The Importance of Partnership Agreements
Having been under a number of different pressures over recent months, many of us are thinking about our families and longer term plans for the future. There has been a lot of reflection about succession and how to enable the process of handing down wealth to the next generation to be as smooth and clear as possible. Part of this is ensuring that the documentation in place governing the business relationship is clear and comprehensive and that Wills are up to date.
For partnership businesses a formal Partnership Agreement is central to this, setting out the key terms on which the partnership is based, including each partners’ entitlement to profits and to the capital value of the partnership’s assets.
In many family farming partnerships, the farm typically constitutes the majority of the family wealth and is often held as an asset of the partnership. Even a modest farm may be worth a significant amount so it is important to understand who is entitled to the value of the farm so that succession plans can be prepared confidently.
Under the Partnership Act 1890, all partners are entitled to share equally in the capital and profits of the business, subject to any agreement to the contrary.Without clear agreement specifying otherwise, many partnership arrangements may pass part of the capital value of the farm to incoming partners unintentionally, which can complicate matters unnecessarily when it comes to handing those assets down.
Many parents bring their children into the family business as partners to give them clarity and responsibility and as recognition of their contribution to the business.As the new partners may still be relatively young and not yet settled, initially it may not be a sensible time for them to acquire an interest in the capital value of the farm. Without clear agreement that the new partners are not entitled to the value of the farm, they may inadvertently acquire an interest in the farm where it is held as an asset of the partnership.Whilst this may not necessarily create an immediate issue, it has the potential to cause problems in the future.
With the pressures of farming and working closely with family members, the industry is unfortunately experiencing an increasing number of unexpected family fall outs, which sometimes result in a partner leaving the business.Where the outgoing partner has entitlement to the capital value of the farm, they are often due a substantial sum of money on their retirement from the partnership.Where cash isn’t readily available this may require the sale of land or other assets and could stifle the business for several years.
With these increasing pressures there is also a rising number of divorce cases.It is possible that a partner’s share in the capital value of the farm is taken into account in the settlement.
Another potential issue is that there may be assets, such as let cottages, held by the partnership but earmarked to be left to non-farming children.Where parents have unintentionally passed an interest in these assets to the farming children on their admission to the partnership, those children could prevent those assets from being removed from the partnership and transferred to their siblings.
A carefully drafted Partnership Agreement can prevent such issues from arising.It would clearly set out each partners’ entitlement to profits and the capital value of the farm, together with other key matters such as the payments terms for an outgoing partner’s interest in the business and decision making mechanisms.
Whilst a Partnership Agreement may seem like an unnecessary expense whilst the partners enjoy a positive working relationship, we strongly encourage all partnerships to consider having an agreement drawn up.Without a comprehensive agreement in place, the legal costs that may be incurred on a future partnership dispute could cost thousands, in addition to the potential unexpected cost of paying an outgoing partner a share of the market value of the farm.
A Partnership Agreement can be considered as a type of insurance policy.For a modest upfront cost, the farm can be protected for many years to come from unforeseen, unintended and unnecessary complications.
At Evolution ABS, we work closely with our clients and their solicitor to ensure a suitable Partnership Agreement is prepared with the primary aim of creating a robust rule book, but also ensuring it supports the family’s tax position and access to tax reliefs to assist the succession process.
If you do not have a Partnership Agreement, or if you have one that has not been reviewed for a number of years, it would be a very worthwhile and proactive exercise to explore how the family and business position could be clarified and optimised. If it would be useful to discuss this please do not hesitate to contact us and we would be pleased to help.
Victoria Paley ACA CTA
Senior Tax Manager
Victoria joined the practice in July 2019 having worked in accountancy and tax in the rural sector since 2010. As a Chartered Accountant and Chartered Tax Adviser Victoria spends most of her time advising family farming businesses on Capital Gains Tax and Inheritance Tax matters primarily in relation to succession planning and capital transactions.