Taxpayers who have jointly been doing business in a partnership decide at a certain point of time to go their separate ways and therefore agree on partly or completely terminating their cooperation. In this context, three basic scenarios are conceivable. First, only one of the partners retires from the joint venture and the remaining partners continue their trade in partnership. Second, all of the partners end their business activities and dissolve the partnership. Third, the partners demerge the partnership—each partner receives a specified economic unit of the partnership and continues to pursue the same business activity separate from the other partners.
In terms of taxation, these scenarios raise two issues. First of all, it is relevant whether the individual transaction causes the taxpayer to realize built-in gain or loss—be it in the form of a capital gain or loss, or a balancing charge or allowance. Such disparities may arise if a standardized depreciation method does not mirror the asset’s true decrease in value. Over the course of the partnership’s life, these variations are regularly ignored for tax purposes, leaving the partners with a deferred gain or loss. However, at the time of the partnership’s termination, this deferral typically ends.
Furthermore, partnership terminations may affect loss carryforwards. A partnership may have loss carryforwards because the principle of period taxation limits the computation of income to individual fiscal years. Also, a partnership may have loss carryforwards because of a lack of a loss’s effective hardship—for example, in the situation of a limited partner. These loss carryforwards contain an economic value given their potential to offset future income. Therefore, the maintenance of these losses beyond a partnership’s termination is significant.
This Article aims to clarify the tax situation in the economic settings previously mentioned. To exemplify the relevant tax consequences, it focuses on the rules for partnerships in the U.S., the U.K., and Germany, and Part II showcases these countries’ general taxation principles. Subsequently, Part III analyzes the specific tax implications of a partner’s retirement, a partnership’s dissolution, and a partnership’s demerger in each of the three jurisdictions for built-in gains or losses. Part IV will perform the same analysis for loss carryforwards. Based on these analyses, Part V identifies each country’s inconsistencies and discusses a model taxation system that includes each country’s favorable tax components.