Partnership Profit Shares

By | 30 November 2009

Retrospective tax planning would be a wonderful thing in many cases. For example, it would potentially be very useful if partnership profit shares could be adjusted after the year end based on the personal circumstances of the individual partners, particularly in the context of partnerships involving family members.

However, is retrospective tax planning involving the allocation of partnership profits actually permitted?

HMRC’s view

The Partnership Act 1890 states that profits, losses or other income may be shared between the partners as mutually agreed from time to time.

For income tax purposes, the general rule is that a partner’s share of profit or loss for a period of a trade carried on by a firm is determined in accordance with the firm’s profit sharing arrangement during that period (ITTOIA 2005, s 850(1)). A similar rule applies for corporation tax partners in respect of corporate partners (CTA 2009, s 1262).

HMRC accepts that ‘the sharing ratio need not be in proportion to contributions of effort or capital.’ HMRC also state the following (BIM72055):

“The allocation of profits or losses for an accounting period cannot be varied retrospectively after the end of that accounting period.”

HMRC cite the case Bucks v Bower (Ch D 1969 46 TC 275) in support of their approach (‘Merchant banker. An ex post facto reallocation of profits cannot operate to redistribute the right to relief’). It was held in that case that a partner’s profit share is fixed at the end of the year, and cannot subsequently be altered retrospectively by agreement.

However, other case law suggests that profits may be allocated at a later time. In Franklin v CIR [1930] 15 TC 464, the partner of a firm died. He nominated his son to succeed him as a partner under the partnership deed. The other partners could refuse to admit a successor on reasonable grounds. The consent of the remaining partners was eventually refused. The deceased partner’s profit share had been allocated to a suspense account in the meantime. If the son had been admitted, that profit share would have belonged to one partner (Partner A). Otherwise, it fell to be divided between the four partners at death. The profits were actually allocated to two partners (the other two partners having retired), on a 75:25 basis. The Court held that Partner A was assessable to super-tax only on the 25% to which he was entitled in any event, and that for the other partner there was no liability.

This case presents interesting issues where, for example, a partnership agreement provides for the reallocation of profits after the end of an accounting period. However, HMRC’s views seem to be unequivocal, and cannot be ignored. 

Property ‘partnerships’

The joint letting of property will often fall short of being a genuine partnership. In the case of husband and wife lettings, there may be some scope to reallocate property business profits in certain circumstances, although this must be dealt with in advance rather than retrospectively.

As a general rule, property income held jointly is divided 50:50 between a married couple (or civil partnership) living together (ITA 2007, s 836(2)). However, if the couple are beneficially entitled to the income in unequal shares (e.g. 90:10) they can make a declaration to be taxed in accordance with those interests, rather than on the normal 50:50 basis.

The couple can decide whether to make this declaration on an asset by asset basis (ITM142), but must do so within 60 days from the date of the declaration, in relation to income arising on or after the declaration date (ITA 2007, s 837). 

The above article is reproduced from ‘Practice Update’ (November/December 2009), a tax Newsletter produced by Mark McLaughlin Associates Ltd. See the Newsletters section.