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Replies to Queries - 2 - A new partner

24 July 2002
Issue: 3867 / Categories:

My client has for several years traded (profitably) as a sole trader who manufactures and sells double glazing. The manufacturing 'division' ('WindowMaker') makes the windows in a rented factory unit for the sales 'division' ('WindowSales'), which operates from a rented shop. Historically, the accounts for the whole business have been prepared to 31 March.

My client has for several years traded (profitably) as a sole trader who manufactures and sells double glazing. The manufacturing 'division' ('WindowMaker') makes the windows in a rented factory unit for the sales 'division' ('WindowSales'), which operates from a rented shop. Historically, the accounts for the whole business have been prepared to 31 March.

On sending me his business records for the last year, he informed me that, because he could no longer cope with both manufacturing and sales on his own, he had sold a 40 per cent share in the manufacturing part of his business for £15,000 on 31 December 2001 to a new partner. The written agreement basically says that the new partner has purchased a 40 per cent share of the manufacturing business. I am now wondering exactly what I am dealing with - one partnership or (presumably more likely) a sole trader and a partnership - and what are the income and capital tax implications? Also, what would be the implications if the £15,000 was a stage payment to be followed by a further £15,000 in twelve months' time?

The manufacturing machines have a book value of £10,000 and there is £10,000 worth of stock. I have managed to persuade my client that, with effect from 1 April 2002, WindowMaker should bill WindowSales for the windows which are then sold on, but there are no such invoices for the last year. Readers' suggestions on resolving this situation are welcomed.

(Query T16,045) - Glazed-over.


On 31 December 2001, your client made a decision to split his business into two trading entities, a sole trader (WindowSales) and a partnership (WindowMaker). In selling the 40 per cent share of the business, your client will be assessed to capital gains tax on any gains made in the transaction. In calculating this gain, you will need to value the assets of WindowMaker on a market value basis at 30 December 2001, and put a valuation on goodwill. Capital gains tax will be payable on the transaction on 31 January 2003.

The transactions that have already taken place cannot be undone. Therefore the client has missed out on incorporation, and the associated reliefs under section 162 - rollover, and section 165 - gift, plus any retirement relief that could have been attributable. This does not mean that these are not available for WindowSales, should you consider that there is some scope for planning in this direction, particularly in view of the final wind-up of retirement relief on 5 April 2003 and the possible advantages of incorporation.

With the two trades, then of course you can bring into play trading agreements, with the partnership selling to the sole trade, or whatever is going to give you the best commercial outcome, looking as always at the tax position in tandem. Make sure that all agreements are in writing and signed by both parties. Ensure that invoices are raised correctly and paid on time; no one can attack a bona fide trading transaction. I would have thought that there is no problem in backdating invoices to April 2002, providing that this is included in the trading contract, which, of course, should not be backdated.

Persuade your client that he needs to come and have a detailed tax-planning meeting with you - it sounds as if this would be money well spent. - Albertine.


To convert the business into two entities is ill advised, as it entails two marked drawbacks.

(a) A significant extra cash flow burden would arise. Maker and Sales would need separate VAT registration, and sales to the retail outlet would be loaded by a profit margin and VAT, whereas neither VAT nor cash movement is involved in transfers under the current system. There would also be an extra bank account (with attendant charges) needing funds for the holding balance.

(b) Compliance and administration chores would be duplicated. There would be two sets of VAT returns, two pay-as-you-earn systems, and two sets of contracts with utilities and the municipality. Even if all the clerical work were consolidated under the care of the present bookkeeper, the work would increase with no corresponding overall benefit.

These can be justified only by a handsome benefit that is plainly not apparent from the details given. Clearly, good cost and management records are vital, so that transfers by Maker to Sales are internally invoiced at a profit equating wholesale to the trade, so as to indicate the portion of total profit earned by Maker, and generating management trading and profit and loss accounts and balance sheets analysed in three columns - showing Maker, Sales, and the consolidated (or external) exhibit. Quite possibly the client is already running such a system. The new partner's profit share would apparently be computed on the basis of 40 per cent of Maker's profit as shown by the cost accounts. Such accounts should be drawn for the period 1 January 2002 to 31 March 2002, to fix his profit share for the year to 31 March 2002. For the client's purposes, accounts of the sole trade are needed for the period 1 April 2001 to 31 December 2001, which, together with the accounts for the first quarter of 2002, give his profit for the year. The (highly practical) existing accounts date can then continue.

A practical profit sharing clause in the partnership agreement would be one providing that profits and losses be allocated in such amounts or ratios as the partners shall at the time of sharing agree. Although it may be intended to use a fixed ratio, if this flexible clause is in force, the split can be varied, should the need arise, without risk of Inland Revenue objection that it is not in accordance with the agreement. Typically, the need arises for an unusual share out to benefit by unused allowances. To resolve the other queries precisely, two questions must be answered.

(i) What were the assets values of Maker and Sales respectively immediately before receiving the £15,000?

(ii) Was the £15,000 paid to the client personally, i.e. did he bank it privately, or was it paid to the firm, i.e. is it contributed capital?

If private, it buys 40 per cent of Maker's 31 December 2001 value, which would need to be £37,500, and a capital gain arises on the difference between £15,000 and 40 per cent of its original cost, indexed if predating 5 April 1998. Taper relief applies on the business asset scale. If it was contributed capital, Maker's 31 December 2001 value must have been 60 per cent of its value including the £15,000. - Man of Kent.

Issue: 3867 / Categories:
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