• ICE Chartered Accountants

Husband and wife property partnerships: Changing the profit-sharing agreement

This article looks at the tax considerations when spouses (or civil partners) change profit shares in their property business. Much depends on whether the business is carried on as a general partnership or ‘merely’ as co-owners, as the special rules for the taxation of joint income for spouses or civil partners do not apply if the business qualifies as a partnership.

The problem of joint ownership between spouses and civil partners

The default position for spouses and civil partners in receipt of joint income is that they be taxed equally thereon (ITA 2007, ss 836, 837), regardless of their respective equitable interests in the income source itself. This can be displaced by the submission of a Form 17 joint declaration, which formally notifies HMRC of the ‘true’ position, so that thenceforth incomes are assessed to reflect the actual beneficial ownership in the property.

However, this essentially puts co-owning spouses, etc. at a disadvantage to others who co-own property, since those who are not spouses or civil partners can divide joint income largely as they like, regardless of who owns how much in the property itself. This point is confirmed by HMRC in its Property Income manual at PIM1030:

“Where there is no partnership, the share of any profit or loss arising from jointly owned property will normally be the same as the share owned in the property being let. But joint owners can agree a different division of profits and losses and so occasionally the share of the profits or losses will be different from the share in the property.”

Settlements regime

There is a logic to this distinction, in terms of the settlements anti-avoidance regime (ITTOIA 2005, s 624 et seq.). The settlements regime acts to tax income ostensibly ‘given’ to someone as if it still belonged to the donor. There is an exception at ITTOIA 2005, s 626, preventing the regime from applying where (broadly) one spouse or civil partner makes a gift to the other and that gift is substantively more than just income.

Simplistically, if the couple were to re-allocate income so as not to reflect the respective beneficial interest(s) in the property, it could be said that one spouse had made a gift only of income to the other. This would fall outside the protection of ITTOIA 2005, s 626, and the settlements regime could treat the gifted income as taxable on the donor – in other words, reverting to their being taxed in proportion to their respective beneficial ownership.

While it would theoretically be possible to re-allocate incomes by transferring a corresponding proportion of the underlying capital from one spouse or civil partner to the other (without causing CGT problems, thanks to TCGA 1992, s 58), there are other exceptions to the default approach to dividing joint income between couples, notably where the activity counts as partnership income (ITA 2007, s 836(3), Exception C).

Spouses and civil partners: Partnership income

As regards partnerships generally, HMRC’s Business Income manual states (at BIM82055):

“Profits, losses or other income may be shared as the partners may mutually agree from time to time. The sharing ratio need not be in proportion to contributions of effort or capital.”

When it comes to partners who are married or in a civil partnership, the situation is more nuanced. In general terms, HMRC appears to accept that there is little it can do to directly challenge the mechanics of a partnership. HMRC’s guidance states (at BIM82065):

“A spouse or civil partner is sometimes taken into partnership wholly or mainly to maximise the benefit of the tax reliefs that are available.

You cannot challenge the apportionment of profits, as you can a wage, by reference to the value of the partners’ contribution to the firm’s activity. It may be possible in these cases to challenge the spouse or civil partner’s status as a partner, but such a challenge is often very difficult to sustain…there is no need for the spouse or civil partner to contribute capital; or to participate in management; or, in a trading context at least, to be capable of performing the main activity of the business. Indeed to be a partner one need not take an active part in the business at all…

It is worth emphasising that a partnership is not a sham merely because it is set up to save tax, as indeed the spouse or civil partner who is deserted by a partner leaving them to meet the firm’s liabilities may find to their cost.”

Partnerships and the settlements regime

While this seems helpful, HMRC nevertheless believes that the settlements regime may be invoked in some cases. For example, in the Trusts and Estates manual at TSEM4215, HMRC states:

“The creation of a partnership may be regarded as an arrangement for transferring income from a settlor to members of his or her immediate family…

Where the incoming partner receives a share of profits out of all proportion to the contribution made to the partnership, the arrangement would include an element of bounty.”

This could be problematic; on the one hand, the Business Income manual appears to accept that a partner may enjoy significant income for little investment or effort, while on the other the Trusts and Estates manual states that the receipt of partnership income may constitute a gift (bounty) from one spouse to the other, potentially falling within the settlements regime, leaving it taxable on the ‘donor’. However, the manual also states:

“Where the incoming partner is a spouse or civil partner and he or she acquires an unlimited share in the partnership assets and income and there are no other arrangements or conditions applied to the gift then the exemption for outright gifts will apply and a challenge under the settlements legislation is not appropriate.”

So, while HMRC might like to use the settlements legislation to undermine partnership profit allocations between spouses, etc., opportunities to do so may be limited to quite unusual scenarios, such as where one spouse has no share in the partnership’s capital assets, or there are significant conditions imposed on their participation in the partnership.

Note that while TSEM4215 initially focuses on the potential use of the settlements legislation when a partnership is created, many of the examples it then gives as to when the regime may or may not apply actually consider the allocation of profits several years afterwards. However, the guidance does not directly address the implications of a decision by the spouses or civil partners to significantly vary the allocation of partnership profits from one period to the next, which could happen independently of any change in partners’ capital interests in the business. But is this so problematic?

Is there a property partnership?

Many readers will be familiar with HMRC’s view that co-owners in a property rental business will rarely be carrying on a business in partnership, as distinct from acting merely as joint investors. For example, HMRC’s Property Income manual at PIM1030 suggests ‘business’ (in PA 1890, s 45) as “including every trade, occupation or profession”, implying that non-trading activities may struggle. However, HMRC does accept that Griffiths v Jackson [1982] 56 TC 583 suggests that letting property may sometimes be a business.

In the writer’s opinion, Ramsay v HMRC [2013] UKUT 0226 (TCC) is most helpful in ascertaining whether there is a property business (such that there can be a property partnership), and in particular that the distinction in previous cases was primarily used to contrast between trades and lesser activities. Nevertheless, Ramsay identifies a minimum threshold; very broadly, a “serious undertaking earnestly pursued” by the taxpayer. Where a joint property activity meets that threshold, HMRC may have difficulty arguing that re-allocating profits amounts to no more than a gift of income, and I think we are more comfortably within the realms of HMRC’s Business Income manual at BIM82055 and BIM82065.


Where spouses and civil partners jointly own rental property, their options to allocate income are relatively limited. But when the activity qualifies as a partnership, they have much more freedom, although HMRC may be able to invoke the settlements anti-avoidance regime in some ‘edge’ cases.

142 views0 comments