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Tim William, Senior Associate, Burges Salmon

Hello and welcome to the new episode of Death and Taxes, a weekly podcast by the Private Client team at Burges Salmon. My name is Tim Williams and I'm a tax and trust lawyer in the Private Client team and together with my tax and trust colleagues Guy Broadfield and Edward Hayes, we'll discuss a range of issues facing clients and professionals alike. In each episode we'll be joined by specialist lawyers from around the firm to bring you our views on important topics for private clients.

 

In today's podcast Guy and I are joined by Sian Edmunds and Maddie Dunn from Burges Salmon's Dispute team to talk about partnerships and how to get the most out of those business structures, as well as where they can go wrong and what to do about it.

Guy Broadfield, Senior Associate, Burges Salmon

So Tim I think in the first instance it's just important for the purposes of the pod to really establish what we mean by partnerships because they can mean different things to different people, and they are used in a variety of different contexts. So, question number one what do we mean by partnership?

Tim

Thanks Guy,  partnerships come in different shapes and sizes, as you've identified, and I think the reason that they're still widely used as they're very flexible, there's lots of very good things about partnerships and the way that people can come together and work in them, the one that we encounter most are general partnerships or 1890 Act partnerships, which is now a pretty elderly act but one that still applies very widely, then there are LLPs, the more modern variant, somewhere between a partnership and a corporate with companies house reporting obligations and all that sort of thing.

Guy

I'm sorry that's limited liability partnerships.

Tim

Exactly And then, slightly confusingly, there are also limited partnerships which are again another variant on the general partnership and somewhere between an LLP and an 1890 Act partnership.

 

For the purposes of what we're going to talk about today, there are lots of general principles that override all the different sorts of partnerships, but probably what we're going to focus on is 1890 Act general partnerships, but equally LLPs, limited liability partnerships, will have many of the same sort of issues as we dive in.

Guy

And at its base what we're talking about is people coming together with a view to forming a business with a view to profit, is that essentially a definition of a partnership?

Tim

Exactly yes, so that's the statutory definition of a partnership which can lead you into rather difficult territory if you come together to do that but you don't realize that you formed a partnership, so part of the partnership work that Maddie and Sian do a lot of is what we might term "accidental partnerships”, is that fair guys?

Sian Edmunds, Partner, Burges Salmon

Yes, I would say they don't often accidentally happen, although from time to time they do, but what we see more regularly on the contentious side of things is where they have been undocumented, so the parties might be very clear that they are in business together and what they're doing is generally  aimed at raising a profit, but that they haven't actually written anything down, or alternatively they have written something down but they wrote it down such a long time ago that they've either forgotten what it says, they haven't looked at it for a long time or it's just not fit for purpose anymore, so those are the areas where we find that particular difficulties arise.

Guy

Because ideally if you're coming together in partnership and you are going to document it and set it all out clearly for all of the various parties, what do we need in that document?

 

We need to establish what the business is, why they're coming together as a partnership, who is going to be contributing what in terms of assets or time, what the various parties roles are, and what happens if someone wants to leave or dies?

 

Is that, in broad terms, what you expect to see in a good partnership agreement?

Tim

Exactly Guy, and I think the  extra thing there that goes back to Sian's point about time going on is who the partners are as well, so who is actually in this business and it's often something that's not clear particularly over time.

 

But no you're absolutely right that it's setting out one of the key things from our point of view, from the tax and structuring side is what is in the business and what isn't, and that's really something that needs to be carefully recorded in a partnership agreement, and clearly set out what's in there and who's got the value of it as well, that's another key part because the statutory basis for partnerships is very helpful but it can lead to some slightly surprising results because it can often impede things to the relationship that people don't expect, so it's much better to write things down carefully and keep a clear record of what's meant to happen, otherwise you might find that the 1890 Act steps in to give you an unintended result.

Guy

So in many cases at the outset of the partnership clearly the partners agree on the business and have an understanding of who's entitled to what and how it's all going to work, but of course that changes over time with the business and circumstances and is that always updated as people go along Sian, or can that cause issues?

Sian

That can definitely cause issues and often isn't updated and what parties often don't realise is that the law will step in and say if assets have been purchased by partnership funds, for example, that the starting point is that they might be deemed to be partnership assets even if the parties didn't quite intend it to be that way, there are a number of variations that might arise from the original intentions of the parties, and we certainly see issues that then arise with how property and assets are dealt with in the partnership accounts, where the accountants for very good reasons might ascribe certain things to particular places for good tax reasons, but that might then conflict with either what the partnership agreement already says about property or what the parties intended at some point in the past. I think that's something we see very often isn't it, Maddie?

Maddie Dunn, Senior Associate, Burges Salmon

It is, particularly where you've had assets that were originally used by the partnership sold since the partnership started, you've got perhaps a new generation coming in, you may have additional land purchased and that may be purchased by individual partners or may never be intended to be a partnership asset but because it's being used by the partnership you may find that that's been included somewhere within the partnership accounts without necessarily a huge amount of clarity about what the parties intend and how they intend for that to be treated, and so that can lead to conflict in the future if the parties subsequently have a difference of opinion, or perhaps the understanding wasn't as universal as one of them thought it was at the start, so we can end up with parties quite at odds over how particular assets are supposed to be treated and if you've got conflict between the accounts, the partnership deed, the partnership deeds out of date, not all of the partners have necessarily, or not all of the parties that people think are partners have necessarily, signed up to that partnership deed, you can end up with quite a muddle.

Tim

I suppose it's just worth saying why you might want things in the partnership or not, isn't it really?

 

And one of them is the business tax reasons that you've mentioned, there are things that can be helped from that point of view by assets being in the business or not.

 

Another one is the capital tax position, that's probably more Guy and my area, and say land in particular being a partnership asset is very important from an inheritance tax relief point of view so if land is part of a trading business you can receive business property relief on the full value of that land, so that's often one of the reasons that you might see people arguing that land is in a business, but it does come with a consequence once the land becomes a partnership asset, the partners stop owning land and they then have an interest in a partnership which is something rather different and conceptually a little bit odd, but it does bring the land within the net of the rules of the partnership agreement, or, as you've just discussed, the partnership Act which can be which can lead to those unexpected results.

Guy

And also Tim, just to point out at this stage, that in very broad terms partnerships are transparent for UK tax purposes, so unlike a company for example whereby companies are separate personality and has its own tax profile, pays corporation tax etc., that's not the case with the partnership whereby both from an income tax and capital gains tax perspective each of the partners is considered separately and the partnership itself is transparent, so those incoming gains are taxed on the partners individually.

Tim

Exactly and they are a slightly curious beast in that respect, even an LLP, a limited liability partnership, is treated in that way for most tax purposes, despite the fact that it is a sort of quasi corporate and is registered at the company's house and all that sort of thing. The partners or members in the case of an LLP are still taxed on that on a transparent basis.

Sian

So of course the thing about partnerships is that they're run by people, and so you can have the most beautifully and well-crafted partnership agreement that Tim or Guy might have been involved in preparing, and things can still go wrong and when they do partnerships, particularly where their land partnerships, things can become very difficult often the parties are related, often they live cheek by jowl on the same farm or estate, you can end up in a situation where you have a combination of a bit of divorce, a bit of neighbours at war with highly valuable assets often in terms of the land base that they're arguing over, and the personalities and difficulties can arise as a result of personality clashes or new members coming into the fold through marriage, somebody dying, all sorts of life events can alter how people feel about the business arrangements that they have in place and then even with a really well-crafted partnership agreement you can find that the dispute has arisen and unpicking that is the challenge that Maddie and I step up to at that point.

Guy

And so how do you manage those more relationship based events, it's easy if you do have a lovely partnership document as a lawyer you can point to that, all well and good, but actually I imagine from your perspective you need a bit more to be able to bring people together rather than just, dare I say, legal terms.

Sian

Yes absolutely with careful handling you may find a solution, well we aim to find a solution, but they often take a long time to resolve actually these types of disputes. We have some that have been rumbling on for a number of years and that's because the parties will do a dance of ebbing and flowing in terms of how enthusiastic they are about finding a solution, working through with them what that solution might be and trying to help them to be as open-minded as possible about what a solution might look like, and I often remind them that at the end of the day they may still have to be seeing each other over the garden wall or across the other side of a field and so burning bridges is not always the best way to resolve things, often it needs to be a little bit more nuanced than that.

Maddie

A lot of what we end up with depends on having quite a detailed understanding of what the parties want and can live with, because often a deal is not likely to be the preferred outcome for either side, it's likely to be something that's a compromise that both sides can live with, and it's working out where we can get that provides, if it's a partition for example that you're looking at then you're trying to work out whether there is enough there to have two viable businesses at the end of it and working out how you work through that, whereas sometimes if there simply isn't enough to do that then you are needing to look at whether perhaps a more pragmatic approach is for one side to be buying out the other, for example, so it's quite flexible.

Tim

And there's quite a lot that we can try and anticipate at the outset of these things isn't there, we can put in provisions around buyouts, around exits and all those sorts of things, but it is in the moment sometimes difficult to get people to recognise that that is what they agreed five years ago, seven years ago, whatever but it's not to say that you shouldn't try at the outset to try and get things right, and try and think into the corners of where the tensions might be.

Sian

That's right and often these things can have been rumbling on at a lower level for many, many years and unpicking some of that is part of the trick as well, and of course people's priorities change, something that they might have signed up to seven years ago perhaps when they weren't married and didn't have children for example, or the grandfather was still alive and everybody expected certain things to happen and then things have changed, so these things can be agreed with the best of intentions and then the parties can find that it doesn't suit their purpose later down the line.

Tim

We've been mainly talking about sort of family businesses here, haven't we, which is what a lot of land businesses are isn't it, but I suppose the same does go for say a professional partnership doesn't it, again it's people working together, things change, businesses evolve and personalities don't always rub along together.

 

I suppose in those contexts would we tend to focus more on things like good leavers, bad leavers, people coming in at different stages having different abilities to make decisions and that sort of thing?

Sian

Yes absolutely and having a clear exit arrangement where when the parties find they just can't work with one or more of the others is really important as well as ensuring you have provisions in place, perhaps non-compete provisions or things that mean that you aren't going to have difficulties further down the line when somebody does exit. But yes the clearer you can be in professional partnerships about what might happen when one or other of you goes, the better.

Guy

Of course like any business, circumstances change and people's approaches to the business may change and there might be some disagreement between the partners, but I think what we're saying here is it's not the black and white, it's not everyone's getting along or everyone's in court, there is a middle ground there for the partners and actually finding a solution, or perhaps changing the terms of the partnership to suit, is what is needed in some circumstances.

Tim

Yes I think that's right Guy, I think one of the good and bad things about partnerships is that they are quite flexible, so whilst you have got a framework, a safety net, of what the partnership agreement says, the parties can vary that as they go along provided they will agree, I think the challenge comes where those people are not prepared to move, and that's where you might get Sian and Maddie involved to help.

Sian

Yes I think that's right and I think it's important to note that most of the cases, the vast majority of the cases that we deal with in this context, don't go to court, or if they do at least start the process they don't end up in a full-blown trial, and that's because it's usually not in the party's best interest to deal with things in that way, our role is largely to help parties to find a solution that works for them through means that are more flexible than you might be able to achieve it with a judge hearing your case and making a determination based purely on the law.

 

So mediation is one solution, or one tool that we use to help parties to find a solution, that can be really powerful if the parties are in a mind to try and negotiate and compromise, but there will be many steps along the way where we can help them to try and find a position that works for everybody. I think we find that the hard litigation approach generally isn't right for many of these cases, wouldn't you agree Maddie?

Maddie

I would agree, absolutely. I see going through the full court process, going to a trial, occasionally that is necessary if the parties really can't reach some other form of agreement, but it is quite a blunt instrument, it lacks the nuance that you can achieve through a negotiated settlement, a negotiated deal, and actually if we can achieve something that provides a more favourable outcome for all of the parties that is something that we would always try to do.

 

Ultimately a lot of the time our clients and the other side are related to one another, they do need to be able to in some shape or form communicate going forward, and actually going through an adversarial court process, the whole way through that, with a perceived winner and loser, or with a sale of the property and split the proceeds, it is unlikely to achieve an ongoing relationship that's in any way healthy, whereas actually if we can achieve a negotiated settlement that may well be more nuanced, more flexible, more advantageous for everyone involved, so we do mediate, we do negotiate, we have without prejudice discussions, there are any number of different ways in which you can resolve a dispute between the partners.

Tim

I think one of the good things about the negotiation is being able to agree a tax efficient solution, isn't it as well.

 

In the context of a land business, lots of the settlements we see will involve moving land around, moving assets around, all of which will have a tax consequence, and given the values involved, there can be a lot of tax at stake there, so one of the things that we do a lot of is working together to try and work out what a tax efficient solution might be, that's not to say that the tax drives the deal, but I think it should be something that's very much in people's minds as they negotiate, because it would be a real shame to get to the end of a deal and then for somebody to pop their head up and say well that's going to give you an enormous tax bill that may derail the whole thing.

Sian

I think it is worth adding at this point that we've talked a lot about the contentious side of partnerships and when things go wrong, but actually we don't see any more disputes in the partnership world than we do in any other form of business arrangement.

 

There are disputes in companies, whatever the setup where you've got people involved, there is the potential for a dispute to arise and the joy and benefit of a partnership is that it does give you that flexibility that Tim's already mentioned, there's real scope to be quite creative about how you deal with assets, how you deal with departures, how you deal with running the business generally, and I do see them as a very positive vehicle for many, many people to work with.

Tim

Thanks again for listening to Death and Taxes, a Private Client podcast from Burges Salmon. You can find out more about Burges Salmon and our team at Burges-Salmon.com, or on our LinkedIn page. In our next episode, Guy will be discussing how we at Burges Salmon work with entrepreneurs throughout the lifecycle of their businesses.

 

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