Can it really be right that the taxability (or not) of a receipt can be determined by the partnership, with the recipient partner having no right to object? Writing for Tax Journal, BKL tax consultant David Whiscombe discusses a tribunal decision that considered for the first time the scope of TMA 1970 s 12ABZB.
Summary
In Anderson (a case in which the writer of the article acted), the First-tier Tribunal considered for the first time the scope of TMA 1970 s 12ABZB. The case focused particularly on the extent to which s12ABZB(4) prevents a referral of a dispute as being ‘in substance’ about the quantum of partnership profit. The FTT was persuaded that the fact that the outcome of the dispute potentially affected the quantum of the partnership profit inevitably meant that that was what the dispute was ‘in substance’ about, and no s12ABZB referral could be made. The inescapable conclusion from Anderson is that if a partnership allocates as profit share anything that would otherwise be tax-deductible, that allocation may not be challenged by the allocatee under s12ABZB. Can it really be right, as the FTT decided, that the taxability (or not) of the receipt can be determined by the partnership, with the recipient having no right to object?
TMA 1970 s 12AB(1)(b) requires that a partnership return rendered under s 12AA must include a statement (a ‘partnership statement’) showing how the partnership’s income (as well as any loss, tax, or consideration for capital gains disposals) is allocated between the partners.
If a partner considers (or even knows for sure) that the amount allocated in a partnership return is incorrect, what is he or she (or it – corporates can be partners too) to do? On the one hand, s 8(1B) requires that an individual’s self-assessment tax return must include the amount which, in any relevant partnership statement, is stated to be the individual’s share of income, loss etc; on the other hand, s 8(2) requires that the return must include a declaration that it is correct to the best of the taxpayer’s knowledge and belief. Similar provisions apply to self-assessment returns of corporate partners.
In the conjoined cases of Morgan v HMRC and Self v HMRC [2009] UKFTT 78 (TC), the taxpayers had received payments on their (involuntary) departure from the partnership of which they had been members. The partnership considered the payments to have been profit share and showed them as such on the partnership tax return: the taxpayers disagreed with that characterisation.
The partnership was not a party to the case, which involved only HMRC and the taxpayers. HMRC considered that the payments were correctly shown as profit share: but also argued that ‘because the firm had made a partnership return under the 1970 Act, which included a partnership statement showing the amounts of the further payments as being income accruing to each partner, it followed that each partner was obliged to include the same amount as income in his or her personal return and that was the amount upon which each partner was chargeable to tax.’
The FTT held that the payments were indeed profit share. That was sufficient to dispose of the appeals. However, the FTT considered, albeit as obiter dictum, that ‘the further payments would only be chargeable to income tax in the hands of the Appellants if they were so chargeable following a correct application of the charging provisions and not on the sole ground that the further payments had been returned by the firm in the partnership statement’.
In King and others v HMRC [2016] UKFTT 409 (TC), the matter in dispute was subtly different. The dispute in this case was not as to the character of amounts received from the partnership, but rather the correctness of the computation of profit submitted as part of the partnership return: the appellant partners considered that nearly £1.5m had been incorrectly ‘added back’ in the computation.
In King, HMRC argued that Morgan ‘was wrongly decided and in any event should not be followed as it was concerned with the nature of particular payments and not the computation of partnership profits or allocation between the partners’. The case is also remarkable for HMRC’s having, in effect, argued that their own published guidance on the matter at the time (which was in accordance with the Morgan decision) was wrong and should not have been followed.
The FTT agreed with the appellant partners: partners were obliged to include on their personal tax returns the figures they believed to be correct, even if those differed from those on the partnership statement.
Statute law
In response to these decisions, FA 2018 inserted new s 12ABZB into TMA 1970, which applies in relation to returns for 2018/19 and subsequent years. As a result, the conflict which previously existed between s 8(1B) and s 8(2) and to which Morgan and King offered a solution no longer exists.
The basic rule is now that a partnership return is conclusive for tax purposes not only as to the amount of a person’s share in the partnership profits or losses, but even as to whether a person has a share at all. In other words, s 8(1B) trumps s 8(2).
This is a startling proposition. It means that if some partnership I have never heard of declares on its partnership statement that I am a partner and that my share of profits is a million pounds, the starting point is that that is the amount on which I must pay tax!
Happily, although that is the starting point, it is not necessarily the finishing point. If I consider that the amount allocated to me in a partnership statement is incorrect (or that I do not have a share of taxable profit at all, perhaps because I dispute that I am a partner), I may refer the dispute to the FTT for determination under s 12ABZB(3). The FTT determines what amendments if any are to be made to the partnership return and HMRC make any necessary consequential amendments to partners’ returns. But it’s important to appreciate that if, for whatever reason, no referral is made, the allocation on the partnership statement stands good unless it is amended either by the partnership during the ‘amendment window’ or as a result of a closure notice following an HMRC enquiry.
Plainly, I am able to refer a dispute only if I am aware of it. This may present, if only in theory, a conundrum in that tax law imposes no express obligation on a partnership to notify a partner of the share of profit, loss and other amounts allocated in the partnership statement. Although HMRC’s partnership tax return guidance notes enjoin a partnership to ‘make sure that you give individual partners the information they need to fill in their personal tax returns as quickly as possible’ this is not backed by any express legal requirement nor by any sanction for failing to do so promptly – or at all. This provokes some pause for thought. How can it be reasonable for me to be subject to tax in respect of amounts the quantum or indeed the existence of which may be entirely unknown to me?
Section 12ABZB sets out procedural requirements.
Where a dispute is referred to the FTT, the person making the referral must at the same time notify both the partner who filed the partnership return (the ‘reporting partner’) and HMRC. The reporting partner must in turn give notice to every other partner in the partnership and to any other person appearing to the reporting partner to be a party to the dispute (though it is not easy to envisage what other parties to the dispute might exist). Where a partnership return has been the subject of one referral it may not be the subject of a second one: so, this requirement to notify all partners ensures that if, in relation to a single partnership return, there are multiple disparate disputes involving multiple partners they are all heard together. The exception is where the return is amended by the partnership during the ‘amendment window’ permitted by s12ABA: there is then a fresh opportunity to make a (single) referral of any dispute(s) arising from the amendment.
If, after a dispute has been referred, the reporting partner notifies HMRC (sic – not the FTT) of the terms on which a settlement of the dispute has been agreed in writing by all the partners, the dispute is treated as having been determined by the FTT in accordance with those terms.
The right to refer a dispute to the FTT is made subject (by s 12ABZB(4)) to a very important limitation: a dispute may not be referred ‘to the extent that it is in substance about the amount (before sharing) of the partnership’s profits or losses for the period’.
One can see why this should be so: the logic appears to be that any disagreement as to the amount of the partnership profit must remain a matter for resolution between the partnership and HMRC at the partnership level without requiring the involvement of the individual partners. There should not be any opportunity for a second bite of the cherry by allowing the same matter to be re-litigated by the ‘back door’ by one or more of the partners separately by way of a referral under s12ABZB.
Thus, one may have thought that the legislation was attempting to draw a distinction between the kind of dispute that arose in King – which was about the quantum of the partnership profit and would not have been within the scope of a s12ABZB referral – and that which arose in Morgan – which was not, essentially, about the quantum of partnership profit and would prima facie have been a candidate for a referral. Anderson v PricewaterhouseCoopers (HMRC, third party) [2022] UKFTT 457 (TC) however, suggests that the limitation may be interpreted much more widely.
The Anderson case
The principal battle-ground in Anderson was what the dispute was ‘in substance about’. However, there was first another skirmish which had to be fought and won if the case was to proceed.
Any referral must be made within the 12 month period beginning with the day after (a) the day on which the partnership return was ‘delivered’ or (b) (if the dispute relates to an amendment to the return) the day on which the amendment was made. There is no provision in the primary legislation for the time limit to be extended, either by HMRC or the tribunal.
This was, at first blush, problematic for Mr Anderson. The partnership return was filed on 26 October 2020; Mr Anderson referred the dispute on 10 December 2021.
Two arguments were adduced on Mr Anderson’s behalf.
The first was that a power to extend the time limit (even where no power existed in primary legislation) was to be found in the combined effect of rule 5 and rule 21 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules, SI 2009/273. The position had been considered in VK v HMRC [2016] UKUT 331 (AAC) where the Upper Tribunal had noted, albeit as obiter dictum, that although the wording of rule 5(3)(a) ‘ostensibly prevents an extension of time if that would conflict with an enactment setting a time limit’ it was nonetheless the case that ‘the specific provision for extending time in rule 21 must have been intended to operate as an exception to the rule 5(3)(a) restriction’. The FTT, while recognising the view expressed by the Upper Tribunal in VK, declined to follow it as ‘not supported by any reasoning, obiter and therefore not binding’. It considered that it simply did not have the power to accept a late referral.
The second – rather bolder – argument was that Mr Anderson’s referral was not in fact late at all. The legislation does not require the partnership to notify a partner of the date on which the partnership return is submitted to HMRC; nor (as noted above) is any time limit imposed within which the partnership is required to notify a partner of the allocation of profits between partners. Thus, if the time limit for referring a dispute runs from the date of submission of the return to HMRC, it is in principle possible that the time limit may have expired before the partner is aware that it has started running – and even before the partner is aware that there is a dispute at all since in principle the partner may not by that time even have been told what share of profit has been allocated. From that, it was argued for Mr Anderson that the reference in s12ABZB to ‘the day on which the partnership return was delivered’ could and should be read as referring not to submission of the return to HMRC but to the provision of relevant details to the partner – which was in his case 5 January 2021, making his referral of the dispute on 10 December 2021 a timeous one.
The FTT were equally unconvinced by the second argument: ‘delivered’ must mean ‘delivered to HMRC’.
Rejection of the time limit points meant that the decision on the main event – whether the dispute was capable of valid referral – was academic. But it is in this part of the FTT decision that the main interest for tax advisers lies.
What was the dispute ‘in substance’ about?
Mr Anderson had been a partner in PwC. In May 2018 he was served notice of his compulsory retirement, which took place on 30 November 2018. Mr Anderson claimed that in requiring him to retire, PwC had unlawfully discriminated against him by reason of a pre-existing medical condition which had been aggravated by their actions. His claim was settled by PwC’s making a payment to Mr Anderson comprising two distinct elements:
1. a payment described as ‘the balance of profit share’ for the period 1 July 2018 to 30 November 2018; and
2. a payment described as ‘an additional payment of an amount equal to 12 months’ profit share’ (the ‘additional payment’).
Both elements were included as profit share allocated to Mr Anderson in PwC’s partnership return. Mr Anderson said that that was wrong: it was only the first element that was a share of partnership profit. The ‘additional payment’ was not as a matter of fact a share of profit paid to him as partner: it was paid to him as claimant by way of settlement of his claim for damages – which are not, of course, taxable. The manner in which it had been computed was irrelevant to its character.
It’s important to appreciate that at this preliminary hearing the FTT was not adjudicating on whether the ‘additional payment’ was a (taxable) share of profit or (tax-free) damages. Rather, it was deciding only what the dispute was ‘in substance’ about. If it was ‘in substance’ about the amount of PwC’s profit for the relevant period, the referral would be rejected. It was only if it was ‘in substance’ about something else that there would be a substantive hearing.
PwC (supported in the appeal by HMRC) asserted that if the additional payment was not a share of profit, it would be deductible in computing taxable profit. That meant that the dispute affected the quantum of PwC’s taxable profit. Any dispute which affected the amount of profit was simply and inevitably ‘in substance’ about the amount of that profit. So no referral was competent.
Mr Anderson said that that was simplistic and wrong. Section 12ABZB(4) required the FTT to ask itself what the dispute was really about. Was the nub of the dispute that he and PwC disagreed as to the quantum of the partnership profit or was it really about the character of the payment he had received? He pointed out that he had never even seen a computation of PwC’s tax-adjusted profit: how then could it be said that that was what he was arguing about? He submitted that, even if the outcome of the dispute were to have an impact on the taxable profit (and even that was not certain), that did not mean that that was the ‘substance’ of the dispute. On the contrary, the dispute was ‘in substance’ about whether what he had received was a share of profit to which he was entitled as partner or was something else altogether.
Nonetheless, the FTT were persuaded that the fact that the outcome of the dispute potentially affected the quantum of the partnership profit inevitably meant that that was what the dispute was ‘in substance’ about, and no s12ABZB referral could be made.
Implications: what disputes may be referred?
The inescapable conclusion from Anderson is that if a partnership allocates as profit share anything that would otherwise be tax-deductible, that allocation may not be challenged by the allocatee under s 12ABZB. That has surprising implications. Consider the following.
A partnership of individuals occupies property owned by one of the individuals and makes a payment to the owner in respect of that occupation. HMRC’s guidance in its Business Income Manual (at BIM38110) confirms that rent at a commercial rate is deductible as a partnership expense. However, it follows from Anderson that if, instead, a partnership computation adds back the rent and treats it as a share of profit the owner has no right to refer the dispute to the FTT. Of course, it is always open to HMRC to correct the treatment by enquiry into the partnership and personal returns: but the owner has no such power.
The characterisation of a receipt as a share of profit may have considerable financial consequences to the recipient. For the hypothetical partner-cum-landlord above it creates a modest NIC cost. But in damages or compensation cases, there may be many thousands of pounds of tax at stake, as there were for Mr Anderson. Can it really be right, as the FTT decided, that the taxability (or not) of the receipt in such cases can be determined by the partnership, with the recipient having no right to object?
Even more fundamentally, the decision implies that a partnership may determine whether an individual is to be treated for tax purposes as a partner or as an employee, with no scope for the individual to refer the dispute under s 12ABZB.
Suppose a partnership return shows an individual as a partner and allocates a share of profit, but the individual argues that he or she was not a partner but an employee. Any attempted referral will face the objection that if the amount in question is treated as employment income it will be deductible in computing profit; therefore the dispute is ‘in substance’ about the partnership’s profit and debarred from referral.
Alternatively, suppose that a partnership return treats a payment as a payment of remuneration and the individual asserts that he or she was not an employee but a partner. Again, if the amount in question falls to be treated as a share of profit it will be added back and will increase the partnership’s profit; so here, too, the dispute is ‘in substance’ about the partnership’s profit and debarred from referral.
Such limitations are a long way from simply denying the right to refer a King-type dispute and can scarcely have been the intention of Parliament in enacting s 12ABZB(4). But, with the time limit point spelling the end of the line for Mr Anderson, it will be for others to take up the baton.
The article was published in Tax Journal issue 1610 and is available to subscribers on the Tax Journal website.
