BIM38120 - Wholly and exclusively: partnerships: meeting a partner's personal expenditure

S34 Income Tax (Trading and Other Income) Act 2005

Expense of the partnership or distribution of profits?

You need to examine payments made by a partnership to a partner to decide if it is an expense of the partnership or a distribution of profits. Amounts paid to partners represent part of the profits divisible between all of the partners unless shown to be wholly and exclusively for the purpose of the partnership business.

In MacKinley v Arthur Young McClelland Moores & Co [1989] 62 TC 704, payments made by a partnership towards the removal expenses of partners were held to have an inevitable private purpose, despite the advantages to the partnership of the partner’s change of residence.

Arthur Young McClelland Moores & Co was a firm of chartered accountants, comprising a group of individuals who carried on a profession in partnership together.

The firm had grown over the years. At the beginning of the relevant accounting period the firm had 88 partners; at the end of the period it had 95 partners; by the time of the court proceedings it had over 200 partners. The firm was administered by an executive committee comprising the chairman (the senior partner), six elected members and one appointed member. The partners as a whole meet biannually. The firm has offices throughout England, Wales and Scotland.

As the firm grew in size and acquired offices throughout Great Britain it became necessary to ask partners and employees to move from one part of the country to another to ensure that the staff were deployed to the firm’s best advantage. The Commissioners’ decision records that ‘it became the accepted policy of the firm that any partner or employee might be requested to move for the benefit of the firm’s business’.

To make this policy or practice more acceptable, the executive committee decided that the firm should contribute to the expenses of a partner or employee who was asked to move. They decided that the contribution by the firm should be a sum equal to:

• any estate agent’s charges, surveyor’s fees, legal costs and disbursements and furniture removal charges actually incurred
• reasonable expenses for travel and subsistence to a maximum of three months whilst the partner or employee was looking for a new house and during the relocation period, and
• a disturbance allowance of £1,000 in the case of a partner and £700 in the case of an employee, to meet the cost of, for example, re-laying carpets and refitting curtains

There was evidence accepted by the Commissioners that if the firm had not agreed to make this contribution some partners and employees might have refused to move. The policy was to make a contribution to the cost of the move only if the move was made at the request of the firm. If a partner or employee asked to move to another office, no contribution was made.

During the accounting period in question, the firm paid two partners (R J Wilson, and J A Cooper) contributions to the expenses of moving home. The Special Commissioners found that the expenditure was incurred wholly and exclusively for the purposes of the firm’s business. In reaching this conclusion, it is evident that the Commissioners were paying regard to two and only two considerations, that is to say:

• the conscious motives of Wilson and Cooper in agreeing to move, and
• the motives of the partners (as represented by the executive committee) in requesting them to do so and agreeing to contribute to the cost in accordance with the established policy

Vinelott J thought that, in coming to this conclusion, the Commissioners had directed their minds to the wrong question. What mattered was the firm’s purpose - that is to say the purpose of the partners in the firm. When those partners incurred expenditure to move an employee from one office to another they did so wholly and exclusively for the purpose of the business. However, when the expenditure was incurred to move the owner (or joint owner) of the business then there was inevitable duality of purpose and the expenditure was not deductible.

Vinelot J said the fact that the business was conducted by a substantial number of persons in partnership had no bearing on the deductibility of the cost of moving the partners. Vinelot J concluded that the expenditure was not allowable.

The Court of Appeal found unanimously against the Revenue. The House of Lords found unanimously for the Revenue. Lord Oliver concluded that the expenditure was not allowable because the purpose of the partnership could not to be determined on the basis that it had a separate legal identity such that the purpose of the individual partner could be ignored. The Court of Appeal had misled itself in four particulars:

1. they had been wrongly influenced by the size of the partnership involved, thinking a large partnership somehow different from a small partnership. Partners are partners however numerous they may be
2. the mechanics of the payment involving a decision by an executive committee to reimburse expenses already met out of the individual partner’s own pocket. The mechanics of reimbursement did not change the fundamental nature of the expenditure. What mattered was the purpose of that expenditure
3. the unwillingness of one of the partners involved to agree to the move if not reimbursed. The expenditure served the same purpose whether the partner concerned wanted to move, was merely willing to move or moved with evident reluctance
4. drawing confusing analogies with employees in a similar situation. Employees and partners are quite different. An employee has no interest in the property or profits of the firm. Anything paid to an employee by way of additional remuneration for acting as an employee and to secure their continued loyalty to the firm cannot easily fail to be deductible as an expenditure exclusively for the purpose of the firm’s business. Amounts paid to partners represent part of the profits divisible between all of the partners unless shown to be wholly and exclusively for the purpose of the partnership business

You should note Lord Oliver’s stress on purpose.

The part of Lord Oliver’s judgment on which the above guidance is based is set out at pages 755-757:

My Lords, for my part, I am unable to accept that the purpose of “the partnership”, considered as if it had a separate legal identity, and the purpose of the individual partners for whose benefit the payment enured can be segregated in this way. I cannot, with respect to the Court of Appeal, resist the conclusion that they allowed themselves to be confused and led astray by a number of extraneous factors which do not, as a matter of analysis, have any legal significance. In the first place, they appear to have been influenced by the sheer size of the partnership in the instant case and to have considered that a large partnership falls in some way to be treated differently from a small partnership, so that an element of personal benefit may fall to be taken into account in the case of a small firm but ignored in the case of a large firm (see Slade LJ, at p 1131C-E). It is true that Slade LJ rests this distinction on the ground of the greater ease with which an inference of a confusion of private and collective motive may be drawn in the case of the smaller firm - presumably on the footing that in a large firm a great many of the partners will not, in practice, know anything about the payment and therefore cannot be said to be affected by the purpose of the recipient. But there can surely be no difference in principle. Partners are partners, however numerous; and mere numbers cannot in itself justify an attribution of a “collective purpose” unjustified in the case of a small partnership.

Secondly, I cannot help feeling that some confusion has been caused simply by the mechanics by which the payments concerned in the instant case were effected. They were resolved on by the executive committee and paid out of partnership funds on the orders of the executive committee by way of reimbursement of an expenditure which the two partners had incurred out of their own pockets. Factually this makes it easier to regard the reimbursement and the expenditure reimbursed as quite separate transactions and to have regard only to the motives of the executive committee in sanctioning the reimbursement - a reflection indeed of Mr Park’s submissions to your Lordships. The purpose of the payment, he submits, was not to pay for the partners’ removal expenses. It was to nullify the disadvantage which the partners suffered as a result of having paid those expenses themselves, and the only motive for nullifying that disadvantage was to secure their concurrence in moving in the interests of the partnership. Attractively as this submission was put, I find myself quite unable to accept this way of looking at the transactions. Indeed, on this analysis the reimbursement, at the instance of the other partners, of the costs of a chauffeur-driven car to transport the senior partner to and from work in order to increase his efficiency as a working member of the firm or of the cost of a holiday in Switzerland to convalesce after an illness would qualify as deductible expenditure so long as it could be established that the “collective purpose” of the sanctioning partners was to further the partnership business. There is no warrant in statute or authority for this concept of collective purpose and I do not, for my part, find it acceptable as a matter of analysis. It can make not the slightest difference whether a partner incurs an expenditure out of his own pocket and recovers it from the partnership funds or whether he draws the money required directly from the partnership funds in the first instance - for example, where he is enabled to draw cheques on the partnership bank account and his partners, either expressly or by implication, agree that he need not bring the money drawn into account in ascertaining his share of the profits. There is in either case only one relevant expenditure and it is the purpose of that outlay which has to be regarded.

A third factor which, I think, has led to some confusion at any rate in the minds of the Special Commissioners, is the initial unwillingness of Mr Wilson and Mr Cooper to move. I do not, for my part, see how this can possibly be a relevant consideration in ascertaining whether the costs of moving were exclusively for the purposes of the partnership profession. The expenditure serves the same purpose whether the partner concerned wants to move, is merely willing to move or moves with evident reluctance.

Finally, I think that a good deal of the confusion was caused in the Court of Appeal, as indeed it was before your Lordships, by an appeal to the position of employee as providing a useful analogy. Superficially, the analogy is attractive, as indeed is the suggestion that ‘the reality’ of the situation renders absurd any distinction between, for instance, a senior employee and a junior partner. But, with respect, the distinction is not only legal but real. An employee has no interest in the property or profits of the firm and anything paid to him by way of additional remuneration for acting as an employee and to secure his continued loyalty to the firm cannot easily fail to be deductible as an expenditure exclusively for the purpose of the firm’s business. There are, of course, limits to this - for instance, the firm cannot pay the employee’s PAYE tax for him and claim to deduct it as an expense (see Bamford v ATA. Advertising Ltd [1972] 1 WLR 1261). But, in general, money laid out in order to secure the continued loyal service of the workforce is referable solely to the business or profession in which that workforce is employed and is accordingly deductible. The purpose to which the employee chooses to devote what he receives does not enter into the picture and one is not concerned to inquire into the connection between that purpose and the business in which the employee is employed. A partner, on the other hand, whether he be senior or junior is in a quite different position. What he receives out of the partnership funds falls to be brought into account in ascertaining his share of the profits of the firm except in so far he can demonstrate that it represents a payment to him in reimbursement of sums expended by him on partnership purposes in the carrying on of the partnership business or practice - the example was given in the course of argument of the partner travelling to and staying in Edinburgh on the business of the firm - or a payment entirely collateral made to him otherwise than in his capacity as a partner [as in Heastie v Veitch & Co [1933] 18 TC 305, see BIM38110]. It may be that in relation to a particular receipt by a partner of partnership moneys not falling under either of the above heads, his co- partners are agreeable to his retaining it without bringing it into account so that to that extent the divisible profits at the end of the year are notionally reduced by the amount retained; but this cannot alter the fact that what is retained is part of the profits which would otherwise be divisible. What is taxable is the actual not the notional profit and what has to be demonstrated if a deduction is to be allowed for tax purposes in respect of moneys paid to a partner is that it was paid exclusively for the purposes of the partnership business.

For details of the employee's benefit in kind position in relation to removal expenditure paid or reimbursed by the employer, see EIM03100.

The Arthur Young McClelland Moores & Co decision does not preclude a deduction to the partnership for payments to a partner where the sole purpose is a trade or professional purpose and the payment is in return for full commercial consideration. For example, a partnership that paid a commercial rent to one of the partners for the use of a property that they owned, would not face disallowance (see BIM38110). As ever, the issue turns on the particular facts.