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Be careful what you wish for...

Back in July, I wrote about how the Office of Tax Simplification (OTS) had been given the job of simplifying the tax rules relating to partnerships. Back then, I thought that this had to be good news.

As we all know, a partnership is transparent for tax purposes meaning that its profits are taxable by reference to its partners. This can cause some real headaches and so there are plenty of areas out there where the OTS can make all our lives easier.

Roll forward three months and we now have an indication of the areas the OTS will be focusing their efforts on. Some of the more interesting proposals are considered below.

1. The need for a partnership return. Could the details currently entered on a partnership tax return be entered on the tax returns of the partners instead, removing the need to file a partnership return?

2. Recording partnership expenses. Where partners incur partnership expenses themselves (eg travel costs, use of home as office), could these be recorded on the partners' own tax returns rather than on the partnership's tax return as is currently the case? The current system complicates profit share calculations and can delay the submission of returns.

3. Paying tax on drawings rather than profits. Partners are taxed on profits as they are earned and not as they are drawn down. This can cause confusion and also reduces the funds available to invest in the business. Could the rules be changed, for small partnerships at least, so that tax is paid on drawings rather than on profits?

There is much to like here, particularly with regard to the third point above. A key advantage a limited company has over a partnership is that less tax is paid where some profits are retained in the business. Taxing partners on drawings rather than earnings would level the playing field between partnerships and limited companies. And it would also give partners greater control over how much tax they pay and when.

However, it's not all good news. At present, a partnership can prepare its accounts to any date in the year it sees fit; i.e. it is not tied to the end of the tax year (5 April). This can cause some difficulties but generally only in the first year or two after a new partner joins.  And there are benefits as partnerships can chose an accounting date that suits them.

However, this may be about to change as the OTS will also consider whether all partnerships should be moved to an accounting date of 5 April (or 31 March, being the next best thing). Simpler yes, but if this goes ahead it may well mean increased tax and superannuation liabilities in the year of change. No doubt the tax issues will occur to the OTS and it may be that arrangements are put in place to avoid a problem. However, it seems unlikely that the OTS will factor in the superannuation issue although we at BW Medical Accountants will be doing all we can to raise it with them.

In summary, there are opportunities to welcome and pitfalls to be wary of here. Let's hope that the OTS see sense and only make those changes which will simplify and improve the tax rules for partnerships.

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