The Budget Statement of March 2013 announced that the government would be reviewing aspects of partnership taxation with a view to countering tax and NIC avoidance. A Consultation Document has now been published. Responses to it are invited by 9 August 2013, to be followed by legislation effective from 6 April 2014. It is, however, clear that it is not expected that the proposals will be substantially changed before enactment: the Consultation Document merely invites views on the detailed legislative design and the detail of implementing the changes.
The Consultation Document will principally be of interest to two kinds of partnership, namely
- LLPs which have individual members who are less than full equity members – so-called “salaried” or “fixed profit” members; and
- Partnerships or LLPs which include as members both individuals and companies which are economically associated with some or all of the individual members.
By contrast, the proposed changes will not affect, for example, partnerships or LLPs where:
- All members are individual full-equity members; or
- All members are limited companies
- Members are a mix of individual full-equity members and companies, but no individual member has any economic interest in any corporate member
Salaried and fixed-profit-share members of LLPs
Under current law any member of an LLP is treated as a self-employed person rather than as an employee. HMRC believe that this gives rise to scope for avoiding tax and NIC by introducing to the LLP individuals whose economic relationship with the business has more in common with employment than with co-ownership of the business. There are thus two circumstances in which individual LLP members will from April 2014 be treated as if they were employees of the LLP (with consequent obligations on the part of the LLP to operate PAYE on payments to the member). The new rules will apply to an individual member if
- On the assumption that the LLP is carried on as a partnership by two or more members of the LLP, the individual would be regarded as employed by the partnership by reference to the normal tests of employment. These deal with matters such as control, the requirement for personal service, financial risk, the ability to profit from sound management, and so on. In some cases it will be plain that the terms on which the “salaried member” is engaged are indistinguishable from employment: in others (especially in “eat what you kill” partnerships) it may be very easy to show that relationship is not one of employment.
- Alternatively, HMRC propose to treat a salaried member as an employee if he or she is not an employee under the first test but is nonetheless someone who:
- Has no significant economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
- Is not entitled to a significant share of the profits beyond the “fixed share”; and
- Is not entitled to any significant share of surplus assets arising on any winding-up of the LLP.
What is “significant” will be determined in the light of all the circumstances and by reference to the overall package: but – for example – an entitlement to a share of profits which in practice would never exceed 5% of any fixed share would be unlikely to be regarded as “significant”.
Action: Over the period to 5 April 2014 partnerships and LLPs will need to consider carefully
- whether any individual member is at risk of being re-categorised as an employee from that date and
- what changes to the relationship may be necessary to preserve the current self-employed status
- the commercial impact of any such changes
A partnership or LLP where some members are individuals and some are companies can have a number of tax benefits. Normally there is either a single company member owned jointly by the individual members; or each individual member owns his or her own personal “corporate member.” Typically, profits of an income nature which are in excess of a member’s immediate requirements are allocated to the corporate member, where they are subjected to tax only at corporate rates. Profits “warehoused” in this way may either be reintroduced to the partnership or LLP as working capital; or invested independently of the partnership or LLP. Normally any capital profits arising from the partnership or LLP are allocated to individual members, where Entrepreneurs Relief may be available.
Somewhat surprisingly, HMRC, having tolerated such structures for many years, have come to the revised view that they are now not acceptable. Accordingly, the proposal is (broadly speaking)
- where the members of a partnership or LLP include both a person chargeable to Income Tax (“P”) and a person not chargeable to Income Tax (“C); and
- a significant amount of profit is allocated to the person not chargeable to Income Tax; and
- there is an economic connection between P and C such that P may benefit in some way from C’s profits; then
- C’s profits are to be taxed on P
Where there is more than more than one partner P who has an interest in C, the profits of C are to be allocated between them in a “just and reasonable” way. HMRC recognise the practical difficulty of doing this where P’s interest in C is contingent or provisional (as it might be in the context of the kind of “profit deferral” arrangement sometimes seen in hedge funds or similar financial businesses) and invites comment on appropriate solutions.
Action: Over the period to 5 April 2014 individual partnership or LLP members who also have an interest in a corporate partner will need to consider the options carefully. These may include any of
- resigning as individuals from the partnership or LLP
- removing the corporate from the LLP
- divesting themselves of their interest in the corporate
Where individuals hold valuable rights as members, consideration will need to be given to how those rights will be held after resignation:
- Can they continue to be held personally outside the partnership?
- Should they be transferred to a continuing corporate member?
In some cases a fundamental re-think of the operating structure may be necessary:
- Is incorporation of the business now a desirable option?
- Can aspects of the business be hived-down or sub-contracted into a more tax-efficient structure?
The Consultation Document also seeks to counter two kinds of tax avoidance scheme, which are of a quite different character to the mixed partnership structure described above and may already be challengeable under existing legislation. Since we have not generally promoted or recommended these schemes we cover them only briefly in this note.
These are “loss schemes” and “sale of income” schemes. In the first, tax losses (typically in excess of commercial losses) are allocated to individual members of a partnership or LLP and tax relief given at Income Tax rates, while in subsequent years income is allocated to a corporate member and taxed at much lower corporate tax rates. These are to be countered by simply denying Income Tax relief in appropriate circumstances. “Sale of income” schemes typically involve a partner (who may be an individual or a company) “selling” a right to share in partnership profit and receiving in return a payment which is either untaxed or taxed at a much lower rate than would have applied had the profits “sold” been received. This is to be countered by taxing the amount received in the same way as the profits “sold” would have been taxed.
For further information, please contact your usual lead partner at BKL.