Calculating the taxable profits: termination payments
Termination payments made to leaving partners are often provided for in the partnership agreement as the payment of an ‘additional’ or ‘special’ profit share (although other terminology could be used). The partnership will not normally claim a deduction for such a payment but, instead, will show this as an allocation of profit to the leaving partner in the partnership statement.
However, the leaving partner may contend that the partnership statement is incorrect as the payment does not represent a share of the profits but, rather, a capital payment or compensation. You will need to consider the consequences of this on the partnership’s tax computation. For example, if the payment is one of compensation, it is likely that this should be treated as an allowable deduction and not an allocation of profits.
The risk to HMRC arises from the tax consequences of the payment on the leaving partner. They may be claiming that an amount that is an allocation of profits is actually a payment in respect of compensation in order to take the payment out of their income assessable to tax.
You should examine fully the facts surrounding the making of the payment, and in particular the partnership agreement as it relates to retiring partners. In many cases (such as Self and Morgan v Commissioners of HMRC  UKFTT78 (TC)), the payment will represent an allocation of profits to the leaving partner as it is made to them in their capacity as a partner and not as an entirely collateral payment made to them otherwise than in their capacity as a partner.
However, there are occasions when a payment will not be an allocation of profits. For example, in the case of AB v HMRC  UKFTT 685 (TC), heard before the First-Tier Tax Tribunal in August 2011, a payment to AB was held to be compensation even though the partnership statement described it as an allocation of profit.
The payment may be agreed between the partnership and the partner with no admission of fault by either party. Therefore, the manner in which the payment has been treated in the partnership return may not accurately represent the true nature of the payment and it is important to consider all the evidence available where there is disagreement between the partners as to whether or not the payment represents a profit share. This is in line with the guidance at EM7025.