I have a client partnership which has begun discussions with another partnership with a view to their joining forces. How can this be done and what would be the tax consequences of a partnership merger?
It is perfectly possible for
partnerships and LLPs to merge. For an LLP merger there will be company law aspects which are not considered here.
If the partnerships carry on different activities, and the new combined firm is going to carry on a new business which is different from either of the two predecessor partnerships, then there will be a cessation of the old partnerships and the commencement of a new partnership. The cessation/commencement provisions of ITTIOA 2005 will therefore apply, and consideration will need to be given to relief for overlap profits.
It is assumed in the following paragraphs that all the partners are individuals.
HMRC’s Business Income Manual at BIM82410 states the following in respect of the rules on the cessation of previous businesses and commencement of new business:
‘At the "merger" of business A and business B a new business (business C) may be created which is entirely different in nature to either business A or business B.
‘In such circumstances, as a question of fact, the two original businesses have ceased and an entirely new business commenced.
‘The normal cessation rules apply both to business A and to business B and the normal commencement rules to business C.
‘This means that partners in businesses A and B will crystallise their overlap relief in relation to both their "notional trade" in terms of their trading profits and their "notional business" (if they have one) in terms of their other untaxed partnerships income. These persons then become partners in business C and are taxable on the trading profits and untaxed income of that new partnership on an actual basis, from the date of commencement to 5 April.’
ITTOIA 2005 s 852 deals with the rules for the commencement and cessation of the notional trade, and ITTIOA 2005 s 205 deals with overlap relief in the final tax year of a trade.
If the new venture is essentially a continuation of each of the old partnerships albeit under a combined business, then there will be no cessation/commencement for tax purposes. The new LLP will simply succeed to the business of the old partnerships. Unless both partnerships make up accounts to the same date, there will probably be a need to change to an agreed new date and this may lead to overlap profits arising (or overlap relief being utilised).
HMRC’s guidance at BIM82415 states the following in respect of the continuation of previous businesses as a merged joint business:
‘Where the activities of business A and business B are similar in nature the activities of "merged", business C may have the same essential characteristics as both business A and business B.
‘Taken in isolation this merged business may properly be described as a single business (business C). Otherwise no merger has taken place and business A and business B are simply continuing side by side under common ownership. Considered in this context the new business can also be described as an enlarged version of either business A or business B, In such circumstances business C has "succeeded" to business A and/or business B.
‘If the newly merged business has the same accounting date as the previous businesses, all the partners in the merged partnership will continue to be taxed on the trading profits arising on their notional trade and the other untaxed partnership income arising on their notional business under the general rule. The general rule is that the basis period for a tax year is the period of 12 months ending with the accounting date in that tax year.
‘The newly merged business may have a different accounting date to one or more of the previous businesses. In such a case, the partners moving to a new accounting date upon merger will be treated as having changed their accounting date and the usual rules apply.’
The rules for changes of partnership accounting date are dealt with at ITTOIA 2005 ss 214–220 and s 853.
As the business is deemed to continue, this means that the tax treatment of any trading losses brought forward is unaffected.
For capital gains purposes, generally a merger can be effected without crystallising chargeable gains. Technically there is a deemed disposal of fractional shares of assets of each predecessor partnerships and a corresponding acquisition, but no actual tax charge should arise. If gains do arise (possible if consideration passes outside the accounts or if any of the partners are connected other than through the partnership, for example father and son), then rollover relief under TCGA 1992 s 152 will apply to qualifying assets such as goodwill. The rules are set out in Statement of Practice D12 which is summarised in HMRC’s Capital Gains Manual at CG27150 and in more detail in respect of partnership mergers at CG27700.
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