What happens when partnership profits are not paid?

Generally, a partnership return should include the taxable profits of the partnership along with details of how this is allocated to the various members of the partnership.

The issue

In the vast majority of cases it will be appropriate for the individual partners to transpose the profit figures which have been allocated to them in the partnership return to their individual returns. But what happens when the partners have not actually been paid those profits?

The general answer from HMRC will be “Tough!” and they will take a position that the personal return should match the partnership return.

However, there can be exceptions...

Example

Miles is a member of an LLP and has dutifully been recording his profit shares from the partnership return for many years and paying tax thereon. He left the partnership on 31 March 2022 and there were £150,000 of profits that he had not been paid.

In other words, the profits that had been allocated to him (and on which he had been taxed or would be taxed) were £150,000 more than what he had received.

After a few months passed, Miles began to think that he would never see those profits and the partnership was being evasive in its communications. He began to look for ways to relieve his tax liability on the profits that he would never receive.

HMRC Guidance

In their guidance (EM7025), HMRC state:

A partner’s personal return must include the amount that the partnership statement says is their share of the partnership profit or loss in accordance with section 8 (1B) TMA 1970.

However, there are occasions where individual partners may not agree with the profits allocated to them in the partnership statement. In the first-tier tribunal cases Morgan v HMRC and Self v HMRC TC00046, there was a genuine dispute about profits allocation. The Judge commented that the individual partner should make a return that was correct and complete to the best of their knowledge and belief, which would mean the return could include supplemental information if the individual believed the profits or losses allocated to them in the partnership statement were too low or too high.

This potentially presents Miles with a solution, although he would have some work to do. He would need to get clear information from the partnership about why his outstanding balance is not being paid. Assuming that Miles has his numbers right, they would need to provide some basis for not paying him and it is difficult to see how they can do this without contradicting the profit shares shown in the partnership return.

It is feasible that Miles could use such communications to include different figures in his personal tax return to those allocated to him in the partnership return. He would need to be prepared to provide a detailed white space disclosure here to explain any discrepancy. This could involve explaining that, although £X was allocated to him in the partnership return, this should be reduced to £Y because that is the figure that the partnership has allocated him in reality (by withholding the rest).

Hamilton Rose's view

Although the scenario highlighted above should be quite rare, I can see that it could feasibly arise in dispute scenarios where one partner leaves.

Hopefully, in these cases, the partnership can be encouraged to either pay up any outstanding balances or at least agree an amendment to the partnership tax return. They may be more keen to assist here if not doing so leads to someone like Miles returning a figure which is different from the partnership return, potentially leading into an enquiry into the allocation of profits in the partnership return.

If Miles is correct in the above example, then HMRC may think that the other partners were under-assessing their profits…

Of course, Miles may still want to take legal action to pursue his outstanding profits but that is a separate issue.