Mark McLaughlin looks at a recent case on whether individual business partners can declare profit shares on their tax returns that differ from the amounts shown on the partnership tax return if they consider the partnership tax return figures to be incorrect.
The UK tax system seems to struggle in some respects when it comes to partnerships.
Which amount to declare?
For example, disagreements can arise between the partners over profit allocations. If there is a disagreement over partnership profit shares, what amount should be included in an individual partner’s tax return – the profit (or loss) allocated by the partnership, or the figure that the partner considers to be correct?
Partnerships are generally required to make tax returns, which must state each partner’s share of profit or loss (TMA 1970, s 12AB(1)(b)). An individual business partner is also generally required to make tax returns, and ‘to deliver with the return such…information…as may reasonably be so required’ (s 8(1)(b)). Furthermore, the partner’s return must include his or her share of any income, etc., for the period in which the partnership statement is made (s 8(1B)).
In King and Ors v Revenue and Customs  UKFTT 409 (TC), the appellant taxpayers were members of a limited liability partnership (LLP). The LLP accounts for the period ended 30 April 2011 showed a loss. However, as a result of an ‘add-back’ by the designated members in the tax computation, the partnership tax return for 2011/12 included a profit for the LLP. The taxpayers did not consider that there was any legal basis for the add-back. They filed their personal tax returns to reflect what they considered should be their share of the LLP’s profit for tax purposes, and provided an explanation in the ‘white space’ in their respective tax returns.
HM Revenue and Customs (HMRC) enquired into the taxpayers’ (and the LLP’s) returns for 2011/12, and subsequently amended the taxpayers’ returns on the basis that their profit shares were understated. The First-tier Tribunal had to consider whether the LLP members were entitled to declare different profit share figures on their individual tax returns than those declared on the partnership tax return, if the partners believed the figure declared on the partnership return to be incorrect. The tribunal held on the evidence that there was no basis for the accounts adjustment by the LLP. Therefore, the ‘correct’ figure from which to establish the right amount of tax was as recorded in each taxpayer’s return.
Doing the ‘right’ thing
The tribunal in King and Ors referred to another case (Morgan and Self v HMRC  SFTD 160), which involved payments to taxpayers who were asked to withdraw as partners in a large firm of chartered accountants. The tribunal noted the above statutory obligation for a partner to include in his tax return whatever amount is shown in the partnership statement as his partnership share.
However, the tribunal commented (obiter dicta) that the legislation (in TMA 1970, ss 8, 9) required that the partner’s return is both complete and correct to the best of his or her knowledge; this meant that the information sent with the return should include any information required to supplement the partnership statement, if the partnership statement was thought to be too high or too low (i.e. to state what the individual thought was the right amount).
HMRC guidance (at EM7025) indicates that partners can go beyond the tribunal’s stated approach in Morgan and Self, albeit in ‘exceptional’ cases where disagreements cannot be resolved between the partners. If the individual does the following, HMRC would not ‘automatically’ regard the personal tax return as incorrect:
- enter as their share of partnership profits the amount they consider to be correct; and
- advise HMRC accordingly by making an entry in the ‘white space’ on the return to show: (a) the profits as allocated in the partnership statement; (b) a deduction (or addition) of the disputed amount; and (c) an explanation why they think the profit allocated to them in the partnership statement is wrong.
HMRC’s consultation document ‘Making Tax Digital: Bringing business tax into the digital age’ published on 15 August 2016 included a proposal to abolish the requirement on partners to report their individual profit share in an annual tax return. Where this would leave partners who disagree about their profit shares remains to be seen.
This article was first printed in Business Tax Insider in November 2016.