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Hello, hello

21 July 2009
Issue: 4215 / Categories: Forum & Feedback , Business
A ‘golden hello’ payment is made to a partner on his joining a partnership. Is this subject to tax and, if so, is it as an income or capital payment? It seems unlikely that goodwill is being introduced and it seems more likely that this may be a payment of a higher profit share for the first year as a partner.

I am familiar with the idea that a golden hello paid to a new employee is taxable as an inducement. What about a golden hello to a partner?

The individual concerned has left an employment in which he would have been entitled to share awards had he stayed, and because he has foregone those awards his new partners have made a lump sum payment to him on joining the partnership.

My immediate reaction is that this is probably taxable; but on the other hand a payment by him to join the partnership would be regarded as capital and would not be deductible from his profit shares for income tax purposes, so why should the other partners’ payment to him be added to his profit share?

I cannot immediately find any precedent cases. I do not think that the payment is ‘linked with the termination of his employment’ in the sense required for the golden handshake rules to apply – it is linked with the loss of his option rights, which I believe has been held in past cases to be a different thing.

Does anyone have any strong views that this receipt should, or should not, be taxable as income?

Query 17,438 – Terminator.

Reply from The Snark

I think that the ‘golden hello’ is chargeable to income tax.

To deal with the ancillary issue first, it is common for an incoming partner to be asked to make a contribution to the capital on joining the partnership.

There is insufficient information in the question to know whether that is the case here.

However, it is not exclusively the case that such a payment actually purchases anything for the new partner. Indeed, in many modern partnership agreements, incoming partners expressly do not acquire anything in return for their subscription.

Rather, the payment has the character of a loan.

If we turn this around the other way, by making a payment to the incoming partner, what could the firm be purchasing?

Presumably there are no capital assets which the individual is introducing.

One might tentatively introduce the concept of goodwill. But what is goodwill?

In simplistic terms it is an intangible appendage to a business; it cannot exist in isolation. It is what might make an independent purchaser pay more for a business than its value as a mere collection of assets.

Without a business goodwill cannot exist. The new partner was an employee elsewhere, so he has no business to transfer to the new partnership. Therefore he cannot bring in goodwill.

There might be anticipation that the partnership can win new work from the incoming partner’s contacts, but that cannot amount to goodwill.

I rather think that the payment made by the partnership has a character of income.

That is not to say that I think it is an allowable deduction in arriving at the profits. Rather, it is an appropriation of those profits.

It seems to me incontrovertible that the corollary is that it should be that it is income in the hands of the newcomer, in recognition and anticipation of services in the future.

That may not be the end of the story. Why is the payment being made?

The individual has left his employment voluntarily and forfeited his rights to some ‘share awards’.

We do not know how those awards would have been taxed. Except in the case of certain schemes, such as the enterprise management incentive, share-related remuneration is usually charged to income tax.

It seems to me that the payment is compensating for what would have been income.

Does that give it the character of income? I rather suspect so.

The nearest parallel I can find in case law is Shilton v Wilmshurst [1991] STC 88, although that did concern a footballer moving from one employment to another.

The House of Lords had little difficulty in deciding that a third-party inducement payment to join the new employer was earnings under what is now ITEPA 2003, s 62. ITTOIA 2005, s 5 similarly charges income tax on the profits of a trade, profession or vocation.

I have little doubt that a court would find that this payment is part of those profits.

Reply from Hodgy

The exact tax outcome will depend on the particular agreement between the client of Terminator and the partners of the partnership which he has joined. I will consider what I feel are the two most likely possibilities.

The first option is that the payment is an extra fixed profit share for one year only.

As such, the extra amount paid to the client will be additional profit and subject to income tax and Class 4 National Insurance contributions.

As a profit share, this would not be deductible in the partnership tax computation, but this is not a problem.

The partnership taxable profit is a finite sum and so if an additional portion is allocated to Terminator’s client, the profit shares for the other partners will be reduced by the same amount. It follows that their tax liabilities will also reduce.

The other possibility is that the client may be introducing additional profit earning potential into the partnership.

The fact that the existing partners are willing to make this payment, particularly in the current economic climate, leads to the conclusion that they must have high hopes as to the abilities of Terminator’s client.

If this is the case, it could be possible to argue that the payment is a payment for goodwill.

On that basis, the amount received would be taxed as a capital gain.

We are not given any details to be able to make a definitive statement, but it seems likely that any such goodwill will have a cost figure of nil.

Depending on any other disposals made by the client, there may be an annual exemption to set against the sum received and any excess will be taxed at 18%.

If any goodwill held by the client is personal to him, he cannot transfer that goodwill to the partnership in the same way that you cannot place a value on personal goodwill when incorporating a business.

This would bring us back to the idea that the payment is an extra one-off profit share.

Terminator needs to review any documentation relating to the payment, but two possible treatments are that the payment is a one-off profit share or possibly a payment for goodwill.

Issue: 4215 / Categories: Forum & Feedback , Business
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