In Ian Shiner & David Sheinman v HMRC [2020] TC7779, the First Tier Tribunal (FTT) disallowed interest on loans to members of a trading partnership. The loans were taken by the partners as investors and not the partnership and the interest paid was not wholly and exclusively for the partnership trade.
Interest is deductible in computing the trading profits of a partnership if that interest is:
- Incurred by the partnership, Wholly and Exclusively for the purposes of the partnership’s trade.
- Properly reflected in the partnership’s accounts.
- Not a capital expense.
The appellants owned a property development group and were parties to a tax scheme involving an Employee Benefit Trust (EBT):
- They settled Isle of Man (IOM) trusts of which they were life tenants, and the trustees, which were IOM companies, then set up a land development partnership (the partnership).
- The EBT made interest-bearing loans to the trustees to finance the partnership and allow it to purchase properties from the group. The partnership borrowed the remaining funds required from a third party bank.
- The partnership accounts recorded the EBT loans as capital contributions, not as liabilities of the partnership. The interest was not included in interest payable.
- The appellants had claimed they were not subject to Income Tax on the partnership trading profits due to the provisions of the UK/IOM Double Taxation Arrangement. This point was conceded; as UK settlors with an entitlement to the trust income, they were each liable to Income Tax on the share of the partnership trading profits to which their settlement was entitled. They then claimed the interest on the loans from the EBT should be taken into account as a deduction from the partnership profits.
- HMRC disagreed though the interest on the bank loans was accepted as an allowable partnership expense.
The FTT considered: was the interest an expense of the partners or partnership? Was it income or capital in nature and whether it was incurred wholly and exclusively for the purposes of the partnership trade? The Tribunal concluded:
- The loans were made to the partners who then made capital contributions to the partnership, and not directly to the partnership. The interest on the loans was paid by the trustees as partners on behalf of their respective settlements and outside of the partnership.
- Borrowing by a limited partner to finance a capital contribution into a general partnership in the IOM could not as a matter of UK tax law be analysed as a borrowing by the partnership itself, nor did it meet the conditions of Part 8 of the Income Tax Act 2007 which provides for relief for interest on loans taken by individuals to invest in partnerships.
- There is a difference between expenses incurred by a partner in their capacity as an investor in a partnership and expenses which they incur in pursuing the trading purposes of the partnership.
- The purpose of the trustees in entering into the loan agreements was to finance the trusts’ capital contributions to the partnership and this could not be disregarded. The interest on the loans was not an expense which the settlement was incurring wholly and exclusively for the purposes of the partnership’s trade. This would only have been so if the loans were made to the partnership directly or if the trustees had on-lent the funds to the partnership.
Comment
Taxation of partnership expenses has long been a problem area, with changes to HMRC’s own guidance in recent years causing much confusion. The current position is that if the partnership does not bring an expense into the accounts but does include it in the partnership return, then a deduction is available as long as the 'wholly and exclusively' test is met.
Links
Partnerships: Rolling update
A guide to recent changes and basic principles around the taxation of partnerships.
Wholly and exclusively…toolkit
Revenue expenditure in a trader's or company's accounts is disallowed for tax if it is not 'wholly and exclusively' incurred for the purpose of the business.
Trusts & Tax Planning
What is a trust? How can trusts be used in tax planning? What the advantages and what are the pitfalls?
EBT Schemes
Where are we now?
External link
Ian Shiner & David Sheinman v HMRC [2020] TC7779