Annex 1: Minor Changes in the Law Change 86: Partnerships: allocation of firm’s profits between partners: sections 1263 and 1264
This change legislates the practice in paragraph 72245 of the HMRC Business Income Manual.
It brings the income tax and corporation tax codes back into line.
Section 114(2) of ICTA provides that a partner’s share of the profits or losses of a trade carried on in partnership is to be determined “according to the interests of the partners”. It offers no guidance on how this is to be done.
Some partnership agreements provide for an initial allocation of profits (often in the form of a salary or interest on capital) to some partners before the balance is allocated on the basis of a percentage share in the profits.
For instance, three partners may agree to allocate profits of 250,000 as follows:
But, if the profits were only 90,000, the position would be:
Section 114(2) of ICTA deals in this case with an allocation of the trade profits. So the answer for partner C cannot be a loss. HMRC practice, supported by decisions by the Special Commissioners, is to re-allocate C’s “loss” to the other partners, so that in the example both A and B are allocated 45,000 of the trade profits. C’s share is nil.
A similar position can arise if the result for the firm is a loss. A share of that loss under section 114(2) of ICTA cannot be a profit.
Section 1263 of this Act sets out how a profit is to be allocated between partners, so that no partner’s share is a loss. Section 1264 of this Act sets out the corresponding rule for the case where the overall result is a loss.
Whether the new statutory rules for apportioning profits result in an adverse or favourable result for particular partners depends upon the particular circumstances.
This change is in principle adverse to some taxpayers and favourable to others but it is expected to have no practical effect as it is in line with generally accepted practice.