The mechanics of the taxation of partnership profits are in principle simple. Deceptively so.
The partnership (or, more precisely, a designated member on behalf of the partnership) makes a partnership tax return. That return states both the amount of the partnership’s taxable profit and how it is allocated between the partners. Each partner takes the figure allocated to him on the partnership return, inserts it into his tax return and pays tax accordingly. What could possibly go wrong?
Well, what happens when a partner considers that the figure of taxable profit allocated to him in the partnership is incorrect? Is he required to hold his nose and include it in his return without comment? How can that be consistent with his signing the declaration on his return that it is to the best of his knowledge correct and complete?
The question was previously considered in Morgan and Self v HMRC [2009] UKFTT 78 (TC). Because the case was decided on other grounds, the judge’s comments on the point were obiter dicta but nonetheless persuasive, and they have informed HMRC’s published guidance:
“where there is a genuine disagreement that cannot be resolved between the partners, individual partners should
- enter, as their share of partnership profits, the amount they consider to be correct and
- advise us that they have done so by making an entry in the white space notes section of the return to show
- the profits as allocated in the partnership statement,
- a deduction (or addition) of the disputed amount, and
- an explanation about why they think the profit allocated to them in the partnership statement is wrong.”
It may at first blush seem a little odd to find HMRC apparently arguing the point again in the recent case of King and others v HMRC [2016] UKFTT 409 (TC). But things are not quite that simple: partnership tax seldom is.
Where an enquiry into a personal return is completed, HMRC amend the return by issuing a ‘closure notice’ against which a taxpayer is entitled to appeal. Where an enquiry is made into a partnership return and on closure of that enquiry the partnership return is amended, any necessary consequential amendment is made to the tax return of any individual partners affected. It is now well-established that an individual partner has no right to appeal against such a consequential amendment.
In Morgan and Self, there had been no enquiry into the partnership return: both the partnership and HMRC believed the return to be correct. The question was simply whether the individual partner was bound to make his or her return on the same basis and the answer was no.
In King, as in Morgan and Self, some of the partners in a partnership disagreed with the basis on which the designated member had filed the partnership return and they filed their own personal returns on a different basis. In King, however, HMRC had enquired both into the partnership return and also into the individual returns. So when the enquiries were closed, were the amendments to the partner’s individual return being made by reason of a ‘closure notice’ relating to the enquiry into the personal return (which was appealable) or by a ‘consequential amendment’ notice consequent upon closure of the enquiry into the partnership enquiry (which was not appealable)? The waters are muddied somewhat by the fact that on closing the partnership enquiry HMRC did not actually make any amendments to the partnership return, so it is difficult to see how any amendments made to the individual partners’ returns could have been ‘consequential amendments’. Nonetheless HMRC argued that “the amendments to the appellants’ 2011-12 tax returns, because they implement an adjustment to a partnership return, are essentially [non-appealable] ‘consequential amendments’”. The judge did not agree: the amendments were made pursuant to the closure of enquiries into the personal returns, there was a right to appeal against them and furthermore the appeals would be upheld.
