Query - Tax considerations when a sole trader takes on a partner
My client trades as the sole proprietor of a small building firm. For some years he has been expecting to retire. The client has tangible business assets valued at about £200,000, of which £50,000 is subject to hire purchase agreements.
Instead of retiring completely from his business activities, on 1 April 2016 he decided to bring his son into the business and they formed a partnership, sharing profits equally. Previously, his son had been involved in a similar trade related to the construction industry, but on a smaller scale. The client's son has not put any money into the business.
Several questions occur to me.
- If it is argued that my client has, in effect, given half of the business to his son, could I claim gift relief for capital gains tax purposes?
- Would the gift relief be based on the assets of which he would have gifted 50% less the hire purchase charge - in other words a value of about £75,000'?
- Should I worry about any potential capital gains tax liability on the goodwill of the business?
- Could play around with the partnership share instead?
Can readers advise on the best course of action in a case such as this?
Query 19,019- Transferor.
Answer - Tax considerations when a sole trader takes on a partner.
The SASSO partnership tax return guide provides information on the entries required when a self-employment business is transferred to a partnership for self-assessment purposes. It would also be advisable for the client to consider setting out what has been agreed between them in a partnership agreement. All too often informal arrangements that are not properly documented lead to disputes when the parties disagree on what they were intending to achieve.
The father has a choice of whether to hold the tangible asset and hire purchase agreement asset in his name and then perhaps charge a rent or to include the asset as the initial partnership property. He would need to establish whether the transfer of ownership from his name to the partnership's is possible for the asset owned under the hire purchase agreement.
In terms of goodwill, in a sole trade this will always be a capital asset. The value of goodwill can be introduced into the partnership and held within the capital account.
Any assets acquired after the formation of the partnership using partnership funds will be a partnership asset.
It is possible for partners to have a different profit/loss share for assets and income, but there would need to be a tailored partnership agreement in place. The result is that the father could hold a different capital share percentage from his son: if he was entitled to 100% of the capital of the partnership this would mean that no gift had been made and there would be no capital gains tax implications to consider.
Any adjustments made to the capital share ratio after the partnership is formed is likely to have an effect for capital gains tax of the partner whose share in the partnership assets is reduced, in line with statement of practice D12.
Without a tailored partnership agreement, the partnership will be acting in accordance with the Partnership Act 1890, under which profit/losses and capital are split equally. If the capital is split equally and the assets are transferred into it, a deemed disposal for capital gains tax would take place at market value at the date of transfer on the total value of all the assets, including the asset held under hire purchase agreement (subject to the above point raised). Since business assets (including the goodwill) were used within the trade, a gift relief claim under TCGA 1992, s 165 can be made by way of a joint election within four years from the end of the tax year in which the transfer took place. Any cash consideration received would still be subject to capital gains tax.
For further advice on the tax considerations when a sole trader takes on a partner, speak directly to Reshma Johar at firstname.lastname@example.org.