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HMRC internal manual

Trusts, Settlements and Estates Manual

Settlements legislation: partnerships

The creation of a partnership may be regarded as an arrangement for transferring income from a settlor to members of his or her immediate family - see BIM82065. External customers can see this guidance at

Where the incoming partner receives a share of profits out of all proportion to the contribution made to the partnership, the arrangement would include an element of bounty.

Where the incoming partner is a spouse or civil partner and he or she acquires an unlimited share in the partnership assets and income and there are no other arrangements or conditions applied to the gift then the exemption for outright gifts will apply and a challenge under the settlements legislation is not appropriate.

The settlements legislation will apply where there is an arrangement under which the property received by the spouse or civil partner is wholly or mainly a right to income.

Example 8 - partnerships - sleeping partner - settlements legislation does not apply

Mr and Mrs O and their friend Mr P have a business idea. They want to open a Cycle Repair Shop. Mrs O does not want to work but agrees to invest in the business without taking an active part, that is to say she is a sleeping partner. Each partner invests £10,000 and the £30,000 is used to lease a shop, buy equipment and stock and keep the business going until trade builds up. Under the partnership agreement Mr O and Mr P receive £500 a week with all the remaining profits split three ways between the partners.

The business is a huge success and makes large profits and continues to grow. Within five years Mrs O is receiving £50,000 a year as her share of the partnership profits. Although Mrs O does not work in the business, and her initial investment has turned out to be very successful, the settlements legislation would not apply to treat her share of the partnership profits as Mr O’s. Mrs O’s original investment was vital to get the business started and she risked losing it if the business failed.

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Example 9 - Gifted shares in partnership as an outright gift not wholly or substantially a right to income

Mr Alpha and Mr Beta are in partnership as second-hand car dealers. They own the freehold premises through which the partnership trades (valued at £200,000) and routinely carry a stock of 50 used cars. The business is successful and has established goodwill in the locality as a reliable trader. It employs a number of salesmen and office staff. Profits of £100,000 a year are split equally between the partners. They decide to admit their wives to the partnership and amend the partnership agreement in order to split profits and capital equally four ways. Mrs Alpha and Mrs Beta do no work in the partnership. Although this is a bounteous transaction it is an outright gift that is not substantially a right to income and is excluded from the definition of settlement by ITTOIA/S626.

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Example 10 - sleeping partner - settlements legislation does apply

Mr Y, an architect, commences business as a sole trader. The business is successful and a few years later annual profits are in the region of £80,000. The business is transferred to a new partnership of Mr & Mrs Y. A deed is executed under which income profits are to be shared equally but the rights to share in capital profits belong solely to Mr Y. Mrs Y subscribes no new capital and carries out no work whatsoever for the partnership, that is to say she is a sleeping partner. Profits for the year are £80,000 and £40,000 belongs to Mrs Y. This is a bounteous arrangement transferring income from one spouse to another. The settlements legislation will apply and Mrs Y’s share of the profits will continue to be assessed on Mr Y.

Where the incoming partner is not a spouse or civil partner the legislation will not apply unless there are arrangements or conditions where the property can revert to the settlor (or spouse or civil partner).

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Example 11 - Gift with conditions attached

Mr T is in partnership with his wife Mrs T. Their daughter is a university student. The deed is altered to admit the daughter as a partner. All the partners agree that on finishing her course the daughter’s interest in the partnership will come to an end. The amendment of the partnership agreement under which the daughter is included without any additional capital or value being added by her is an arrangement with the requisite element of bounty. The gift from the parents is subject to conditions under which the property given will revert to them. The daughter’s income is therefore treated as the income of the parents under ITTOIA/S624.

Cases of difficulty should be referred to HMRC Trusts & Estates Technical Edinburgh.