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Drafting of the partnership agreement
It is well known that a large number of partnerships do not have a partnership agreement - and yet they need one. The agreement is important for protection for asset, dispute and tax protection.
Protection of Business Property Relief (BPR) for Inheritance Tax (IHT) purposes at 100% can be obtained through the drafting of the partnership agreement and this should be drawn up so that whilst the partnership remains in force, the property continues to be a partnership asset. Such drafting means the original owner does not have a ‘proprietary interest’ in the land. The objective, to achieve 100% BPR as opposed to 50% BPR, will then be achieved. If an asset is to be held as partnership property but allocated wholly to one partner, the draftsman’s approach will have to be to ensure that none of the other partners, except the intended ‘owner’, have any ‘beneficial interest’ in the asset.
Property used by the partnership
If a partner owns property personally (i.e. not on the partnership balance sheet) which is occupied or used by the partnership, 50% of the value of the property will be excluded from the calculation of IHT when that partner dies.
There are many tax advisers who argue that the simple inclusion of the assets on the partnership balance sheet is enough to prove that they are partnership property and eligible for 100% relief. When it comes to the availability of BPR at the rate of 100% for land in a partnership case, it is assumed that the question will come down to whether the land is a ‘partnership asset’, albeit one that appears to be ‘owned’ by just one of the partners. It is assumed that if the land is ‘partnership property’, then the value of the land will be included in the value of ‘the business or an interest in the business’ qualifying for relief at the rate of 100%. This is an approach followed in HMRC’s IHT Manual (www.hmrc.gov.uk/manuals/ihtmanual/IHTM25104.htm). If the property is not a partnership asset, the property will only qualify for IHT relief at the rate of 50% (under IHTA 1984, s 105(1)(c)).
In Miles v Clarke  1 A11 ER 779 there was a dispute about what was partnership property. Harman J found that the only term agreed by the parties in the partnership agreement was that profits should be shared equally. He rejected guidance from the accounts because of errors in the way in which they were drawn up, and laid down the following principle ‘No more agreement between the parties should be supposed than is absolutely necessary to give business effect to that which has happened’ (see  1 A11 ER at page 782, letter a). Applying this principle, the trading stock was a partnership asset, but the lease of the premises held in the name of only one partner was not.
Proving partnership assets
When property is included on the balance sheet so that the owner has a beneficial interest but not a proprietary interest, there is still the need to prove that the property is a partnership asset. Case law suggests that there is an evidential burden to be surmounted, and also that the courts may be reluctant to allow it to be surmounted with the aid of accountancy evidence, and a partnership agreement is needed to protect the tax relief. In Barton v Morris  1 A11 ER 1032, a man and woman, who were unmarried but who lived together, purchased a farm which they held as joint tenants. They lived at the property and carried on a partnership, without a written partnership agreement. The woman died in an accident. The question was whether the farm had become a partnership property (severing the joint tenancy) or whether the partner became solely entitled by survivorship. The High Court held that even though the farm was shown as a partnership asset in draft accounts, it had not been made partnership property. This point is reinforced by an earlier decision, Miles v Clarke (as mentioned above).
The importance correctly drafting the partnership agreement
A number of partnerships operate without a written partnership agreement, which has obvious dangers as it is important to set out the terms upon which the partners agree to carry on business together. This should go beyond such matters as profit sharing, for example to specify what should happen in the future if there is a dispute or a partner leaves or dies. The importance of the drafting of the partnership agreement is therefore to lay down terms specifying what is to happen when the partnership ceases, or the property ceases to be partnership property. For example, if the property is sold, how will the sale proceeds be treated? Presumably the ‘property owning’ partner will have been credited with the value of the property, in his capital account, which should be adjusted to take account of any profit or loss realised, by reference to the book value. On the partnership ceasing, the agreement may provide for the property appropriated to the property owning partner or towards his capital entitlement.
BPR at 100% for property which may be regarded as beneficially owned by just one of the partners will obviously require a carefully drawn partnership agreement. Not necessarily a deed, as set out by Hoffman LJ in IRC v Gray, but a detailed written agreement which defines the position on partnership assets. Careful consideration should be given to the ‘heads of terms’ and what all the partners really want.
A set of accounts signed by the parties may well be regarded as evidence of agreement between the partners on basic trading concerns, such as the division of the profits shown in the annual profit and loss account. However, accounts unsupported by a detailed written agreement cannot suffice by themselves, to provide the evidence of the detailed and intricate partnership agreement as to property ownership and need to ensure that the property is effectively beneficially owned by just one of the partners.
Persuading HMRC (of partnership assets and 100% relief)
If the drafting problems can be overcome, it may be possible to persuade HMRC that an asset, apparently ‘owned’ by just one of the partners, is partnership property and therefore eligible for 100% relief. The undisputed facts found by the First-tier Tribunal (FTT) in the Balfour case suggest that in the context of IHT this can be achieved.
Practical Tip :
A partnership agreement is an essential business ‘tool’ for any partnership. It is vital that all partnerships, especially those who own property, have an updated agreement or even start to draft an agreement from scratch! The practical tip is that before partnership agreements are updated (or even drafted for the first time), it should be fully understood what is required both in terms of what the partners want, and what is tax efficient in terms of the inclusion of property. It is important to establish who owns what property, what reliefs can be achieved and what protection there could be when BPR is needed at the 100% rate.