Partnership is a creature of contract. The contract can be written, can be
unwritten or partly one and partly the other.
Problems arise where (a) there has been a failure to recognise what is or is
not a Partnership and (b) where there has been a failure to identify and agree
the basis upon which Partnership is to proceed or to continue to proceed in
practice and (c) when unforeseen, often outside circumstances emerge which
require the Partnership to adjust and where the Partners fail to agree as to
how that adjustment is to take place which in turn may lead to the retiral
of a Partner or Partners or indeed to the dissolution or splitting up of the
original Partnership.
I will attempt to define the following:
Section 1 of the 1890 Partnership Act defines Partnership as
“the relationship which subsists between persons carrying on a business in common with a view to profit”.
The 1890 Act codified and clarified the existing common law rules of Partnership
as they existed in Scotland and in England.
What does Section 1 actually mean?
Consideration of Section 1 comes up time and time again in the Courts as to
this definition.
Who is responsible for looking after books, files and papers of the old partnership?
Each individual partnership has its own particular problems which must be addressed.
A professional advisor can often help in easing the partnership through the
difficult period. Conflicts of interest arise and it is important that outside
professional advisors be brought in.
Please remember that major problems in partnerships emerge when disputes arise
between partners and reason flies out of the window and at that stage the Partnership
Act 1890 for all its other very good features fails to deal adequately with
the situation which can only sensibly be tackled through a well thought out
Partnership Agreement.
This paper is not intended to do other than highlight the date of introduction
of self-assessment which was 6th April 1997. Since then Income Tax on the professional
profits is no longer partnership liability but is a personal liability of each
partner. The same applies to Income Tax on any non-trading income of the partnership
(ie investment income from partnership assets). Capital Gains Tax payable on
disposal of partnership assets, is similarly not a partnership liability but
the liability of each partner after the gain has been shared out.
Although the firm is no longer legally responsible for payment of the partners’ Income
Tax it is often though preferable for a firm to retain out of each partner’s
share of profits an amount sufficient to meet that partner’s Income Tax
liability on profits. Such a system relieves each partner from concern as to
whether the resources will be available on the due date to meet the tax liability.
THE IMPORTANCE OF PROVIDING PROPERLY FOR INCOME TAX LIABILITIES CAN NEVER BE
OVER EMPHASISED. Since Income Tax is no longer a legal liability of the partnership
as a whole, some firms prefer to make it clear in the Partnership Agreement
that the tax reserve in name of each partner is legally a personal asset of
the partner and not an asset of the business. This could be important in the
case of a partner or firm insolvency.
On admission partners sometimes have to contribute part of the capital needed
to run the firm. Where a partner borrows to provide this capital contribution
the interest on money borrowed is eligible for tax relief provided that the
money is used to buy either a share in the partnership or to contribute money
by way of capital or loan to the partnership (Taxes Act 1988 Section 362).
This relief is available to salaried partners in professional firms who are
indistinguishable from general partners in their relations with clients (Inland
Revenue Statement of Practice A33).
It is preferable for the capital amount on which a partner is receiving this
tax relief to be separately identified in partnership accounts, in order to
avoid allegations by the Revenue that the contribution has been repaid or replaced
with other forms of capital. It is good tax planning for a partner to maximise
borrowings for this qualifying purpose in preference to borrowing for other
less tax privileged purposes. Even if the partner can later afford to pay back
the loan it may be more tax efficient to invest the money elsewhere and keep
the loan at the full original value. If cars are purchased by partners personally
with borrowings the business proportion of the loan interest is allowable for
tax purposes for up to three years (Taxes Act 1988 Section 359).
All self-employed people are now taxed on the current year basis. This means
that the profit shown by accounts for a normal accounting period ending in
the fiscal year will be assessed for that year. For example if accounts are
made up to 30th June each year then the profits for the accounts to 30th June
1999 will form the basis of the tax assessment for 1999/2000 for all continuing
partners.
To prevent new partners escaping tax in the first period when they have a Schedule
D source of income the basis period is modified for new partners in that new
partners’
assessable profits for the first tax year in which he or she is a partner is
always the actual profit share from the date of joining to the next 5th April.
The business financial year end is ignored and profits are calculated on an
exact daily basis for the tax year instead (figures are derived for the next
available final accounts with profits apportioned on a daily basis for the
new partner). The same rule applies to a sole practitioner who starts business
partly through the tax year. For the second tax year the new partner is assessed
on the exact profits share for the tax year unless in that tax year there is
a set of accounts for twelve months ending in the tax year and that partner
was a partner for the whole of that accounting period. In this case the new
partner goes on to the normal basis in year two. If the business in question
prepares accounts to any date other than 5th April this means that the new
partner’s basis period for tax will differ from those of existing partners
who are assessed to income tax in the normal basis explained above. In either
case by the third fiscal year new partners are assessed on the normal basis.
This can lead to overlap profits and overlap profits which are doubly taxed
because of the above rules are deductible from profits falling to be assessed
later. In the case of a joining partner he or she acquires a personal overlap
figure depending on the date of admission to partnership and the accounting
date of the firm and must carry forward personally for relief in a future year
when he or she leaves the partnership.
For the purposes of this address I would recommend the papers which are presented
by the Law Society at Practice Management Courses which papers are presented
by Joy Travers of K P M G.
see also:
The Essence of Partnership is
Mutual Agency
Partnership
Problem Solving
List
of Cases
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