Partnership Taxation: deposit interest
03 September 2010
Judge Bishopp considered whether interest received by a partnership on short-term funds held in a clients' account was taxable as interest or as trading income.
The case concerned an appeal by a firm of solicitors arising form an amendment made to their partnership return for the year 2006/07.
Although the firm undertook a variety of work, by far the greatest part of its income was derived from volume conveyancing work, principally re-mortgage transactions.
The firms clients were lending institutions advancing money to home owners on the security of their homes, who used the money to pay off their existing mortgage. The firms fees were paid by the lending institution.
The appellant gave evidence to suggest that the lending institutions put their work out to tender and negotiated with the appellant and other competing firms undertaking similar work, driving a hard bargain such that the fee agreed alone, did not cover the cost of doing the work. The appellant therefore relied on the fact that it could earn an additional income from the interest paid to it by its bank on the balance in its client's account. The lending institutions were aware of this and were comfortable with this arrangement.
The question considered was whether interest receivable by the taxpayer was to be treated as interest or as trading income
In finding in favour of the appellant, Judge Bishopp held that as a general rule, earned income of solicitors is limited to monies that they receive from their clients in return for professional services and does not include interest credited to their client's deposit account and received by a solicitor as consideration for the loan of the money to the bank.
Notwithstanding this general rule, as in this case it was understood that the interest would comprise part of the appellant solicitors reward, the interest was earned in the course of the appellant solicitors trading and as an integral part of the trading activities and therefore was money which the appellant solicitor received from his clients in return for professional services.
The interest was therefore taxable as trading income.
Although this decision did not affect the rate of tax applied to the income (it was still charged to income tax at the same rate), it did mean that the appellant solicitor could make a successful carry forward loss relief claim thus reducing tax payable.
We assume that the advantages of doing this more than offset the disadvantages of having the interest payments classified as trading income; namely the fact that the appellant taxpayer would have had to make national insurance contributions on this income.