CG27170 - Partnerships: Statement of practice D12: full text

CG27170 - Statement of practice D12: full text

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D12: Partnerships

  1. Valuation of a partner’s share in a partnership asset
  2. Disposals of assets by a partnership
  3. Partnership assets divided in kind among the partners
  4. Changes in partnership sharing ratios
  5. Contribution of an asset to a partnership
  6. Adjustment through the accounts
  7. Payments outside the accounts
  8. Transfers between persons not at arm’s length
  9. Annuities provided by partnerships
  10. Mergers
  11. Shares acquired in stages
  12. Elections under TCGA92/Sch2/Para4
  13. Partnership goodwill
  14. Entrepreneurs’ relief, “roll-over” relief and business asset gift relief on transfer of a business

D12: Partnerships

This statement of practice was originally issued by The Commissioners for HMRC (previously Inland Revenue) on 17 January 1975 following discussions with the Law Society and the Allied Accountancy Bodies on the Capital Gains Tax treatment of partnerships. This statement sets out a number of points of general practice which have been agreed in respect of partnerships to which TCGA92/S59 applies.

The Limited Liability Partnership Act 2000 created, from April 2001, the concept of limited liability partnerships (as bodies corporate) in UK law. In conjunction with this, new Capital Gains Tax provisions dealing with such partnerships were introduced through TCGA92/S59A. TCGA92/S59A(1) mirrors TCGA92/S59 in treating any dealings in chargeable assets by a limited liability partnership as dealings by the individual members, as partners, for Capital Gains Tax purposes. Each member of a limited liability partnership to which TCGA92/S59A(1) applies has therefore to be regarded, like a partner in any other (non-corporate) partnership, as owning a fractional share of each of the partnership assets and not an interest in the partnership itself.

This statement of practice was therefore extended to limited liability partnerships which meet the requirements of TCGA92/S59A(1), so that capital gains of a partnership fall to be charged on its members as partners. Accordingly, in the text of the statement of practice, all references to a ‘partnership’ or ‘firm’ include reference to limited liability partnerships to which TCGA92/S59A(1) applies, and all references to ‘partner’ include reference to a member of a limited liability partnership to which TCGA92/S59A(1) applies.

For the avoidance of doubt, this statement of practice does not apply to the members of a limited liability partnership which ceases to be ‘fiscally transparent’ by reason of its not being, or its no longer being, within TCGA92/S59A(1).

In 2013 the Government asked the Office of Tax Simplification (OTS) to carry out a review of ways to simplify the taxation of partnerships.  The OTS published its final report in January 2015.  The OTS concluded that as Statement of Practice D12 provides a reasonable result in most circumstances, it should be left essentially as it is, but that some text should be rewritten to replace out of date language and to replace some content which was obsolete.  The recommendations made by the OTS have been implemented in this revision of the statement of practice.

1.Valuation of a partner’s share in a partnership asset

  1. Where it is necessary to ascertain the market value of a partner's share in a partnership asset for Capital Gains Tax purposes, it will be taken as a fraction of the value of the total partnership interest in the asset without any discount for the size of his share. If, for example, a partnership owned all the issued shares in a company, the value of the interest in that holding of a partner with a one-tenth share would be one-tenth of the value of the partnership's 100 per cent holding.
  2. Guidance and an example concerning section 1 are available in HMRC’s Capital Gains Manual at CG27250.

2.Disposals of assets by a partnership

  1. Where an asset is disposed of by a partnership to an outside party, each of the partners will be treated as disposing of his fractional share of the asset. In computing gains or losses the proceeds of disposal will be allocated between the partners in the ratio of their share in asset surpluses at the time of disposal. Where this is not specifically laid down, the allocation will follow the actual destination of the surplus as shown in the partnership accounts; regard will of course be paid to any agreement outside the accounts.
  2. If the surplus is not allocated among the partners but, for example, put to a common reserve, regard will be had to the ordinary profit sharing ratio, which is likely to be indicative in the absence of a specified asset surplus sharing ratio.
  3. Expenditure on the acquisition of assets by a partnership will be allocated between the partners according to the same principles at the time of the acquisition. This allocation may require adjustment if there is a subsequent change in the partnership sharing ratios (see section 4).
  4. Guidance and an example concerning section 2 are available in HMRC’s Capital Gains Manual at CG27350.

3.Partnership assets divided in kind among the partners

  1. Where a partnership distributes an asset in kind to one or more of the partners, for example on dissolution, a partner who receives the asset will not be regarded as disposing of his fractional share in it. A computation will first be necessary of the gains which would be chargeable on the individual partners if the asset had been disposed of at its current market value.
  2. Where this results in a gain being attributed to a partner not receiving the asset, the gain will be charged at the time of the distribution of the asset. Where the gain is allocated to a partner receiving the asset concerned there will be no charge on distribution. Instead, the gain is effectively deferred by reducing his Capital Gains Tax cost by the amount of his gain: the cost to be carried forward will be the market value of the asset at the date of distribution less the amount of gain attributed to him. The same principles will be applied where the computation results in a loss.
  3. Guidance and an example concerning section 3 are available in HMRC’s Capital Gains Manual at CG27400.

4.Changes in partnership sharing ratios

  1. An occasion of charge also arises when there is a change in partnership sharing ratios, including changes arising from a partner joining or leaving the partnership. In these circumstances a partner who reduces or gives up his share in asset surpluses will be treated as disposing of part or the whole of his share in each of the partnership assets and a partner who increases his share will be treated as making a similar acquisition. Subject to the qualifications mentioned in section 7 and 8 below, the disposal consideration will be a fraction (equal to the fractional share changing hands) of the current balance sheet value of each chargeable asset, provided there is no direct payment of consideration outside the partnership.
  2. In certain circumstances the calculation of the disposal consideration by reference to the current balance sheet value of the asset will produce neither a gain nor a loss.  This will occur where the disposal consideration is equal to the allowable acquisition costs and is likely to arise where the partner’s capital gains costs are based on an amount equal to the balance sheet value of the asset.  However, this outcome is unlikely to arise on a change in sharing ratios where, for example, an asset has been revalued in the partnership accounts, or where a partner transferred an asset to the partnership for an amount that is not equivalent to the capital gains base cost, or where the partner’s capital gains base cost were determined in accordance with TCGA92/S171, rather than on the cost of the asset to the partnership.
  3. A partner whose share in a partnership asset reduces will carry forward a smaller proportion of cost to set against a subsequent disposal of his share in the asset; a partner whose share increases will carry forward a larger proportion of cost.
  4. The general rules in TCGA92/S42 for apportioning the total acquisition cost on a part-disposal of an asset will not be applied in the case of a partner reducing his asset-surplus share. Instead, the cost of the part disposed of will be calculated on a fractional basis.
  5. Guidance and an example concerning section 4 are available in HMRC’s Capital Gains Manual at CG27500 and CG27540.

5. Contribution of an asset to a partnership

5.1 When this statement of practice was published in 1975, it did not address the situation where a partner contributes an asset to a partnership by means of a capital contribution.  HMRC clarified its approach to this in Revenue & Customs Brief 03/08.  The OTS asked HMRC to include this clarification in the statement of practice.

5.2 Where an asset is transferred by a partner to a partnership by means of a capital contribution, the partner has made a part-disposal of the asset equal to the fractional share that passes to the other partners.  The market value rule applies if the transfer is between connected persons or is other than by a bargain at arm’s length.  Otherwise the consideration for the part-disposal will be a proportion of the total amount given by the partnership for the asset.  That proportion equals the fractional share of the asset passing to the other partners.

5.3 A sum credited to the partner’s capital account represents consideration for the disposal of the asset to the partnership.  Although this is similar to a change in partnership sharing ratios, it is not possible to calculate the disposal consideration on a capital contribution by reference to section 4, as the asset does not have a balance sheet value in the partnership accounts.  In these circumstances HMRC accepts the apportionment of allowable costs on a fractional basis as provided for in section 4, rather than by reference to the statutory A/A+B formula.

5.4 A gain arises on a contribution of an asset where the disposal consideration, calculated according to the fractional proportion of the total consideration or, in appropriate cases, a proportion of the market value of the asset, exceeds the allowable costs, based on a fraction of the partner’s capital gains base cost.

5.5 Guidance and examples concerning section 5 are available in HMRC’s Capital Gains Manual at CG27900 onwards.

6. Adjustment through the accounts

6.1 Where a partnership asset is revalued a partner will be credited in his current or capital account with a sum equal to his fractional share of the increase in value. An upward revaluation of chargeable assets is not itself an occasion of charge.

6.2 If, however, there were to be a subsequent reduction in the partner's asset-surplus share, the effect would be to reduce his potential liability to Capital Gains Tax on the eventual disposal of the assets, without an equivalent reduction of the credit he has received in the accounts. Consequently at the time of the reduction in sharing ratio he will be regarded as disposing of the fractional share of the partnership asset, represented by the difference between his old and his new share, for a consideration equal to that fraction of the increased value at the revaluation. The partner whose share correspondingly increases will have his acquisition cost to be carried forward for the asset increased by the same amount. The same principles will be applied in the case of a downward revaluation.

6.3 Guidance and an example concerning section 6 are available in HMRC’s Capital Gains Manual at CG27500 and CG27540.

7. Payments outside the accounts

7.1 Where on a change of partnership sharing ratios payments are made directly between two or more partners outside the framework of the partnership accounts, the payments represent consideration for the disposal of the whole or part of a partner's share in partnership assets, in addition to any consideration calculated on the basis described in section 4 and 6 above. Often such payments will be for goodwill not included in the balance sheet.

7.2 The partner receiving the payment will have no Capital Gains Tax cost to set against it, unless he made a similar payment for his share in the asset (for example, on entering the partnership).

7.3 The partner making the payment will only be allowed to deduct the amount in computing gains or losses on a subsequent disposal of his share in the asset. He will be able to claim a loss when he finally leaves the partnership, or when his share is reduced, provided that he receives either no consideration or a lesser consideration for his share of the asset.

7.4 Where the payment clearly constitutes payment for a share in assets included in the partnership accounts, the partner receiving it will be able to deduct the amount of the partnership acquisition cost represented by the fraction of which he disposes. Special treatment, outlined in section 8 below, may be necessary for transfers between persons not at arm's length.

7.5 Guidance and an example concerning section 7 are available in HMRC’s Capital Gains Manual at CG27500 and CG27560.

8. Transfers between persons not at arm’s length

8.1 Where no payment is made either through or outside the accounts in connection with a change in partnership sharing ratio, a Capital Gains Tax charge will only arise if the transaction is otherwise than by way of a bargain made at arm's length and falls therefore within TCGA92/S17, extended by TCGA92/S18 for transactions between connected persons.

8.2 Under TCGA92/S286(4) transfers of partnership assets between partners are not regarded as transactions between connected persons if they are genuine commercial arrangements. This treatment also applies to transactions between an incoming partner and the existing partners.

8.3 Where the partners (including incoming partners) are connected other than by partnership (for example, father and son), or are otherwise not at arm's length (for example, aunt and nephew) the transfer of a share in the partnership assets may be treated as made at market value. Market value will not be substituted, however, if nothing would have been paid had the parties been at arm's length.

8.4 Similarly if consideration of less than market value passes between partners connected other than by partnership, or otherwise not at arm's length, the transfer will only be regarded as made for full market value if the consideration actually paid was less than that which would have been paid by parties at arm's length. Where a transfer has to be treated as if it had taken place for market value, the deemed disposal may be treated in the same way as payments outside the accounts.

8.5 Guidance and an example concerning section 8 are available in HMRC’s Capital Gains Manual at CG27800 and CG27840.

9. Annuities provided by partnerships

9.1 A lump sum which is paid to a partner on leaving the partnership, or on a reduction of his share in the partnership, represents consideration for the disposal by the partner of the whole or part of his share in the partnership assets and will be subject to the rules in section 7 above. The same treatment will apply when a partnership buys a purchased life annuity for a partner, the measure of the consideration being the actual costs of the annuity.

9.2 Where a partnership makes annual payments to a retired partner (whether under covenant or not) the capitalised value of the annuity will only be treated as consideration for the disposal of his share in the partnership assets under TCGA92/S37(3), if it is more than can be regarded as a reasonable recognition of the past contribution of work and effort by the partner to the partnership.

9.3 Provided that the former partner had been in the partnership for at least ten years, an annuity will be regarded as reasonable for this purpose if it is no more than two-thirds of his average share of the profits in the best three of the last seven years in which he was required to devote substantially the whole of this time to acting as a partner. In arriving at a partner's share of the profits, the partnership profits assessed before deduction of any capital allowances or charges will be taken into account. The ten year period will include any period during which the partner was a member of another firm whose business has been merged with that of the present firm. For lesser periods the following fractions will be used instead of two-thirds:

Complete years in partnership

Fraction

1 – 5

1/60 for each year

6

8/60

7

16/60

8

24/60

9

32/60

9.4 Where the capitalised value of an annuity is treated as consideration received by the retired partner, it will also be regarded as allowable expenditure by the remaining partners on the acquisition of their fractional shares in partnership assets from him.

9.5 Guidance concerning section 9 is available in HMRC’s Capital Gains Manual at CG28400.

10. Mergers

10.1 Where the members of two or more existing partnerships come together to form a new one, the Capital Gains Tax treatment will follow the same principles as those for changes in partnership sharing ratios. If gains arise for reasons similar to those covered in section 6 and 7 above, it may be possible for roll-over relief under TCGA92/S152 to be claimed by any partner continuing in the partnership, insofar as he disposes of part of his share in the assets of the old firm and acquires a share in other assets put into the ‘merged’ firm. Where in such cases the consideration given for the shares in chargeable assets acquired is less than the consideration for those disposed of, relief will be restricted under TCGA92/S153.

10.2 Guidance and an example concerning section 10 are available in HMRC’s Capital Gains Manual at CG27700 and CG27740.

11. Shares acquired in stages

11.1 Where a share in a partnership is acquired in stages wholly after 5 April 1965, the acquisition costs of the various chargeable assets will be calculated by pooling the expenditure relating to each asset. Where a share built up in stages was acquired wholly or partly before 6 April 1965 the rules in TCGA92/Sch2/Para18, will normally be followed to identify the acquisition cost of the share in each asset which is disposed of on the occasion of a reduction in the partnership's share; the disposal will normally be identified with shares acquired on a ‘first in, first out’ basis.

11.2 HMRC will be prepared to review any case in which this principle appears to produce an unreasonable result when applied to temporary changes in the shares in a partnership, for example those occurring when a partner's departure and a new partner's arrival are out of step by a few months.

11.3 Guidance and an example concerning section 11 are available in HMRC’s Capital Gains Manual at CG27300.

12. Elections under TCGA92/Sch2/Para4

12.1 Where the assets disposed of are quoted securities eligible for a pooling election under paragraph 4 of TCGA92/Sch2, partners will be allowed to make separate elections in respect of shares or fixed interest securities held by the partnership, as distinct from shares and securities which they hold on a personal basis.

12.2 Each partner will have a separate right of election for his proportion of the partnership securities and the time limit for the purposes of Schedule 2 will run from the earlier of –

(a) the first relevant disposal of shares or securities by the partnership, and

(b) the first reduction of the particular partner’s share in the partnership assets after 19 March 1968.

13. Partnership goodwill

13.1 This paragraph applies where the value of goodwill which a partnership generates in the conduct of its business is not recognised in its balance sheet and where, as a matter of consistent practice, no value is placed on that goodwill in dealings between the partners.

13.2     On a disposal for actual consideration of any particular partner’s interest in the goodwill of such a partnership, that interest will be treated as the same asset (or, in the case of a part disposal, a part of the same asset) as was originally acquired by that partner when first becoming entitled to a share in the goodwill of that partnership.

13.3 This treatment will also be applied to goodwill acquired for consideration by a partnership but which is not, at any time, recognised in the partnership balance sheet at a value exceeding its cost of acquisition, nor otherwise taken into account in dealings between partners.

14. Entrepreneurs’ relief, “roll-over” relief and business asset gift relief on transfer of a business 

14.1 An individual may qualify for entrepreneurs’ relief when their business becomes a partnership.  A partner may also qualify for entrepreneurs’ relief on a disposal of part or the whole of a partnership business.

14.2 A partner may qualify for entrepreneurs’ relief (subject to the normal conditions relating, for example, to a personal company) when he disposes of all or part of a fractional share in company shares which are held as partnership assets.

14.3 Guidance concerning partnerships and entrepreneurs’ relief is available in HMRC’s Capital Gains Manual at CG64040.

14.4 Roll-over relief (TCGA92/S162) is available to individuals who are partners where the whole of the partnership business is transferred to a company as a going concern in exchange for shares.

14.5 Guidance concerning partnerships and roll-over relief on transfer of a business is available in HMRC’s Capital Gains Manual at CG65700.

14.6 Roll-over relief may also be available to partners when there is a disposal of a partnership asset and the proceeds are reinvested in another asset which is also used for trade purposes (TCGA92/S152).  Guidance covering this business asset roll-over relief is available in HMRC’s Capital Gains Manual at CG61150.

14.7 Relief for gifts of business assets (TCGA92/S165) is available to individual partners in partnerships which are treated as “transparent” for tax purposes, when they dispose of a share in partnership assets, subject to the normal conditions.

14.8 Relief for gifts of business assets is also available, subject to the normal conditions, to individuals who dispose of personal assets to a partnership. For tax purposes, the transferee is treated as making disposals to each of the partners who are treated as acquiring a share in the assets.

14.9 Guidance concerning “gift hold-over relief” is available in HMRC’s Capital Gains Manual at CG66910.