Lee Sharpe considers what makes a property rental business a partnership, and why it may help (or not!).
Historically, HMRC has disliked partnerships and particularly rental partnerships, because: (a) it meant more work for HMRC dealing with partnership tax returns; and (b) HMRC feared admitting that a humble joint property investment business could amount to a partnership, in case it got fed after midnight, left out in the rain and – shock, horror – turned into a trade!
However, while it may safely be assumed that HMRC does not have landlords’ best interests at heart, one key point to make in here is this: be careful what you wish for; partnerships are not always ideal, and in some cases can cost you dearly.
The basics: general and limited liability partnerships
A general (or ‘traditional’) partnership arises where two or more parties carry on a business in common with a view of profit. Such a partnership can come about ‘accidentally’, without a written agreement or the parties’ having realised that they were actually in a partnership (although it would be difficult for them not to at least realise they were in business together).
A key potential trap in a general partnership is that each partner becomes jointly and severally liable for the partnership’s debts. This means each partner may have to cover some or all of a failed partnership’s liabilities out of their own pocket – meaning their personal wealth (and even their home) is at risk. This is similar to running a business alone, but with the added complication that one partner can make a bad decision that costs other partners their livelihood, or worse.
While not a tax issue, a tip for those concerned about the personal risk of joining a normal or general partnership, is to consider setting up or joining a limited liability partnership (LLP) instead, wherein each partner’s financial risk is basically limited to just their own investment in the LLP. The potential tax traps for operating as an LLP include:
- Restriction of relief normally available for trading losses (but most property partnerships are not trades), and
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No personal tax relief for any interest paid on financing the cost of ‘buying in’ to an investment business LLP.
Partnerships and tax returns
Unlike a limited company or an LLP, a general partnership has no legal identity distinct from its partners (so if an unhappy tenant sues a general partnership, they are basically suing the partners themselves), although the law differs in Scotland.
However, the UK tax regime requires all partnerships to report their business profits and gains at the partnership level first, through a partnership self-assessment return; next the profits, losses and capital gains are allocated amongst the partners, who are then taxed individually in their own returns. Another tax trap here is that a late partnership return can cost even more in penalties than the partners’ personal tax returns; the more partners there are, the higher the penalty.
Income tax
(a) Profit share
HMRC insists that profits and losses must be shared in accordance with the ratios, etc., agreed at the time, not retrospectively. This is another tax trap: HMRC does not allow partners to work out their annual profits first, and then share them around so as to minimise overall tax exposure.
(b) Cash basis
The de minimis £150,000 annual income threshold, above which the cash basis for landlords may not apply, is gauged at the business level. So, an ordinary joint rental business with gross annual income of £180,000, then split amongst three equal co-investors means that the cash basis could apply to each joint investor, treated as operating their own £60,000 per annum rental business. But a rental partnership with £180,000 gross annual income would be too big.
As I broadly dislike the cash basis except for the smallest property businesses, I might consider this a plus, not a tax trap.
Capital gains tax
Capital gains tax (CGT) can be triggered when:
- The partnership sells an asset externally; or
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When individual partners’ interests in partnership assets fall – they are deemed to have disposed of some or all of their interest in the asset(s). This might happen when a partner retires, or sells part of their partnership share. This can become quite complex.
HMRC’s guidance on CGT for partners’ capital interests is covered in its Statement of Practice (SP) D12. Very simply, interests can move between partners (who are otherwise unconnected) without triggering CGT, so long as assets (including goodwill) have not been revalued beforehand, and money has not changed hands. So, one tax tip is not to revalue CGT’able assets on the balance sheet or, if the partnership is small enough, maybe not even have a balance sheet at all.
(a) Joining or creating a partnership
HMRC’s SP D12 has been updated and it now insists that introducing CGT’able assets when joining or first creating a partnership will usually trigger CGT, even if money does not change hands.
This could be a nasty tax trap for someone who wants ultimately to incorporate their letting business into a limited company – perhaps seeking to avoid the restrictions on residential letting finance costs – and wants to set up a partnership as an intermediate step (see below).
(b) Whose asset?
It is not always obvious if an asset was acquired by the partnership itself, or by the partners personally for use by the partnership. A common example might be where the property partnership orients around former trading premises (e.g., dental practice).
This can make a big difference to the availability of business asset disposal relief, assuming the business is otherwise eligible.
Stamp duty land tax (and devolved equivalents)
Where a ‘genuine’ partnership incorporates, it may be able to reduce (or eliminate) the stamp duty land tax (SDLT) that would normally arise on incorporating a (non-partnership) property business.
It is not uncommon to see a property business become a partnership and then incorporate some time later. But SDLT has a number of special treatments and potential tax traps specific to property investment partnerships, including:
- It is the partnership income share (not capital share!) that matters when considering SDLT due.
- SDLT may be due when forming a property investment partnership and possibly where the income share changes (regardless of whether formed/changed as a precursor to incorporation).
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There are anti-avoidance measures that (for example) negate any SDLT advantage if a partnership has been adopted merely to avoid SDLT on subsequent incorporation.
The rules may differ in terms of land transaction tax in Wales, or land and buildings transaction tax in Scotland.
Value Added Tax
A property partnership is a separate entity on the value added tax (VAT) register. A tax tip for two or more individuals who are each already VAT-registered from other activities but who want to become residential landlords is to go into a property partnership for VAT purposes – as a separate entity, the VAT-exempt residential landlord activity would not then affect their own business’ VAT calculations (although running a partly-exempt VAT business is not always a disadvantage).
But care is needed for commercial property letting businesses or trades and VAT; for instance, a partnership making VAT’able supplies has to register separately for VAT, and notify of changes in the partnership (e.g., when someone joins or leaves).
Inheritance tax
As for CGT, whether a property belongs to the partnership or only to its partners is relevant for inheritance tax (IHT) purposes.
While an asset owned personally but made available for use in an otherwise-qualifying partnership may still rank for business property relief or similar, the IHT relief would be only 50%, whereas direct ownership by the partnership itself could qualify for 100% relief.
Conclusion
This is a brief introduction to some key tips and traps for property partnerships. For those who would scoff at the notion that HMRC is scared of partnerships, I suggest they consider what HMRC set out to achieve in its draft legislation for partnership taxation ‘Proposals to clarify tax treatment’ in September 2017, and what actually made the cut (in FA 2018, Sch 6).
For a recent case on whether a property partnership actually exists, see SC Properties Ltd & Cooke v HMRC [2022] UKFTT 214 (TC), although I would caution that the decision seemed to make some highly questionable assumptions about the prevalence of written contracts for spouses in business!
