When Is A Property Partnership Not A Partnership?

Lee Sharpe warns that HMRC may disagree that a partnership actually exists in respect of property lettings activities.

The title sounds like the opening line in a bad tax joke (as an aside, I know of no good tax jokes: they are universally bad – tax is no laughing matter. If you do know any good ones, please feel free to pass them on). 

The punchline is succinct: ‘when HM Revenue and Customs (HMRC) says it’s not’. Which might be satisfactory, if: 

The issue of whether or not a joint property investment business constitutes a partnership has not been a particularly pressing matter for some years. Many landlords who own property jointly will refer to themselves as a ‘partnership’ even if they don’t fill in a partnership tax return. I suspect that this may change, thanks to the new rules that will restrict residential mortgage interest relief in the next few years (to be clear, partnerships are not themselves immune, but partnership status is a potentially useful stepping stone). 

This article will review some of the key factors to consider. 

There is a Partnership Act, which defines a partnership as:

‘The relationship which subsists between persons carrying on a business in common with a view of profit’ (PA 1890, s 1).

This seems pretty straight forward. But the legislation also says:

‘...joint property, common property, or part ownership does not of itself create a partnership.’ (PA 1890, s 2(1))

To an extent, this makes sense: simple joint holders of a bank account are not in a partnership; likewise a joint holding of shares does not make the holders partners. But what about landlords?

Property developers, hoteliers, etc., acting jointly will generally be accepted as being in partnership. But for those who merely let property, HMRC seizes on the second extract above, as per their Property Income manual (at PIM1030) in relation to jointly-owned property letting businesses: ‘Joint letting does not, of itself, make the activity a partnership. Usually, there won't be a partnership.’

‘Whether or not a taxpayer is a member of a partnership depends on the facts. A partnership is unlikely to exist where the taxpayer is one of a group of joint owners who merely let a property that they jointly own. On the other hand, there could be a partnership where the taxpayer is one of a group of joint owners who:

I read the last point to indicate that HMRC wants to see gardening, laundry, or similar, for which a tenant might be prepared to pay extra. This is, of course, unusual in mainstream property letting. I think it is also a bit of a red herring. 

If we consider the original definition, then joint owners will be ‘in common’, and I should hope that they have a view to making a profit (although those investors who support a year-on-year income loss, in the hope of making substantial capital gains on eventual sale, should be careful).

The real sticking point is whether or not the joint property owners are in fact ‘carrying on a business’. HMRC itself says that property income is taxed as if it were a business (PIM1020). 

But, in a nutshell, HMRC is saying that taxing rental income as a business does not actually make the letting activity into a business, such that joint owners may be partners in a partnership. 

This was recently considered in Ramsay v HMRC [2013] UKUT 0226, in a claim for capital gains tax (CGT) relief on the incorporation of a business. There being no specific definition of a business for CGT purposes, the judge relied on general interpretation. The taxpayer won at the Upper Tribunal, and landlords and advisers may find much of interest in that case. I think this was the right outcome, and I should also emphasise that the tribunal judge made it clear that:

I think, then, that joint landlords, actively managing a property portfolio with sufficient commercial organisation, (e.g. dealing with tenants, chasing debts, managing repairs, etc.), in order to realise an income profit, should be eligible to be considered a partnership for income tax (and CGT) purposes.

Some landlords may recall (and their advisers especially) that it was only a year or so ago that HMRC started testing the water with letters trying to convince landlords they were liable to Class 2 National Insurance contributions (NICs) - usually the preserve of traders (and as noted above, trading is certainly a business). HMRC was unable to explain quite how a letting activity, which it generally argues is simply passive investment for income tax purposes, could somehow become earnings for NICs. Rashid v Garcia [2003] SSCD 36 is a useful case in this regard.

Whilst HMRC seems to think that property letting partnerships are rare for income tax purposes (as per PIM1030 above), this appears to be less the case for stamp duty land tax (SDLT) purposes – see for instance the SDLT manual at SDLTM3310 which, after confirming that the Partnership Act definition applies, then says only that: ‘It is possible that simply holding investment property jointly might not constitute a business.’

Furthermore, SDLTM34010 refers to a property investment partnership (PIP) whose ‘sole or main activity is investing or dealing in chargeable interests’. Strangely, there is no mention of having to provide ‘significant additional services in return for payment’, in order for a partnership to exist in the first place (although, to be fair, that section does mention PIM1030). Could it be something to do with the fact that there is a potential SDLT charge when the profit-sharing ratio changes in a PIP, but not in a mere joint investment property?

The rules for VAT are quite different to those for direct taxes – income tax, CGT, etc. – essentially a joint letting activity will automatically be considered a partnership for VAT purposes. This is unlikely to affect those landlords who deal only in residential properties, since supplies in relation to dwellings are generally exempt from VAT. Those who let commercial properties (or a mixture of both) in joint names are supposed to notify HMRC that there is a partnership for VAT purposes. See, for instance, section 7.2 of VAT Notice: 742 Land and Property.

One might cynically conclude that HMRC’s approach to property businesses depends on whether or not there is an opportunity to extract any tax (or NICs). This is perhaps unfair. But having seen HMRC attempt to extract Class 2 NICs from property letting businesses has not made me less cynical.

Whether or not a particular joint property activity will constitute a partnership will turn on the facts of that case. I suspect that, in the next few years, many joint property investors (or should that be ‘business owners’?) may be tempted to argue that they are in fact in property partnerships. 

Readers will do well to seek good advice so that their arguments are competently prepared – and any possible traps avoided, such as the potential SDLT charge on changed profit-shares in a property investment partnership.

*Property transactions in Scotland are now subject to the new ‘Land and Buildings Transactions Tax’ and, although the rules are quite similar to SDLT, readers should ensure that they take specific advice, where appropriate.