The last 30 years or so have seen a huge move towards small businesses being carried on through limited companies, but farming continues to be largely undertaken through the medium of a partnership. Partnerships continue to be governed by the 1890 Partnership Act which, whilst it may seem somewhat antiquated, has actually stood the test of time surprisingly well considering how business has evolved in the last 125 years.
The year 2000 saw the introduction of limited liability partnerships (LLPs) and professional partnerships and investment and property development conglomerates quickly took to this structure. According to HMRC, so too did those partial to engaging in tax avoidance activities, the now infamous film partnerships leading the charge.
Since the introduction of LLPs the government has introduced wave after wave of anti avoidance legislation, closing perceived loopholes in a series of knee-jerk reactions. This has compounded a problem which already existed, being that partnerships are largely tax transparent (a partnership not incurring tax charges, but rather the underlying partners being personally taxed on the transactions of the partnership). As a by-product of this, the legislation dealing with the taxation of partnerships is sprinkled across the whole of our tax code with little consolidation having taken place, and with little of the tax law having been written specifically with partnerships in mind. They are, in tax terms at least, an afterthought to legislation written for individuals or companies.
The Office for Tax Simplification (OTS) has just published an interim review considering all facets of partnerships, and it contains much commendable content and many short, medium and long term suggestions which could improve the business and tax environment for partnerships considerably. We hope that much of the report is brought forward into law, but for now it falls to partners to make the best of the situation as it stands. This means they should never assume that a change in a partnership or a family transaction involving a partnership will be taxed in a logical fashion. A small amount of advice could save a large amount of unexpected tax.
The importance of having a written partnership agreement is a well discussed topic, yet whilst most would accept the commercial and family reasons why an agreement should exist, especially in an asset rich industry like farming, a surprising number of partnerships are carried on with only informal or verbal agreement.
The focus of any agreement should be on commercial arrangements, dispute and deadlock resolution and succession and estate planning for the business But here are a few tax considerations which a well written agreement should cover:
- A binding contract for sale – a badly written agreement could create a binding contract for sale (to the continuing partners, on death of a partner), jeopardising agricultural property relief (APR) and business property relief (BPR). For a landholding partnership the inheritance tax implications could be huge.
- Ownership of assets – APR and BPR may depend on where legal ownership of assets lies. Are they partnership property or the property of one or more of the partners? And who is occupying the property to carry on the farming business? Simply assuming that because land is farmed it will be free from inheritance tax could be an expensive mistake.
- Split of profits – in the absence of an agreement the Partnership Act applies a default presumption of an equal split between the partners. In dispute, either between the partners or with HMRC, a written agreement of the split will count for much more than a verbal agreement.