Untaxed income of a partnership

By Tolley

The following Personal Tax guidance note by Tolley provides comprehensive and up to date tax information covering:

Untaxed income of a partnership
Introduction
What is not included in ‘untaxed income’
Sources of untaxed income
How the income is taxed
Overlap profits
Bank and building society interest (2016/17 onwards)

Introduction

This note explains the rules which apply when a partner receives untaxed income, other than trading profits or overseas income, from his partnership.

For taxed income, see the Taxed income of a partnership guidance note. For the taxation of trading profits, see the Partnership profit allocation guidance note. For foreign income, see the Partnership foreign income and tax paid guidance note.

The types of untaxed income most commonly received by UK partnerships are UK interest and property income.

Before considering the rules under which these amounts are taxed, it is first important to eliminate certain payments which may be wrongly classified as ‘untaxed income’.

What is not included in ‘untaxed income’

Interest on partnership capital

Interest paid on partnership capital is not treated like other interest, either when paid by the partnership or when received by the individual partners (ie it is not an allowable deduction from trading profits). Instead it is treated as a distribution of profits.

Heastie v Veitch 18 TC 305 page 319, per Romer LJ (subscription sensitive)

As an illustration, if a member introduced capital of £100,000 to a partnership and received interest on capital at 5% per annum, £5,000 (£100,000 x 5%) would be disallowed when calculating the adjusted trading profits of the partnership for the relevant year end, and instead would form part of the distribution of profits in accordance with the profit sharing agreement. Note that the partner’s capital account would be updated accordingly.

See Partnership profit allocation ― Example 1.

Salaries paid to partners

In some partnerships, one or more partners may be given a guaranteed payment from the partnership, termed a ‘salary’ or a ‘fixed share’. This may happen when a former employee is first offered partnership, in order to reassure him that