PARTNERSHIP TAXATION

1
PARTNERSHIP TAXATION
Theory and practice of taxation BModule code
C33TB2 Lectures 4,5,6
1
2
PARTNERSHIP TAXATION

• DefinitionA partnership exists where two or
  more persons join together for business purposes
  forming an association which is not a separate
  legal entity.

2
3
PARTNERSHIP TAXATION

• PrinciplesComputation of adjusted profits, basis
  periods, capital allowances and losses of a
  partnership are the same as for a sole trader
• The tax assessment for partnership profits is
  made on the individual partners and not the
  partnership
• Consequently the new problem to consider with
  partnership taxation is each partners
  individual tax position with regard to
  partnership profits

3
4
PARTNERSHIP TAXATION

• Procedure1 Calculate the adjusted trading profit
  , capital allowances etc of the partnership in
  the normal way
• 2 Allocate the adjusted profit to the partners
  according to the profit sharing agreement in
  force during the period of account
• 3 Partners are then assessed to tax individually
  on their share of the profits as if each was a
  sole trader

4
5
PARTNERSHIP TAXATION

• Allocation of profits
• Alpha, Beta and Gamma are in partnership sharing
  profits equally. Gamma is entitled to a salary of
  3,000. The adjusted profit for the year ended
  31/12/06 is 24,000
• Allocation of profit for the period to 31/12/06
  is
• 
  Alpha Beta GammaSalary
  
  3,000 Share of profits (24,000-3,000) 21,000
  7,000 7,000 7,000
• Total
  7,000 7,000 10,000

5
6
PARTNERSHIP TAXATION

• Allocation of profits (cont)Notes1 Partners
  entitlements (salaries, interest etc) are
  accounted for first. The balance is then shared
  in the profit sharing ratio
• 2 If this is not a commencement or cessation
  period the partners will be assessed on their
  profits in 2006-07
• 3 If the profit sharing ratio changes on 1/1/07
  it will not affect the allocation of these
  profits becausePartnership profits are
  allocated in accordance with the rules of the
  partnership agreement applicable in the period of
  account and not the year of assessment

6
7
PARTNERSHIP TAXATION

• Assessment to taxExample GammaIf a continuing
  business
• 2006-07 (CYB) year ending 31/12/06 10,000
• If business commenced 1/1/062005-06 3/12 x
  10,000 2,5002006-07
  10,000
• The normal rules which apply to a sole trader

7
8
PARTNERSHIP TAXATION

• Change in profit sharing ratio
• If the change takes place part way through an
  accounting period it will be necessary to
  apportion the profit on a time basis
• ExampleX,Y,Z have been sharing profits equally
  change to ratios of 321 on 31/3/06. Profits for
  the year ended 31/12/06 are 24,000

8
9
PARTNERSHIP TAXATION

• Example Change in profit sharing ratio (cont)
• Allocation of profitsyr/end 31/12/06
  X
  Y Z1/1/06 to 31/3/06 3/12 x
  24,000 6,000 111 2,000 2,000
  2,0001/4/06 to 31/12/069/12 x 24,000 18,000
  321 9,000 6,000 3,000 Total
  24,000 11,000 8,000
  5,000

9
10
PARTNERSHIP TAXATION

• Change in partnership composition where a new
  partner joins or an existing partner leaves
• Partners who are there before and after the
  change will be taxed on a current year basis
  throughout. (As if no change had taken place)
• New partner has commenced to trade and the
  commencement rules will apply (For partner
  leaving, the cessation rules apply)

10
11
PARTNERSHIP TAXATION

• Example Change in partnership composition
• New partner
• A partnership commenced trading on 1st June 2004
  with the following taxable profits. There are
  three partners (X,YZ). The partnership agreement
  states that partnership profits are shared
  equally (i.e. 1/3 each). On 1/6/06 W is admitted
  to the partnership, the profit ratio becoming 1/4
  each. 1/6/04 to 31/5/05 12,000 1/6/05 to
  31/5/05 15,000 1/6/06 to
  31/5/07 24,000Compute the taxable profits
  for 2004-05, 2005-06, 2006-07 and 2007-08 in
  respect of each individual partners share of the
  taxable profits

11
12
PARTNERSHIP TAXATION

• Example Change in partnership composition (cont)
• Share of profits
  Total X Y Z
  WYear to 31/5/05 12,000 4,000 4,000
  4,000 Year to 31/5/06 15,000
  5,000 5,000 5,000 Year to
  31/5/07 24,000 6,000 6,000 6,000
  6,000

12
13
PARTNERSHIP TAXATION

• Example Change in partnership composition
  (cont)
• Year of X Y Z W
• Assessment
• 2004-05 10/12 x 4,000
  3,333 3,333 3,333
• 2005-06 12m to 31/5/05
  4,000 4,000 4,000
• 2006-07 12m to 31/5/06
  5,000 5,000 5,000
• 1/6/06 to 5/4/07
  10/12 x 6,000
  5,000
• 2007-08 6,000 6,000 6,000 6,000
• (i) When W is admitted to the partnership there
  is an automatic continuation for X, Y, and Z
• (ii) W is deemed to have started in business on
  1/6/06 (actual basis for 2006-07)

13
14
PARTNERSHIP TAXATION

• Example Change in partnership composition
• Partner retiresA,B and C have been in
  partnership for many years making their accounts
  up to 31 December each year. A retires on 31
  October 2006.
• The partnership agreement provided
• Salary Profit
  Share
• A 2,400
  2/5
• B 3,600
  2/5
• C 1,800
  1/5
• Profits for recent years were
• Year to 31 December 2005
  39,000
• 2006 15,000
• 2007 20,000
• After As retiral, B and C retained their same
  salaries but shared profits equally.
• Show the division of profits for the relevant
  years of assessment

14
15
PARTNERSHIP TAXATION

• Example Change in partnership compositionPartner
  retires Share of profits
  Total A B C
• y/e 31/12/05 Salary 7,800 2,400
  3,600 1,800
• Profit 31,200 12,480 12,480
  6,240
• 39,000 14,880 16,080 8,040
• y/e 31/12/06
• 1/1 to 31/10 Salary 6,500 2,000
  3,000 1,500
• Profit 6,000 2,400
  2,400 1,200
• 12,500 4,400 5,500 2,700
• 1/11 to 31/12 Salary 900 600
  300
• Profit 1,600 800 800
• 2,500 1,400 1,100
• Total y/e 31/12/06 15,000 4,400
  6,900 3,800
• y/e 31/12/07 Salary 5,400
  3,600 1,800
• Profit 14,600
  7,300 7,300
• 20,000
  10,900 9,100

15
16
PARTNERSHIP TAXATION

• Example Change in partnership compositionPartner
  retiresThe relevant years of assessment are
  2005-06, 2006-07 and 2007-08.
• Year of A
  B C
• Assessment
• 2005-06 y/e 31/12/05 14,880
  16,080 8,0402006-07 y/e 31/12/06
  6,900 3,800
  1/1/06 to 31/10/06
  4,4002007-08 y/e 31/12/07
  10,900 9,100There
  will be overlap profits to deduct from As final
  assessment

16
17
PARTNERSHIP TAXATION

• Notional profits or losses
• If partners salaries or interest cause a partner
  to go into loss even though, overall, the
  partnership has made a profit, then
• i) the partner with the loss is set to nil
  andii) his loss is allocated to the other
  partners in proportion to their original profit
  allocations

17
18
PARTNERSHIP TAXATION

• Notional profits or lossesExampleD,E,F are in
  partnership sharing profits 321Salary
  entitlements D 10,000, E 12,000Show how the
  profit for the y/e 31/12/06 of 16,000 is
  allocated
• Allocation Total D
  E F Salary
  22,000 10,000 12,000
  Loss (6,000) (3,000)
  (2,000) (1,000)
  16,000 7,000 10,000
  (1,000)
• Fs notional losss 7,00010,000
  (412) (588) 1,000Profit
  allocation 16,000 6,588 9,412
  nil

18
19
PARTNERSHIP TAXATION

• Non-trading incomeWhere a partnership has
  non-trading income
• Untaxed income (Property Income, interest
  received gross). This is treated the same as
  trading income i) allocate to partners in profit
  sharing ratio ii) assessment uses same basis
  periods as trading income
• Taxed income ( eg bank interest, dividends)i)
  allocate to partners in profit sharing ratioii)
  apportion between tax years and assess on actual
  basis

19
20
PARTNERSHIP TAXATION

• Non-trading taxed income ExampleA,B,C share
  profits equally and begin trading on 1/1/06First
  period of account to 31/12/06Net bank interest
  y/e 31/12/06 1,600
  y/e 31/12/07 2,400Compute bank interest
  assessable on each partner in 2005-06 and
  2006-07Solution Gross interest y/e 31/12/06
  2,000/3 667 y/e
  31/12/07 3,000/3 1,000Assessment 2005-06 3/12
  x 667 167 2006-07 9/12 x
  667 3/12 x 1,000 750
  

20