees.
Are there any trees to bark at?
Well, we haven't really been given chapter and verse as to what is really happening here.
But agree totally with SK that his assumed outcome is the most obvious and most likely scenario, subject to further enlightenment from the OP.

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By Anonymous
17th Jul 2009 10:50

Hello from the OP
Yes, I can see that Stephen has hit the nail on the head.
Very little chance of recovering the money from the partner. As you can imagine, having to pay the same amount of tax for less income ie. drawings in this case, does not sit well with the other partner.
I don't think that the profit allocation can be arbitrarily skewed unless there is something in the agreement providing for this? The Revenue will assume equal profit sharing.

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By Anonymous
17th Jul 2009 12:06

well, I'm stumped as well.
It is up to the partners to agree the profit split !!
No-one else can do it.

What was the agreement on profit split?
Yes, they could agree it to be not 50/50, of course they could. But they would both need agree it!!

How come it seems to be accepted that one partner has walked off with a debt to the other, and everyone seems to be shrugging their shoulders in bewilderment?
Of course it wouldn't sit well with the partner owed the money!!
What action he takes to recover his debt is up to him.

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17th Jul 2009 18:18

This is just a gift or payment between the partners
And will only become relevant if CGT becomes an issue or if they are related and so open market values should be applied to the breakup of the partnership. So not relevant if talking about a small amount of money.

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