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Partnership losses - tackling avoidance?
by David Whiscombe
The HMRC Brief 18/07 is titled “Tackling Avoidance” but it is now plain that the proposals are wide-ranging and will affect transactions where no tax avoidance is involved. Of particular concern are the rules limiting to £25,000 per year the offset of losses from trading partnerships in which the taxpayer is a “non-active partner”.
Who is affected by these changes?
Anyone who is a non-active member of one or more trading partnerships and who incurs a trading loss
Does it apply only to trades or are professions and vocations also included?
The rules will apply only to trades.
Does it apply to conventional partnership? LLPs? Limited Partnerships?
Yes: it applies to all of these?
What is a “non-active member”?
Someone who spends an average of less than ten hours a week personally engaged in carrying out the partnership’s trading activities.
What is the loss restriction?
If you are a non-active member you cannot claim relief on more than £25,000 per year of trading losses
Is this £25,000 per partnership?
No, it’s £25,000 per year regardless of how many partnerships you are in.
What happens to any excess loss over £25,000?
It is carried forward an can be allowed against future trading income from the trade in which the loss arose
Does this apply for all years or is it restricted to the first four years of trading?
Unlike existing restrictions the restriction applies for any year.
When does this start?
Broadly, for losses incurred after 1 March 2007
Examples
Example 1
Mrs A starts a small business from home. She has no other income and she expects that the business will be loss-making for the first year or two. Her husband Mr A is a higher-rate taxpayer with a full-time job and he is happy to fund the start-up losses. They form a partnership where losses are shared 90% Mr A 10% Mrs A. First-year losses are £50,000 and Mr A subscribes capital of that amount. Under current law he will get tax relief on £45,000. Under the new rules relief is restricted to £25,000.
Example 2
Mr X is an entrepreneur with substantial assets. He is prepared to act as a passive investor in a business proposal brought to him by Mr Y and Mr Z. They form an LLP on terms that Mr X will fund start-up losses to a maximum of £100,000 and profits will be shared 20/40/40 once start-up losses have been recouped. In year 1 the LLP loses £100,000 and Mr X injects capital of that amount. Under current law he will get tax relief on £100,000. Under the new rules relief is restricted to £25,000
Note:
Even under the existing law, relief for losses is restricted to the amount of capital contributed. For this purpose, guarantees of loans do not count as capital contributed. So in example 1, it’s not enough that losses are debited to Mr A’s capital account: he actually needs to introduce capital. Similarly, Mr X would need to introduce capital to the LLP (not merely lend it to the LLP as a loan) in order to get the £100,000 relief under current law or the £25,000 under the new law.
Disclaimer
This note is prepared for general guidance only. It is not an exhaustive statement of the law and Berg Kaprow Lewis LLP do not accept liability for reliance placed upon it.
