Lee Sharpe looks at possible tax pitfalls where partnerships and property are concerned.
This article looks at some of the main tax implications for someone joining a partnership and, in particular, introducing chargeable assets for capital gains tax (CGT) purposes, such as property.
I’ll consider general partnerships (as per Partnership Act 1890) in the context of English and Welsh law. The legal regime for Scottish partnerships differs a little and may be relevant.
HMRC will often argue that property-centric businesses do not have ‘enough substance’ in terms of commercial activity to qualify as partnerships – as distinct from mere co-ownership. The writer’s opinion is that HMRC does have a point but sets the partnership bar too high. We shall assume that the bar has been surpassed in the rest of the article, although this is not always a good thing!
CGT special regime for partnerships
The legislative provision for partnerships and CGT is limited. Partners are each deemed to own a fractional interest in the partnership assets, in proportion to their capital-sharing ratios, which can differ from income or profit-sharing ratios and vary from one asset to another (TCGA 1992, s 59).
Otherwise, HMRC relies on Statement of Practice (SP) D12 – a declaration of how HMRC applies CGT to partnership assets.
When a partner’s fractional interest in an asset reduces, they have made a disposal; if their interest increases, they have made an acquisition – typically where partners join or leave and profits or assets are then apportioned differently.
When the partnership disposes of an asset outside the partnership, each partner will make a disposal of (their entire respective fractional interest in) the asset for proceeds.
Generally, under SP D12, where one or more partners’ fractional interests fall (while others’ rise), and they are deemed to have made a CGT part-disposal as a result, the usual rules for part-disposals are ignored, and the proceeds will be their share of the balance sheet value of the asset. If, as in many cases, the asset is carried in the accounts under historical cost, the deemed proceeds of the parts disposed of align with the corresponding cost or acquisitions by the partners whose interests have increased – the parties effectively use balancing amounts for proceeds and cost – no gain, no loss.
This effective no gain, no loss treatment will not apply, however, if:
- the asset has been revalued away from cost since acquisition;
- the partner receives some other consideration such as money; or
- the ‘proceeds = market value rule’ must apply because the transaction is not on commercial terms at arm’s length (in this context, connection simply and only because they are partners in the same partnership may be ignored – TCGA 1992 s 286(4)).
For a long time since SP D12 was introduced in 1975, HMRC applied a similar approach when a new partner joined the partnership and added assets to the partnership. However, the policy was changed in 2008 because of a perceived risk of avoidance.
CGT and introducing a new partnership asset
HMRC has decided that while the introducing partner’s reduction in fractional interest in the new partnership asset still represents a disposal, the proceeds will not be a corresponding fraction of the balance sheet value (as might typically have secured a no gain, no loss outcome in the past), but either:
• market value, if not undertaken on a commercial basis, etc. as above; or
• such consideration as is passed to the disposing partner, such as by credit to their capital account.
Example: Joining a partnership
Suella joins a partnership, introducing a property in Manchester that cost her £200,000, which is now worth £400,000; assets are shared equally amongst the otherwise unconnected (now) four partners. The asset goes on the balance sheet at £400,000 and Suella’s capital account is credited with £400,000 – a commercial approach. No partnership assets are revalued.
Under the ‘original’ SP D12, Suella would have been deemed to have given up 75% of £400,000 for cost and proceeds, as her fractional interest fell from 100% to just 25% – i.e., no gain, no loss, with any substantive capital gain typically being recognised only as and when the partnership ultimately sold to external parties.
Under the post-2008 approach, Suella will still have given up 75% of her interest in the asset (again, under SP D12, this can be £300,000); but this time, the proceeds will be whatever she actually received for the asset (in this case, a credit of £400,000 to her capital account). Overall, a gain of £100,000 under the post-2008 approach. Broadly, Suella recognises a chargeable gain now that under the old rules would generally not be recognised until the partnership made an external disposal.
Stamp duty land tax
As noted above, readers dealing with property situated in devolved nations should consider the local niceties, as appropriate. There are similarities between the approach for CGT and stamp duty land tax (SDLT) purposes. When a new partner joins and introduces chargeable assets, there are usually two aspects to consider:
- The original partners may acquire chargeable interests in the incoming assets, potentially triggering SDLT.
- The incoming partner may acquire interests in the pre-existing partnership chargeable assets, also potentially triggering SDLT.
However, there are also savings in the SDLT legislation (the mechanism of the required calculation), and particularly where the chargeable assets move between connected parties.
Critically, however, SDLT follows the movement in income profit-sharing ratios.
When it comes to a change in those income ratios themselves (as distinct from introducing new assets etc.), this will not trigger an SDLT event, except if the partnership is a property investment partnership – such as a property letting business. In such cases, a similar calculation is required to recognise the change in shares in the market value of chargeable assets.
VAT position
A joint VATable activity will likely comprise a partnership for VAT purposes; the aforementioned bar is lower for VAT. Owners should note that VAT makes little distinction between capital and income receipts; they are all supplies for VAT purposes. Residential property is usually VAT-exempt, but the registered party will often have opted to tax their interest in commercial property, holiday lettings or similar; by default, VAT will then be due on sale.
However, it is possible that the supply (particularly of properties in a rental business) can comprise a transfer of a going concern (TOGC). This essentially means that the transfer of (the assets of) a qualifying business into a partnership will not constitute a VAT-able sale; VAT will not be chargeable.
Usually, this is good news (e.g., because SDLT is chargeable on the VAT-inclusive consideration). But TOGC treatment applies automatically if the criteria are met, which will likely continue to catch some businesses off guard. In the occasional circumstance that a TOGC is undesirable, it is possible to opt out of TOGC deliberately, such as by causing anti-avoidance paperwork conditions to fail.
Conclusion
Partners and their advisers need to be alert to the risk of CGT when capital-sharing ratios change – although no gain, no loss treatment may well apply unless assets are revalued, or consideration has otherwise changed hands (or the ‘market value rule’ is in force). But care is advised when a partner introduces an asset, as a no gain, no loss outcome is less likely. Even so, it may be possible to adopt holdover relief, such as into the investment into new fractional interests acquired (see HMRC’s Capital Gains manual at CG27700), or potentially gift relief, to postpone the CGT charge that would otherwise arise (TCGA 1992, ss 152, 165).
With SDLT, there is no substitute for following the mechanics of the legislated calculations, but a charge may well reduce or fall to nil. When it comes to property investment partnerships and changing income profit shares (except where connected party rules may save the day), it may very well be a case of ‘be careful what you wish for’. I have not yet seen a scenario where unconnected co-owners in a property letting business have demanded they be treated as a partnership (say) on the path to incorporation, only to find that historical changes in income profit-share rack up substantial SDLT bills; but I fancy there may well be a good few out there.
