Lee Sharpe looks at whether a joint property letting activity amounts to a partnership, and why it is relevant to landlords.
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Property partnerships seem popular these days – typically, as a stepping-stone to greater things. Regular readers will know that I have long criticised HMRC’s published position on whether a property partnership exists, as distinct from simply co-owned property. My argument is that HMRC has drawn up its guidance to set an unreasonably high threshold to ‘make the grade’ as a partnership.
Even so, I have counselled that would-be partners should be careful about what they wish for:
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There may be capital gains tax (CGT) and stamp duty land tax (SDLT) implications for creating or joining a property-letting partnership.
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There may even be SDLT consequences for changing the property income-sharing ratio.
Further, landlords hoping to benefit in future from having partnership status should consider not only the current position and possible future benefits, but also take care about when the partnership was created and what has happened since then.
Why partnerships matter for rental income
There are two key reasons why ‘qualifying’ as a partnership can be helpful in terms of flexibility:
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Partners may change their income profit share as and when they like without significant concern in relation to the ‘Settlements’ anti-avoidance legislation (ITTOIA 2005, s 619 et seq.). HMRC’s Trusts Settlements and Estates Manual (at TSEM4215) states that where an ‘incoming partner receives a share of profits out of all proportion to the contribution made to the partnership, the arrangement would include an element of bounty’; however, more general commercial arrangements between partners are largely immune.
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Where the parties are each other’s spouses or civil partners, joint rental income must be split either 50:50 or, by joint election, in accordance with the respective spouse’s underlying beneficial ownership of the property. This can be cumbersome, but these requirements are ignored when the relationship amounts to a partnership (ITA 2007, s 836(3), Exception C).
Also, when it comes to the default application of the cash basis for landlords, the income threshold test (for now, £150,000 per annum) is applied at the business level; for mere joint owners, the test is against the owner. But where the rental business is a partnership, the test is at the partnership level.
Investment or business - Or both?
Holding property for letting is, by default, considered to be an investment activity, where one might hold a portfolio and enjoy a passive income stream of rents broadly equivalent to dividends or interest (in contrast, acquiring property in order to improve it and sell it for profit is a trading purpose.)
If I inherit a property and decide to let it out, I might need to do no work other than engage an agent to maintain it, and (tenant willing) an income stream arises without any ongoing effort on my part. This differs from earned income, which requires me to sustain effort to generate returns.
However, for income tax purposes, property letting is taxed as if it amounts to a business, with much of the income tax code in terms of administration and allowable expenditure applying similarly to letting as it does for ‘real’ earnings. For me, there are two key issues here:
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HMRC thinks it is doing landlords a favour by treating rental businesses almost on a par with full-fledged trading activities (more accurately, the legislation allows a wider range of expenditure for property letting than for other investments; for example, you would not get tax relief against dividend income for interest on loans to buy a FTSE share portfolio or for its ongoing management fees).
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My typical landlord clients tend to be much more ‘hands-on’ and actively manage their portfolio. So, notably more perspiration than your average ‘passive’ investor whose ongoing efforts might cynically be accused of being limited to reviewing monthly rental statements.
What makes a partnership?
In terms of the general partnership being considered here, the Taxes Acts do not prescribe what amounts to a ‘partnership’, but the Partnership Act 1890 essentially states a partnership involves:
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two or more parties;
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carrying on a business together; and
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in order to make a profit.
So, assuming one can count, and does not set out actually to lose money, then the real test is (2).
As an aside, having recently been asked about the difference between a partnership and a joint venture, the clues are that a joint venture will typically involve two or more pre-existing and functionally or administratively independent businesses that undertake a project together while still doing other ‘stuff’ independently of one another. As always, there will be real-life scenarios that fall in between.
Partnership Act 1890 also states that just owning property jointly does not of itself make the joint owners partners; nor does sharing gross income of itself make a partnership. This makes sense; otherwise, simply holding (say) a joint deposit account might create a partnership. But this does not prevent them from contributing, with other indicia, to an overall finding that a partnership exists.
HMRC ‘advice’
HMRC broadly agrees with all this in its Property Income Manual at PIM1030. But where HMRC really starts to colour outside the lines is its further assertion that to qualify as a partnership, the joint landlords likely have to provide ‘significant additional services in return for payment’.
HMRC wants you to think that you must be providing things like laundry or concierge services on top of the rent charge. This (in my opinion) is ‘cobblers’, and is in fact lifted from a case where the taxpayer lost but was trying to prove that their rental business actually amounted to a trade – broadly on an equal footing with an hotel.
But what about…?
There are two recent cases that might appear to undermine my argument that partnership status is easier than HMRC states:
In SCP Ltd & Cooke v HMRC [2022] UKFTT 00214 (TC), a taxpayer argued he was in partnership with his wife, so ‘their’ property transfer to a connected company for onward development could enjoy elections that (broadly) relied on partnership status so as to postpone gains until they were realised in the company’s onward sale. So, securing that the property was in a partnership was an important interim step that meant gains, etc., were recognised later, and in the company’s subsequent sale.
The taxpayers failed because the judge found that the property was not held in partnership. Based on the case notes, it is difficult to see that the spouses actually applied themselves personally to the property in the period that it was supposedly a partnership asset. Yes, there was work, but that was through the connected company SCP Ltd. So, hard to pass (2) above. Nor was there much contemporaneous evidence of an intention to carry on in partnership.
That tax case, in turn, referred to a non-tax case of Burnett v Barker [2021] EWHC 3332 (Ch); remember, the existence of a general partnership is not determined by tax law but more generally. In this case, the claimant had provided ‘back-office’ support to the defendant for several years, and some initial funding, then on their break-up, tried to argue that they were in partnership. The parties had already been running their own separate businesses for some time and, at least initially, the claimant had invoiced the defendant for time spent working in the business – so they did not share even in gross income at that stage. The relationship at the beginning perhaps had more in common with a joint venture than a partnership. The tax tribunal judge in Cooke had liked Burnett for the following:
“Fundamentally, partnership is a contractual relationship, or a relationship resulting from a contract, whether express or implied, which has been described as a continuing personal as well as commercial relationship. Like any other contract, the terms must be sufficiently certain…”
Even so, the judge in Burnett noted the claimant’s growing commitment to the administration of the business in later years, and lamented that the only question put to him in this respect was to decide whether they were actually in partnership from the outset rather than several years later. In the context of parties actively running a property letting portfolio together, we would not expect to see cross-charging for time spent in the business and, crucially, there would be just one letting business.
Conclusion
While the two recent legal cases might seem to undermine my long-held conviction that HMRC sets its threshold too high for the often useful status of partnership for landlords, the question will almost always be a matter of fact and degree. However, that in turn means a careful consideration of each particular case – and, as before, with the caveat that the consequences of being in a partnership may not be felt only when trying to secure favourable treatment at some point in the development of the business, but potentially long beforehand as well.
