Partnership planning found to be 'too good to be true'

01 September 2022

In the recent case of The Magnet Partnership vs Commissioners for HMRC, it was highlighted that “if something sounds too good to be true, it probably is”. So it proved to be for the partners in this case who had declared zero taxable profits on the partnership’s tax return for over a decade, regardless of the business’s level of turnover.

Broadly, the owners of a trading company worked with their accountant to establish a number of different partnerships that involved family members of the main shareholders, namely The Magnet Partnership and other family partnerships.

For those unfamiliar with partnerships, they are defined in law as “the relation which subsists between persons carrying on a business in common with a view to profit”. In plain terms, a general partnership involves persons, either individuals or corporates, working together in a business to make profits.

Unlike companies which pay corporation tax on their profits, a partnership is typically treated as transparent for tax purposes. It is the partners themselves who are taxed directly on the profits of the business. If there are a lot of individual partners in a partnership, the level of tax paid may be minimised as each partner may be able to benefit from an income tax personal allowance and the basic rate tax band (currently 20%) on their share of the business profits. Partnerships can also provide flexibility in how much of the business’s profits are allocated to each partner.

The Magnet Partnership was said to have owned the intellectual property rights in patents and these were licensed to the trading company, producing the sole source of income for The Magnet Partnership. The other family partnerships that were created in turn received all of their income from The Magnet Partnership and disclosed that this income was in return for services described as consultancy and design work.

The net result was that the trading income was declared as split amongst various family members, utilising their various tax allowances and tax bands. HMRC disputed the validity of this arrangement and contended that the expenses of these family partnerships also included non-tax-deductible expenditure, such as rent for university accommodation for family members.

Whilst the primary focus of the case was on whether HMRC was capable of using its powers of discovery, the decision outlined that the family partnerships involved had to be trading and there was a lack of evidence that they did. If the family partnerships had undertaken a legitimate business activity, then the manner of apportioning profits between family members may potentially have been accepted by HMRC.

In HMRC’s guidance on the subject, it is noted that “a spouse or civil partner is sometimes taken into partnership wholly or mainly to maximise the benefit of the tax reliefs that are available” and an HMRC Inspector “cannot challenge the apportionment of profits, as you can a wage, by reference to the value of the partners’ contribution to the firm’s activity”. So, whilst the case of The Magnet Partnership demonstrates the idiom of something being too good to be true, it also highlights that in the right circumstances, a partnership might provide an appropriate structure to provide flexibility on how profits are shared tax-effectively in a family business.