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Partnership

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HMRC’s guidance on partnership losses

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HMRC’s guidance on partnerships

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Make your spouse a business partner to save tax

Income splitting

By splitting income with your spouse or civil partner you can reduce the tax bill on it if they pay tax at a lower rate than you. The trouble is HMRC looks at such arrangements with suspicion. Typically, HMRC attacks income splitting arrangements that involve one spouse paying the other a salary to reduce their business profits or giving them shares so that profits can be diverted in the form of dividends. By contrast HMRC rarely attacks arrangements where profits are diverted to a spouse by making them a partner in a business. There’s a good reason for this.

HMRC’s view of partnerships

In English law (it’s different in Scotland), a partnership is created simply by two or more persons sharing business profits. This makes it difficult for HMRC to dispute the existence of a partnership and, consequently, the allocation of profits between the partners. In fact, HMRC’s internal guidance says, “It may be possible in these cases to challenge the spouse or civil partner’s status as a partner, but such a challenge is often very difficult to sustain.”

Tip. Notwithstanding HMRC’s reluctance to challenge the existence of a partnership, drawing up a partnership agreement to formalise the arrangement is advisable (see The next step ).

Tax avoidance

Having cleared the initial hurdle of creating a partnership, you might still be concerned that HMRC could attack the arrangement where you split the profits with your spouse in order to avoid tax. Surprisingly, HMRC’s guidance helps out again. It says, “A spouse or civil partner is sometimes taken into partnership wholly or mainly to maximise the benefit of the tax reliefs that are available” , it continues, “It is worth emphasising that a partnership is not a sham merely because it is set up to save tax” and “You cannot challenge the apportionment of profits, as you can a wage, by reference to the value of the partners’ contribution to the firm’s activity” (see The next step ).

Trap. While HMRC can’t do much about tax avoidance through splitting profits, it can limit tax relief for partnership losses. Special rules limit income tax loss relief for partners who are not active or have limited input into the business (see The next step ).

A possible catch

HMRC’s generally relaxed attitude to partnerships is tempered by the so-called settlements legislation. It allows HMRC to block tax savings by treating the profits allocated by the partnership to a spouse who’s not active in the business as taxable on the other spouse. The good news is that this type of attack is fairly simple to rebuff as the settlements legislation can only apply if the inactive partner is only entitled to income, i.e. a share of the profits, but not a share in the partnership’s capital assets, e.g. goodwill etc.

Tip. A partnership agreement which sets out each partner’s entitlement to income and capital will be enough to defeat HMRC’s attack.

For a sample partnership agreement and links to HMRC’s guidance on partnerships and partnership losses, visit https://www.tips-and-advice.co.uk , Download Zone, year 21, issue 05.