Sale of partnership interest

Our role in the sale of the partnership involved handling several intricate processes on behalf of a key partner to ensure that the transaction proceeded smoothly.  We explain some of the stages we considered.

Sale of partnership interest

We guided our client on the difference in tax treatment between unpaid drawings and capital payments when advising on the sale of his partnership interest. This included taking care of aspects such as:

Unpaid Drawings

Unpaid drawings would be subject to the rate of income tax and national insurance applicable to self-employed earnings.

Capital Payments

Capital payments made for the sale of our client’s equity holding to the remaining partners would be subject to capital gains tax.

This is because capital gains are 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.

Earn Out Payments

We then analysed the taxation of the earn-out payments, in order to recommend to our client whether he should pay tax on the up front benefit, or pay tax as the-earn out arose.

Paying the 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. If he paid tax up-front on the earn-out, then Entrepreneurs’ relief, giving an effective rate of capital gains tax of 10%, was available. The tax would be based on the contingent value, however, and therefore that value may not be received.

Paying the tax when the earn out arose

Alternatively, our client could defer the capital gains tax payment until after receiving the earn-out. Although he would pay tax on the sum actually paid, the rate of capital gains tax would rise to 18%.

Settlement deed to end partnership claims

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.

We ensured that the settlement deed allowed our client provisions to inspect the accounts and access to records of the partnership. This meant that the partnership was transparent over the income they  received after our client had sold out. Hence, our client would be able to accurately calculate the earn-out payments owed to him.

HMRC clearance

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.

Unwinding the offshore interests

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 we liaised with overseas lawyers running the holding company on the trust aspects to help achieve a clean break.

Ultimately 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 which in turn would reduce the available earn-out.

Documenting the Earn Out

The tail end commissions and payments determined the earn out amount. These had been hedged for several years.

Securities

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 that our client would be free to pursue wholly new business ideas. Detailed definitions proved to be important in this case.

The next chapter

Several months after the sale of the partnership, our client set up a new business. We advised on the structure, and prepared new articles, the shareholder’s agreement, and director service agreements. That business is running with funds obtained from the initial exit.