Revenue Note for Guidance

426 Partnerships involving companies: effect of arrangements for transitional relief

Summary

This section aims at preventing abuses in partnerships involving companies in the matter of group relief. The section is designed to ensure that relief for losses, etc can only be allowed in respect of a company’s share in a partnership profit or loss where the share really accrues to or is borne by the partner company. Where artificial arrangements exist, for example, where one partner pays another for its right to claim tax allowances or receives compensation for meeting actual losses, relief for losses in a partnership trade is to be confined within the partnership and is not available for relief against other profits of a partner which is a company.

Details

(1) The company’s share of profits or loss is the amount net of capital allowances, etc (that is, it is the amount chargeable or allowable for corporation tax and is the equivalent of the company’s profits or loss in the several trade).

(2) The section applies to a company in a partnership carrying on a partnership trade if arrangements exist so that —

in respect of the company’s share of profit or loss of any accounting period of the partnership, another member of the partnership or a person connected with that member receives any payment or rights in money’s worth, or
in respect of the company’s share of loss of any accounting period of the partnership, the partner company or a person connected with it receives any payment or rights in money’s worth (other than a group relief payment to the partner company by another company which is a member company of the same group as the partner company).

(3) Where the section applies, the following restrictions operate to keep within the “partnership net” the partnership profits or losses of an accounting period in relation to which artificial arrangements exist. Where there are such arrangements, the partner company is not able to use its share of the partnership profits or losses to reduce or satisfy the tax properly due on profits arising outside the partnership. In addition, the company cannot use tax relief from a non-partnership source to reduce tax payable on partnership profits.

(4) Where the partnership profits arise from a source assessable under Case IV or Case V of Schedule D, the company’s share is to be treated as if it arose from the exercise of a trade and any allowance to be made were an allowance to be made in taxing the profits of a trade.

Examples

The following examples show the type of transaction that could occur if this section was not in force. In all 3 of the following examples, Mr. X who has been carrying on business as a sole trader takes a company Y Ltd into partnership. Y Ltd does not put any capital into the business. Under the terms of the partnership deed, profits and losses are to be shared equally. Y Ltd pays corporation tax at the higher rate (see section 21A).

Separate arrangements may be made which in effect vary these terms.

For example

If Y Ltd is a loss-maker and Mr. X is liable to income tax at 41 per cent it may be arranged that Y Ltd will pay to Mr. X 60 per cent of the half-share of the profits of the partnership to which it becomes entitled, or
If Y Ltd is a profit-maker, the partnership is a loss-maker and Mr. X is not a higher-rate taxpayer, it may be arranged that Mr. X will pay to Y Ltd 75 per cent of the half-share of the loss which Y Ltd takes over, or
If Y Ltd and the partnership are both profit-makers but the partnership profit is more than offset by capital allowances to which the partnership is entitled and Mr. X is not a higher-rate taxpayer, it may be arranged that Y Ltd will pay to Mr. X 99 per cent of its half-share of the profits and of the relief it gets by setting off against its other income the notional loss created by deducting the capital allowances from the partnership profit.
In each case, both Mr. X and Y Ltd will gain at the expense of the Revenue, the gain being the result of switching profits from a higher to a lower rate of tax. This is illustrated by the following 3 examples.

Example 1

Partnership profits	€20,000
Y Ltd’s half-share	€10,000

Y Ltd sets off part of its own loss (unconnected with the partnership) against this €10,000 so that it does not have to pay corporation tax on it.

Y Ltd pays to Mr. X 60 per cent of €10,000 = €6,000. Y Ltd thus ends up with €10,000 – €6,000 = €4,000 which is €1,500 more than the corporation tax value (€10,000 @ 25% = €2,500) of the €10,000 loss which it could otherwise have carried forward for set-off against future profits.

Mr. X gets from Y Ltd	€6,000
and avoids income tax at 41 per cent on €10,000	€4,200
	€10,200
less the half-share of profits given over to Y Ltd	€10,000
Mr. X thus also gains	€200

The total gain, €1,500 + €200 = €1,700, is the result of switching profits of €10,000 from Mr. X’s income tax rate of 41 per cent to Y Ltd’s corporation tax rate of 25 per cent (that is, €10,000 @ 17%).

Example 2

Partnership loss	€20,000
Y Ltd’s half-share	€10,000
Y Ltd sets off this loss €10,000 against part of its own profits
Y Ltd saves corporation tax on €10,000 @ 25% =		€2,500
Y Ltd gets from Mr. X 80 per cent of his half-share of the loss €10,000 =
		€8,000
		€10,500
less half-share of loss taken over		€10,000
Y Ltd thus gains		€500
Mr. X saves the amount of the loss taken over by Y Ltd		€10,000
less income tax relief he might have got on that loss €10,000 at 20 per cent =		€2,000
Amount paid to Y Ltd 80 per cent of €10,000 =	€8,000	€10,000
Mr. X gains		€0

The total gain €500 is the result of switching of losses €10,000 from Mr. X’s income tax rate of 20 per cent to Y Ltd’s corporation tax rate of 25 per cent (that is, €10,000 @ 5%).

Example 3

Partnership profits	€40,000	half-share		€20,000
Capital allowances	€80,000	half-share		€40,000
Notional loss	€40,000	half-share		€20,000
Y Ltd gets half-share of profits				€20,000
but does not have to pay corporation tax on this and sets off notional loss, €20,000, against its other profits, saving corporation tax €20,000 @ 25 per cent				€5,000
				€25,000
less payment to Mr. X 99 per cent of €25,000 =				€24,750
Y Ltd thus gains				€250
Mr. X gets from Y Ltd 99 per cent of €25,000 =				€24,750
less half-share of profit given over to Y Ltd			€20,000
less income tax relief he might have got on half-share of notional loss, €20,000, at 20 per cent			€4,000	€24,000
Mr. X gains				€750

The derivation of the total gain, €750 + €250 = €1000, is more complex in this case, but it is the end result of switching the half-share of capital allowances, €40,000, from Mr. X’s income tax rate of 20 per cent to Y Ltd’s corporation tax rate of 25 per cent.

Relevant Date: Finance Act 2021