WIP uplift

What are the tax consequences for retiring, continuing and incoming partners where there is an uplift in work in progress (WIP) in professional partnerships?

This is required by the retirement deed and a set of 'retirement' accounts will be drawn up with WIP valued at selling value and with the retiring partner credited with his share of the revaluation.

In the actual accounts, WIP will be written back down to cost. How should the revaluation be treated as regards all the partners from both an accounting point of view and for taxation purposes?

Statement of Practice D12 deals with partnership matters, but seems to be concerned with capital gains tax. If the revaluation and subsequent write back of the valuation of WIP are covered by this, it implies that the payment to the outgoing partner is a further payment for goodwill subject to capital gains tax and the continuing and incoming partners will therefore be charged to income tax on the whole of the profit when it is ultimately realised.

If this is the case is there any relief for the payment to the outgoing partner for either capital gains tax or income tax, and who gets the relief? Should there be any entries in the actual partnership accounts?

Alternatively, the uplift could be dealt with by way of an additional allocation of profit. When the profit is actually realised, either the continuing partners, or if agreed the continuing and incoming partners, are taxed in the next period.

Which do readers think is correct?

(Query T16,511)

We were faced with almost exactly these circumstances three years ago on the retirement of a partner. We spent some time working out the ‘correct’ way to approach the problem – and ultimately submitted on the basis set out below with full disclosure and with no query from the Revenue.

The key to the correct treatment is to recognise the commercial reality of what is happening. The retiring partner is, in effect, selling his part of the work in progress (WIP) uplift as at the date of his retirement to the continuing (and possibly new) partners at a price in excess of cost.

It thus follows that, as at the date of the accounts (at which point the partner has retired and has accrued his right to his share of the WIP uplift), the profit is actually realised as regards the partnership. The tax accounts must therefore recognise this.

The correct procedure is thus to:

1. calculate the uplift attributable to the retiring partner in the ‘retirement accounts’;
2. prepare the tax accounts as normal and then make an entry to debit WIP in the balance sheet and credit closing WIP in the trading account with the amount of WIP uplift attributable to the retiring partner only;
3. allocate the additional profit arising to the retiring partner.

Of course, in the tax accounts for the following period, the opening WIP in the trading account will be the previously uplifted figure, so the taxable profits will be lower in that following period. That makes perfect sense, of course, because the continuing partners have purchased that opening WIP at that higher figure.

The debit arising from the amount by which the profit was previously uplifted should, in equity, result in a reduction of the following period profit shares of those partners who funded the paying out of the retired partner.

However, that is a matter for agreement between the partners. It could, for example, be debited to the profit share of an incoming partner who took over the portfolio of the retiring partner.

What is clear is that this is nothing to do with capital gains or goodwill. The valuation of WIP simply determines the accounting period in which profits are taxed. The retirement of a partner cannot somehow convert that process into capital or goodwill. – MBK.

I wonder if there is a simple answer to this question? It seems to me that what we are saying is that the outgoing partner has earned income, which has not yet been billed, but by the time that it is billed he will have left the partnership and will thus not receive his ‘due’.

Presumably, therefore, we want to ensure that he receives this amount and that it will be taxable in his hands rather than the continuing partners. Would not a simple answer be, as required by the partnership’s retirement deed, to prepare a ‘retirement account’ to calculate the amount of WIP that relates to our outgoing partner and simply enhance his normal share of the partnership profits for the final period of account by that amount? The balance of the profits will be divided between the incoming/continuing partners in the normal way.

The ‘downside’ is that the outgoing partner is subject to income tax on this amount at his marginal rate, whereas if he had received an enhanced payment for goodwill this would, presumably, have been eligible for taper relief. The advantage for the other partners is of course the ‘flip side’, in that they have obtained immediate tax relief for the ‘payment’ to the outgoing partner. – The Dude.

Statement of Practice D12 does indeed deal with partnership capital gains only because statements with a ‘D’ prefix relate to capital gains only. It is worth noting that the statement was updated in October 2002, but the old numbering of D12 was retained.

In drawing up accounts to calculate income tax, stock is valued at the lower of cost and net realisable value. That is also the value that will be used to show the partner’s current or capital account. The transaction as suggested by Dilemma is a way of calculating the amount to be paid to the retiring partner. The partner will receive an amount over and above the accounting profits and this will, therefore, be a payment outside the accounts. Under paragraph 6 of the statement will be treated as an additional payment for goodwill.

The payment to the outgoing partner will be an allowable cost to set against the remaining partners’ disposal of goodwill when they come to dispose of their partnership goodwill in the future.

Doing anything to tax the outgoing partner to income tax in the next period would only be possible if the individual has remained as a partner with a ‘funny’ profit share. Is that what the partners want? – New Road.

Issue: 3983 / Categories: Forum & Feedback