Sale of partnership interest
- John Deane
- Updated: Wed, 7th Dec 2016
We advised a partner on the sale of his partnership interest in a financial services trading business.
Dealing with the intricacies
We managed to:
- Unwind the partner’s beneficial interest in an offshore trust holding company.
- Ensure payment of the earn outs.
- Manage the director’s resignation process.
- Structure a deal which extracted capital and provided security for the earn outs.
Sale of partnership interest
We advised our client of the difference in tax treatment between unpaid drawings and capital payments:
- Unpaid drawings would be subject to the rate of income tax and national insurance applicable to self-employed earnings.
- Capital payments made for sale of our client’s equity holding to the remaining partners would be subject to capital gains tax.
- Capital gains were taxed at lower rates of tax than self-employed earnings.
Addressing the tax position
We reviewed the income and capital accounts of the partnership. We valued and obtained agreement that our client’s equity interest was worth £2 million, which other partners purchased from him on leaving the partnership.
We also advised on the taxation of the earn out payments, and recommended a different basis of taxation. We analysed whether our client should pay tax on the up front benefit, or pay tax as the earn out arose:
Pay tax on the up-front benefit
Our client could pay capital gains tax on the up front benefit of the estimated value of the earn out. Entrepreneurs’ relief, giving an effective rate of capital gains tax of 10%, was available if he paid tax up-front on the earn out. However, the tax would be based on the contingent value, and that value may not be received.
Pay the tax when the earn out arose
Alternatively, our client could defer the capital gains tax payment until when the earn out was paid. Although he would pay tax on the sum actually paid, the rate of capital gains tax would rise to 18%.
We drafted a settlement deed. This clearly set out the drawings, and distinguished them from the capital payment for his partnership interest. The settlement deed included various other provisions as highlighted below.
Resignation of directorships in associated companies
We advised our client to resign from all directorships. This eliminated any risk of being a company director of a business, with which he was no longer involved. That reduced the risk of him being considered a partner in the business, if the business were to proceed to make poor management decisions after his exit.
We negotiated severance payments on ceasing to be a director. These payments qualified for the £30,000.00 tax exemption currently permitted by HMRC, on payments made on a voluntary non-contractual basis following termination of an office.
We submitted the required filings to Companies House.
Unwinding the beneficial interest under offshore holding company trust
Some partners were not domiciled in the UK for tax purposes and were non-residents. However, the tax reliefs available to such partners were not available to our client. Our client was UK domiciled and resident in the UK.
The structure of the trade was complex. It required care to extract our client from his beneficial interest under the trust, and achieve a clean break. We included a provision in the settlement deed:
- that blocked the partnership from diverting profits abroad to decrease the value of our client’s partnership interest and in turn reduce the available earn out.
We liaised with overseas lawyers running the holding company on the trust aspects.
Documenting the earn out
The earn out was based on tail end commissions and payments. These had been hedged for several years. We included in the settlement deed:
- Provisions to inspect the accounts;
- Access to records of the partnership; and hence,
- Visibility on income received by the partnership after he had sold out, so our client could calculate the earn out payments due to him.
We discussed the retention of funds in escrow to cover the substantial part of the earn out to provide security for our client. We negotiated an agreement from the other partners in the settlement deed that:
- There were no factors they were aware of which could give rise to non-payment in the future.
- In return our client was locked into restrictive covenants whereby he would not join a competitor or set up a competing business.
We negotiated the restrictions to ensure our client had the freedom in practice to pursue new business ideas. Detailed definitions proved to be important.
We obtained clearance from HMRC that the sale did not amount to a transaction designed to avoid tax. This gave the parties a degree of certainty to proceed to signing.
A new business for our client
Several months later our client set up a new business. We advised on the structure, and prepared new articles, the shareholder’ agreement, and director service agreements. That business is running with funds obtained from the initial exit.
Leaving a partnership or an LLP can be a daunting process, particularly where the departing individual has been involved for a number of years. John Deane heads the partnership and LLP team at Gannons. We aim to streamline the process for the parties involved, by providing the necessary legal, tax, and commercial advice.