The decision as to how partnership property should be owned can be directed by a number of factors, including:
- Tradition;
- Ability to obtain finance;
- Historical preference; or
- Tax advantage.
The tax considerations can often be overlooked. This is not to say that the tax considerations should be top of the agenda, but they must be considered in line with the other contributing factors.
There are some events that are certain with regard to the ownership of property used in the partnership. The owner will either:
- Die owning the property; or
- Sell or gift the property.
There must therefore be planning around inheritance tax (IHT) and capital gains tax (CGT) protection. However, striking a balance between the two can prove a challenge for any tax adviser.
Capital disposals
On the assumption that most partners retire before they die, one goal will be the achievement of entrepreneurs’ relief, with its CGT rate of 10%. At the stage of retirement, rollover relief for CGT purposes may not be the retiree’s preferred course of action, as they may want to pay the tax and enjoy the money; therefore the very favourable rate of CGT at 10% is a keenly pursued route.
Disposals by a partner of a personally-owned asset used in the partnership also benefits the partner, if the individual is withdrawing from the business and, as a result, disposes of the whole or part of his interest in the partnership (e.g. when a partner is retiring). When a partner is fully retiring from the partnership and this coincides with their disposal of an asset used in the partnership, this is relatively straightforward for the tax adviser.
This emphasis on withdrawal from the business and the disposal of the whole or part of the interest in the partnership is currently occupying the mind of many tax advisers. Development land opportunities are increasing, and therefore the desire to get entrepreneurs’ relief on sales is strong. The complications arise when a partner wants to remain a partner and there has to be disposal of part of their interest in the partnership. This is very common when it comes to development land as it usually amounts to a small area of the farm, and therefore the farming partnership is likely to be continued.
Under the entrepreneurs’ relief legislation (TCGA 1992, s 169K(2)), an associated disposal needs to be made as ‘part of the process of withdrawal of the individual from participation in the business of the partnership’. HMRC’s Capital Gains manual (at CG63995) discusses what ‘withdrawal’ means, and includes an example of a father and son partnership, where the share of the father reduces from 60% to 20% and he continues to work in the business. The guidance confirms that this would be sufficient to constitute a disposal and withdrawal for entrepreneurs’ relief. What does constitute a significant withdrawal is not made clear in the guidance and is currently being debated by some advisers.
This would indicate that holding the property outside the partnership is the most efficient way to hold property, as under the associated disposal rule the owner does not have to cease but just withdraw.
To achieve entrepreneurs’ relief for partnership property there has to be cessation.
Inheritance tax
There are many partnerships without partnership agreements. Such agreements are needed to give structure, to resolve disputes and to help protect the tax position of the partners.
A well-drafted agreement will identify what is ‘personal’ property and what is ‘partnership’ property in terms of the availability of 100% (as opposed to 50%) business property relief (BPR) for IHT purposes. The BPR position is straightforward; property made available to a partnership only achieves 50% BPR, whereas ‘partnership’ property achieves 100%.
Thus if a partner dies owning partnership property, i.e. property owned by the partnership and used in the partnership trade it should achieve 100% BPR, but if they own the property personally and outside the partnership the BPR rate is only 50%.
This is where the dilemma lies for taxpayers and their advisers. For IHT purposes, it is clear that property should be partnership property and achieve 100% BPR. However, this raises complications for entrepreneurs’ relief. If the property is partnership property there must be a cessation of the business. Striking the balance between IHT and CGT should be considered carefully.
Example: Personal vs partnership property
A high street florists is operated through a partnership. Partner A owns the freehold property. They do not have a partnership agreement. The property would be defined as ‘personal’ property.
If partner A died, their estate would only be able to achieve 50% BPR, and therefore half the value of the property would be chargeable to IHT. However, if partner A did not meet an untimely demise and received an offer they could not refuse on the property or wanted to relocate, in order to achieve entrepreneurs’ relief on the disposal of the property this would have to coincide with a reduction in partner A’s interest in the partnership.
Now assume the partnership had been advised to speak to a solicitor, who completes a partnership agreement for them and makes the ‘personal’ property partnership property and therefore achieves 100% BPR and the value of the property does not come into the estate of partner A. This is clearly a good result from an IHT perspective. However, if partner A wants to dispose of the property the partnership must cease in order to achieve a 10% rate of tax. If the business is to continue after the disposal a new entity must be formed. This requires careful planning by the partners and their advisers.
Check the legal documentation
It has been said that many accountants and partnerships do not know the difference between properties ‘owned by the partnership’ and those owned by the partners individually.
To avoid problems, it is important to plan in advance and carefully understand the ownership status. In the case of partnerships, identify if the property is an asset used in the partnership or a partnership asset. Just because historically the asset is shown in the partnership accounts does not necessarily make it a partnership asset. This is especially poignant when taking over from a previous adviser. Check the legal documentation and ensure your understanding (and the partners’ understanding) is correct right from the start.
Losing out on 50% BPR on the death of a partner for this oversight or misunderstanding could be expensive from an IHT perspective.
Practical Tip:
Action plan for partnerships:
- Ensure tax planning is put in place before the purchase of any partnership property or there are any changes in ownership. Establish the tax ‘needs’ of each individual.
Action plan for advisers:
- Ensure there is a robust, up-to-date partnership agreement in place from the commencement of every partnership;
- Review all partnership agreements and ensure the correct ownership of the partnership, in particular be clear about the value of the buyout when a partner leaves, as well as providing for an exit strategy;
- Take steps to ensure all potential business disagreements are covered by the partnership document; and
- Ensure the partners are aware of the difference between ‘personal’ property used by the partnership and partnership property, and the tax implications thereof.
