However, that gift horse should be approached with care; it has hidden teeth that might bite the unwary.

To understand why we think care is required, four important points must be appreciated:

• the liability to pay tax before 31 July 2020 is that of the individual partner – not the firm;

• money held by the firm to enable the partners to pay their tax may already be a debt due from the firm to the partner;

• management committees may not have the power to decide not to pay HMRC; and

• even if management committees have the power, they may owe a duty of care to the partners when exercising that power.

There will of course be considerable discussion ahead of the 31 July deadline about the financial impact the coronavirus is continuing to have on “the business” and steps that “the business” can take to alleviate that impact.  However, there is a risk that in such discussions lines may become blurred between “the business” and the individual partner liable to pay tax. In such circumstances, there is a risk that too little attention will be paid to who is liable to pay HMRC, who has the authority to decide to defer, who has control of the money and what the consequences of that decision might be.

In our view those with management responsibilities in limited liability partnerships and traditional partnerships, and the individual partners in such business must be much more rigorous in their consideration of the tax deferral question.

A warning to management

Most well drafted membership and partnership deeds will include provisions about when the profits of the business are “allocated” to the partners.  When profits are allocated, they become a debt due from the business to the partner. 

In firms where allocated profits are paid to the partners gross, the partners will have control of the funds and will sort out their own tax payments to HMRC.  However, in firms where partners receive profits net of tax, the firm retains the amount which has been estimated as the tax liability of the partner for the relevant period.  This retained profit is often ‘credited’ to a “tax reserve” account for the partner and the terms of the deed set out how sums standing to the credit of that tax reserve account will be paid to HMRC by the firm on behalf of the partner, or otherwise dealt with by the firm.   

For firms operating tax reserve arrangements, any consideration of deferring the tax payment of the individual partner to be made in July 2020 must begin with a careful review of the terms of the deed.  If, for example, the terms stipulate that allocated profits credited to a tax reserve account “shall” be paid to HMRC on behalf of the partner, the management committee of the firm may have no power to take advantage of the Government proposal to defer payment until January 2021. If the firm did decline to pay HMRC in July 2020, partners opposed to the deferral may have a claim for breach of the deed and the management committee may be liable to claims for breach of duty. 

If the management committee insists that advantage must be taken of the opportunity to defer the July 2020 tax payment, they may be forced to consider amending the terms of the deed in accordance with the agreed mechanisms for amendment and accept that they may need to secure the partner votes required for such an amendment.

Even if the deed does provide the management committee with a discretionary power in relation to how it may deal with partners tax reserve accounts, when exercising that discretion management committees must have regard to duties which they may owe to the individual partners. It is established law that individuals with management responsibility in traditional partnerships may owe a duty of care to partners in relation the way in which they fulfil those management responsibilities. Accordingly, when discharging a management function, any breach of a duty of care owed may result in members of the management committee being personally liable to a partner for any loss which results from a breach of that duty.

In limited liability partnerships the position is perhaps less clear, but even if the members’ agreement does not expressly state that members of the management committee owe a duty of care to the other members, there may be circumstances where a duty of care is owed either in tort or as a result of a term being implied in the members’ agreement.

The existence of a duty of care owed by members of a management committee will no doubt be examined if the ongoing financial difficulties caused by the coronavirus result in the businesses becoming insolvent before January 2021 if the tax liabilities of the individual partners have not been paid.

It should not be assumed by management committees that they have the authority to make decisions deferring the tax payments of individual partners and it should not be assumed that they cannot be held personally liable for the decisions they make.

A warning to individuals

Regardless of whether a firm operates a tax reserve arrangement, it is the individual partner that has the obligation to pay tax to HMRC; if the tax is not paid HMRC will claim against the individual for the payment of the tax (and any interest and penalties). The obligation and the liability do not change because the firm has an internal tax reserve arrangement and it will be no defence to a claim by HMRC to say that the money was in a tax reserve account controlled by the firm.

Individuals are also sometimes unclear about the nature of tax reserve accounts. It is a common misconception that firms with tax reserve account arrangements open a separate bank account into which part of a partner’s allocated profit share is paid and which is available to pay that partner’s personal tax liabilities.

The reality for most firms is that allocated profits not distributed to partners are effectively used as working capital for the business without being formally (or legally) classified as capital. Capital is an investment made in a firm by a partner and which that partner intended to be risked; it is very different from a debt owed by the firm to the partner.

When an individual partner considers the Government proposal regarding deferring tax payments from July 2020 to January 2021, it must be understood that this means that the partner may wish to consider deferring their personally liability to pay HMRC. It the partner is in possession and control of funds to pay HMRC in July 2020 then that partner will have the ability to ring fence the funds and ensure they will be available in January 2021.

But it is different if the funds are in the possession and control of the firm.  The partner will have a debt owed by the firm of the amount credited to the tax reserve account. However, if the firm became insolvent without having paid HMRC the sum credited to the tax reserve account, while the partner would have a claim against the insolvent business (and possibly the members of management committee personally) that partner would still be liable to pay HMRC the tax which was due in July 2020.

Any individual asked by a management committee to agree to defer their July 2020 tax payment and leave the money in the control of the firm as a debt – must consider the level of risk they will be taking personally.  The question is whether the individual will have enough resources to pay both the July 2020 and the January 2021 tax payment if the debt owed to them by the firm (the tax reserve account credit) has not been paid by January 2021 (perhaps because the firm is insolvent or perhaps because of cash flow issues).

It’s not a straightforward matter – the partner will have an interest in the firm having the financial strength to survive the effects of the coronavirus, but they will also have personal circumstances which they will want to take into account (and be taken into account by others) when considering deferring a tax payment.

Conclusion

Fundamentally, a decision to defer paying tax due by July 2020 is a decision to be carefully considered by the individual liable to pay that tax. If management committees consider it necessary or appropriate to take a decision on behalf of the individual, they must be very clear that they have the power to do so and have regard to any duty of care owed to the individual. If businesses survive the coronavirus and all its consequences then the decision may never be revisited, but if an individual becomes exposed to a liability as a result of the July 2020 tax payment being deferred by a decision of others, one can expect that decision to be very carefully scrutinised.