I've asked this question to several accountants and there is a distinct split in opinion so thought I'd ask on here and see if that split is reflected.
Put simply, where you have a partnership client (usually husband and wife but not always), do you think it's acceptable (and do you do it!) to work out the tax situation of the partners and then decide how to allocate the profit accordingly to minimise the tax bills?
A lot of accountants seem to think that this is fine and that HMRC can't do anything about it, but I can't imagine an Inspector seeing this happening and not challenging it!
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I've seen it done
In many cases, but this was largely at a firm I used to work for who, shall we say, had a reputation for 'pushing the envelope' with such matters. There was one particular case where a set of partnership accounts was produced for tax purposes, allocating a higher share to one partner, but a different set produced for the purposes of the courts (he was going through a divorce) to 'prove' his income was lower and so was less able to make maintenance payments...
Morally reprehensible? I think so. Should be challenged vigorously? Probably. My views on that particular firm are not favourable.
In theory of course it shouldn't happen as there should be a partnership agreement setting out the profit shares, with a default to equal shares under the Partnership Act if there is no agreement. From memory I think they got around it by putting a clause in the agreement 'the profits will be shared in such a way as the partners see fit from time to time' or similar. I'd be amazed if this wasn't challenged reguarly though.
Back in the days of the investment income surcharge, which is be
... a large legal firm I am familiar with sought Counsel's Opinion in this respect with a view to allocating the firm's investment income to junior partners and trading profits to senior partners to mitigate their overall exposure to the surcharge, which I understand took the effective rate of tax on investment income up to almost 90%!?
I haven't had sight of the Opinion, but the fact the firm in question went on to allocate their profits in this way implies it must have been favourable.
Regards
I don't see anything wrong...
...with splitting profits however you like to mitigate the tax position. After all isn't it our job as accountants to minimise the tax our clients pay?
Almost all the partnerships we act for have a different profit split most years for the exact reason of avoiding tax whenever possible. None of the clients have partnership agreements and we have never, to my knowledge, been challenged by HMRC over any of them.
The only "partnership" related challenge we had was where a client who owned a rental property in his own name said the income was his wife's so he could avoid higher rate tax on the rental profit. Needless to say he lost the argument and the property is now in their joint names with profit allocated as they see fit, just like the schedule D profits clients make....
partnership law ...
Without a written agreement, and even with a written agreement, the rules governing how the partners act are merely the actions said partners undertake ... so if the partners have a written agreement saying that no partner can commit the partnership to any contract worth more than £1k without another partner's consent, and then one partner commits the partnership to a contract for £10k on his own, that partnership is still bound by that £10k contract, since the partner effectively changed the partnership agreement by entering into that contract.
Every year partners can have different agreements in force for splitting the partnership profits, regardless of what the written partnership agreements state. Nothing needs to be even committed to paper, apart from, of course, the accounts showing the new partnership division of profits. And, having seen many partnerships with changing profit ratios over the years, none of which was ever taken to account over the changing profit-sharing ratios, I can't really see much that HMRC can do.
-- KH
HMRC internal guidance
BIM72055 - Partnerships: General notes: Sharing Profits / Losses
Profits, losses or other income may be shared as the partners may mutually agree from time to time (Sections 19 and 24 Partnership Act 1890). The sharing ratio need not be in proportion to contributions of effort or capital. It is not necessary for the partners to share profits and losses in the same proportions, nor income from other sources in the same proportions as trading or professional income. A partner's share of the income on which they are assessable is computed according to their entitlement in the partnership’s accounting period.
The allocation of profits or losses for an accounting period cannot be varied retrospectively after the end of that accounting period - see Bucks v Bowers, (46TC275) (Merchant banker. An ex post facto reallocation of profits cannot operate to redistribute the right to relief).
Profit share
All partnerships with a written agreement can agree to share profits on any basis they choose, and vary them from year to year as they decide. The deed should be explicit as to the mechanism of calculation eg "as the partners shall from time to time decide".
What they cannot (should not?) do, is do this in the absence of an agreement to vary the terms of the Partnership Act which rules them if they do not have a Partnership agreement.
I am amazed at the moral outrage expressed by some accts who seem to think that their job is to decide that a client might want to avoid paying more tax than is necessary, and do not seem to understand that only legal principles should apply in deciding what tax is payable. Morality has no part to play ,except in avoiding criminal behaviour in my view.
F Evans
APP
A bit before my time
but I believe the case that we know as "Arctic Systems" began as a partnership case , "Jones -v- Garnett". Do the more knowledgeable contributors believe this applies.
.
Arctic systems has nothing to do with partnerships, it was about income splitting arrangements between husband and wife in respect of shareholdings.
not so and yes
"All partnerships with a written agreement can agree to share profits on any basis they choose, and vary them from year to year as they decide. The deed should be explicit as to the mechanism of calculation eg "as the partners shall from time to time decide".
What they cannot (should not?) do, is do this in the absence of an agreement to vary the terms of the Partnership Act which rules them if they do not have a Partnership agreement."
There is no legal requirement for a partnership to have a written agreement and there are many that do not. That is not to say that best advice should be that there is a written agreement in place.
But a partnership with a verbal agreement (which is entirely within the law) can vary the profit sharing basis from year to year (or daily if they wish) and there is no reason why the terms of the Partnership Act cannot be varied by verbal agreement.
Again this is not to say that if there was a dispute there could be problems in demonstrating what the verbal agreement was and that in the final analysis the terms of the Partnership Act might be applied by a court.
And surely a clause that says profits should be shared "as the partners shall from time to time decide" is anything but explicit.
But to answer the original question: It is acceptable to share profits in a tax efficient way. There are many partnerships that do that; and there are many partners in firms of accountants and solicitors who would not agree that their profts were shared on the basis of each partners "contribution"!
What other way would you suggest? And why would that be better?
Partnership profit shares
The allocation of profits between the partners does not just determine the tax but also how much money is due to each partner.
I can understand that if you have a husband and wife partnership and all profit shares are paid into the joint matrimonial account that this might seem like a non point but what happens if there is a divorce?
Profit share
Does this mean that it is legitimate to contribute to a company (in terms of bringing profits to the company) and take non of the profits for tax reasons? For example a married couple where the husband is in full time employment and wants to allocate 100% of company profits to the wife for tax purposes.
Reallocation of partnership capital account
I have a partnership between an elderly mother and two sons. They would like to reallocate the capital in the partnership so the sons have a split equal to their profit share. The partnership owns a commercial property which it lets out. What are the tax implications for this reallocation of capital?
Partnership: can one Partner make a Profit and one make a Loss
Because of various apportionments of incomes, costs and capital allowances, is it possible to have the above situation. And if so, with an overall Partnership profit figure, how would this be entered on the Partnership Tax Return, which seems to only accept either a profit figure going across all partners, or the converse of a loss going across all partners. Or can one enter a negative profit figure on the profit line for the respective loss making partner? Help!!
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