A recent Tax Tribunal case has shown the importance of factual circumstances and evidence to the application of the legislation concerning the incorporation of partnerships.
Where the right set of circumstances does not exist, the favourable tax legislation will not apply and can result in hefty Capital Gains Tax (“CGT”) and, when property is involved, Stamp Duty Land Tax (“SDLT”) charges for the taxpayer.
The case concerned a husband and wife who purported to be operating a business of property development through a partnership. The facts of the case are discussed in more detail below, but shows that the crucial elements of a partnership needs to be proven to be present above and beyond simply holding assets jointly.
Recent case on the existence of a partnership
The existence of a partnership was recently discussed in a case before the Tax Tribunal (SC Properties vs. HMRC, 2022 UKFTT 214 (TC)). The appellants were a married couple who had developed a property with a view to selling it as a profit. The property was subsequently transferred to a company owned by the couple, and HMRC issued CGT and SDLT assessments.
HMRC claimed, based on the facts of the case, that there was no evidence to suggest such a partnership existed. On this basis, the favourable SDLT rules could not apply, and there was also no possibility that a business was being run for the purposes of incorporation relief. The appellants argued that an implied partnership was operating and being carried on as a business with a view to profit. One of the key arguments was that a partnership not formally documented between spouses would not be unusual because of the existing relationship of mutual trust. They also pointed to the fact that partnership accounts and tax returns had been filed for several years and the activities of the partnership, being the development of a property with the view to a sale, was a business being operated with a view to profit.
The Tribunal ruled in HMRC’s favour on the following grounds:
- There was little evidence of the wife being involved in the management of the property development, and as such it was not sufficiently demonstrated by the appellant that the two individuals were acting ‘in common’, as required for a partnership to exist.
- In addressing the point concerning the ‘mutual trust’ of a spousal partnership, the Tribunal stated that as a partnership in law must be for a business purpose, this suggests it has hallmarks above those of a typical spousal relationship and that should be reflected in the formality of the partnership arrangements, particularly concerning the significant property development activity which was undertaken.
The Tribunal judgement continued to lay out other evidence which made it difficult to establish that a partnership genuinely existed, including:
- Documents were signed in the name of the husband and wife, rather than partners of the partnership.
- Partnership tax returns and partnership accounts were ‘self-serving’ documents which cannot be treated as independent evidence that the partnership existed. These filings should reflect the existence of a genuine partnership rather than be able to create it.
- The appellant could not provide consistent evidence as to when the partnership commenced.
- The partnership was not registered for VAT, did not issue invoices, did not enter into contracts and did not have its own bank account.
We would note that this is not an exhaustive list of factors which might be considered in determining whether a partnership exists. HMRC are likely to consider the situation ‘in the round’ having regard to all of the facts and circumstances.
Conclusions
It should be noted firstly that HMRC refute the presumption that joint property owners are in partnership, so the existence of a partnership always needs to be explicitly evidenced in this regard. The Tribunal’s ruling shows that it is insufficient to simply illustrate some of the hallmarks one might expect to see in connection with a partnership, such as the filing of partnership accounts and tax returns. The rules concerning the transfer of a property partnership business to a company are designed only to benefit genuine partnerships and genuine businesses. This must be rigorously demonstrated, and HMRC are likely to attack any arrangements which they view as bogus or sham arrangements which have only been entered into to try and take advantage of the rules.
The existence of a partnership is likely to need to be demonstrated over a number of years and would need to be formalised as far as possible with paperwork, for example a formal partnership agreement, but would also need to be reflected in the ongoing operation of the partnership, including the entering into contracts by the partnership, the existence of a partnership bank account, the payment of National Insurance Contributions in relation to partnership profits, registration for VAT in the partnership’s name if applicable, and generally in the day-to-day activities undertaken by each of the partners to show that they are acting in common with a view to profit as owners of any business would.
Finally, the case also proves that the tax position on the incorporation of partnerships is very much an item on HMRC’s agenda, and it is likely that they will continue to challenge these arrangements, particularly when significant CGT and SDLT liabilities could be at stake. HMRC have extensive powers of information and access to Companies House and Land Registry records and should be able to flag property incorporations with relative ease. Incorporations should only be undertaken when there is a robust and defensible filing position (though even then there might be no guarantee of success in the event of a HMRC challenge), and all transactions should be disclosed in detail on the partners’ self-assessment tax returns.
