Annex 1: Minor changes in the law made by the Act: Change 143: Partnerships: allocation of firm’s profits between partners: section 850
This change legislates the practice in paragraph 72245 of the Inland Revenue’s Business Income Manual.
Section 111(3) 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 111(3) of ICTA deals in this case with an allocation of the trade profits. So the answer for partner C cannot be a loss. The Inland Revenue 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 111(3) of ICTA cannot be a profit.
Section 850(2) and (3) of this Act set out how a profit is to be allocated between partners, so that no partner’s share is a loss. Subsections (4) and (5) set out the corresponding rule for the case where the overall result is a loss.
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 current practice.