Partnership taxation: proposals to clarify tax treatment

The Government has released draft legislation for the reform of partnership taxation to be brought into effect from April 2018.

In March 2017, HMRC released a Summary of Reponses to its 2016 consultation on a number of further reforms to the partnership taxation rules, the latest in a long running set of changes to the taxation of partners and LLP members that have caused substantial uncertainty for taxpayers. The Government has now released draft legislation to be included in the Finance Bill that will be released following the Budget on 22 November 2017 to implement these changes. The draft legislation very much follows the revised HMRC approach as set out in the Summary of Responses.

Key features of the changes which will affect many businesses operating through partnerships and LLPs include steps to ensure profits for tax purposes follow the profits as commercially determined and requiring greater transparency and disclosure obligations where a chain of partnerships exists.


The 2016 Consultation Document put forward proposals with the stated aim of removing uncertainty and ensuring the partnership rules are fit for modern commercial practices. The consultation also sought to put beyond doubt the treatment of some aspects of the partnership rules which, in the Government’s eyes, some taxpayers had unfairly sought to take advantage of. However, the revised approach suggested by the Government would have cut across longstanding practice in some cases.

In response to significant adverse feedback, the Government in the Summary of Responses accepted significant changes to its proposals. In particular, the Government amended its original proposals as regards bare trusts and nominee arrangement and also moved away from its original proposal to look through chains of partnerships when identifying the relevant partner subject to taxation.

The consultation also looked at the position of investment partnerships and although the Government accepted that investment partnerships may have differing requirements, it was not persuaded to create a separate administrative regime for such partnerships.

Proposed revisions

Allocation and calculation of partnership profit for tax purposes

As regards partnership profit sharing arrangements, the Government accepted in its Summary of Responses that it was reasonable for partnerships to have the flexibility to allocate profits between partners on a commercial basis and that the tax position should respect such allocation. Accordingly, new legislation will provide that the allocation of profit for tax purposes between partners must be made in line with the “partner’s percentage” of the trading profits or losses calculated for tax purposes. The “partner’s percentage” will reflect either the fixed percentage or fixed proportionate entitlement of a partner, where this is specified in the partnership profit-sharing arrangements, failing which it will reflect the partner’s share of the firm’s total profit or loss, ie effectively the same as the allocation of commercial profit between the partners. For these purposes, a partner’s share of profits must be determined in accordance with the firm’s profit sharing arrangements in place during the relevant period (and so retrospective (ie post period end) variations to a partnership’s profit sharing arrangements will not be taken into account for tax purposes).

The effect of this can be illustrated as follows. At the moment, the allocation of partnership profits for tax purposes does not strictly have to follow the allocation for accounting purposes. As a result, if a partnership has accounting profits of 100, but taxable profits of 110 (due to e.g. disallowance of certain expenses for tax purposes or the making of transfer pricing adjustments), the partnership can allocate 10 of accounting profits and 10 of taxable profits to an individual member, and allocate the remaining taxable profits (reflecting all of the disallowables) to a corporate member (which has a lower tax rate, and hence a lower absolute cost). When the draft legislation takes effect (which is stated to be for accounting periods beginning after the date of Royal Assent to the Bill), this will no longer be possible. Instead, the individual will be allocated ten of accounting profits but will be treated as receiving 11 of taxable profits, ie their effective tax rate will go up.

It remains somewhat unclear as to how this will operate where partnerships have discretionary profit sharing arrangements with the discretion being exercised (for example by a management or remuneration committee) following the end of the period in question.

Given that the amendments made operate in the context of computing the profits or losses of the trade allocable to individual and corporate partners, and operate by reference to the share of the firm’s total profit or loss, being the total of profits and losses of all trades carried on by the firm before making tax adjustments, it would seem that where a partnership carries on a trade but also holds investments outside that trade, the new provisions should not, it seems, affect the manner in which amounts derived from investments are allocated for tax purposes.

In addition, legislation will make it clear that the allocation of partnership profits shown on the partnership return is the allocation that applies for tax purposes for the partners and will introduce a new process to allow disputes over the correctness of the allocation of profit (or loss) for tax purposes to be referred to the tribunal to be resolved. Disputes concerning the partnership’s total profits or losses, as opposed to allocations to partners, will remain a matter for an appeal by the nominated partner in respect of the partnership tax return, however. As a result, the profit allocation stated in the partnership tax return will be the first point of reference in determining a partner’s taxable profits, whilst protecting partners from being taxed on incorrect profit shares, in particular where they are not, as a matter of fact, entitled to those profits as partner. There will also be no requirement for partnerships to notify HMRC of changes to profit sharing arrangements, which is positive.

Partners in nominee or bare trust arrangements

New provisions proposed will clarify that where a beneficiary of a bare trust is entitled absolutely to any income of that bare trust consisting of profits of a partnership, but are not themselves a partner in the partnership, then they are subject to the same rules for calculating profits and reporting as actual partners.

Partnerships with partnerships as partners

The Government originally proposed that HMRC should to look through chains of partnerships when identifying the relevant partner subject to taxation. A number of concerns were expressed around the administrative burdens this would cause, together with concerns over whether higher-tier partnerships would be prepared to provide information to lower tier partnerships concerning the allocation of profits made at a higher level or whether, indeed, it would be possible to do so where the higher tier allocation fell to be made on a discretionary basis and had not yet been decided.

In response to this feedback, the Government will now instead legislate to require a partnership which has a partner that is itself a partnership to report to HMRC the details of that partner and to provide both to HMRC and the partner concerned computations of the partnership’s taxable profits on all four potential bases that could apply (ie UK-resident and non-UK resident individual, and UK resident and non-UK resident company). If HMRC has received details of all the ultimate recipients of the profits of the second partnership, computations need only be prepared on the basis appropriate to those persons. This will still involve compliance over and above that currently required, but is likely to be more acceptable to taxpayers.

However, in the case of investment partnerships, the Government accepts that where partnerships that are reporting financial institutions under the OECD Common Reporting Standard have provided details of partners under CRS, it should not be necessary for the partnership also to provide full details of partners on the partnership tax return where only investment profits are received. Accordingly, in relation to partnerships that do not carry on a trade or profession or a UK property business, only the identity of and profit allocation to partners reported under CRS will be required to be provided in the partnership tax return. Such partnerships will not be required to return the tax reference for a partner if that partner is not chargeable to income tax or corporation tax in the UK and the partnership reports details of the partner to HMRC under the CRS. This is a helpful simplification, which deals to some extent with the perennial problem of sourcing Unique Taxpayer Reference numbers for non-resident partners in investment partnerships, although it is disappointing that the same does not apply equally to partnerships investing in real estate.

Partnerships that are partners in another partnership

If a partnership (the reporting partnership) is a partner in one or more partnerships that carry on a trade, profession or business then the legislation will make clear that the profits or losses from each partnership must be shown separately, and separately from any other income or losses, on the reporting partnership’s return.

Indirect partners

In addition, a new provision will provide that an indirect partner in a partnership is considered to carry on a notional trade or business in respect of their interest in that partnership for tax purposes. An “indirect partner” means a person who is a partner in a partnership which is itself a partner in the underlying partnership, either directly or indirectly via any number of intermediate partnerships.


It is proposed that the new rules for the allocation of partnership profits and losses will have effect for accounting periods and periods of account starting on or after Royal Assent to the Finance Bill containing these provisions (most likely prior to April 2018). The provisions dealing with overseas partners in investment partnerships will apply from the same date. Other changes will have effect from the tax year 2018/19.

The proposals in relation to allocations of profits and losses will cause significant issues for a number of partnerships that currently align the accounting and tax allocations of profits of individual partners. It is possible to restructure partnership arrangements to mitigate the impact of the proposals, but absent such restructuring the effect on such partnerships, and the partners therein, will be significant. This will apply both on a current year basis, but also as between generations of partners, for example where expenses are incurred for accounting purposes in an earlier period, but the relief for those expenses only arises in a later period of account.

As regards the remainder of the proposals, overall, the final proposals are likely to be a great deal more palatable to affected taxpayers than those originally contained in the 2016 consultation, although additional administrative burdens remain a feature of the rules.

See our response to the original consultation here.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.