Partnerships or LLPs which include among their members one or more companies (“Corporate Partnerships”) are a fairly widely-used structure, for a number of tax and commercial reasons. The Autumn Statement of 5 December 2013 announces significant changes to the taxation of some members of Corporate Partnerships, which we explain below. In this note we use the term “partner” to include both a partner in a conventional partnership and a member of an LLP.
When do the changes come into force?
They apply to accounting periods which begin after 5 April 2014. But an accounting period which straddles 5 April 2014 is deemed to end on that date and a new one to commence on 6 April 2014. The new rules apply to this second notional accounting period.
What are the implications of the proposed changes for Corporate Partnerships?
First, it is important to understand a partnership is not itself charged to tax: the tax charge lies on the separate partners. So within a single partnership, the proposed changes may affect partners differently, or may affect some partners but not others.
Second, it is clear it will no longer be attractive to be a “mixed partner.” By this we mean being a partner both as an individual and via a company whose profits you have “power to enjoy.” That term is very widely defined to include, broadly, any arrangement through which you are connected with the company or can (directly or indirectly) enjoy any part of the company’s profits. In the case of such “mixed partners” the corporate partner’s profits will, broadly speaking, be charged to tax as income of the individual except to the extent that they represent a reasonable return on capital. Where more than one individual partner in the partnership has “power to enjoy” part of the company’s income, the profits will be allocated between the partners on a “just and reasonable” basis.
What about pure corporate partnerships (PCPs)?
The position of “pure” corporate partnerships (that is to say, partnerships which include as partners one or more companies but do not include any individuals who have “power to enjoy” any part of the profits of any corporate partner) is not so clear-cut. Essentially, there is an anti-avoidance rule which brings a PCP within the new rules if (in the words of the draft legislation) it is “reasonable to suppose” that there are one or more individuals who would (personally) have been partners in it had it not been for the existence of the new legislation on mixed partnerships described above. In that case the legislation operates in regard to any such individuals as if the partnership were a mixed partnership with profit re-allocated to the individual “deemed partner” as appropriate. The difficult question left unanswered by the legislation and by HMRC guidance is – in precisely what circumstances is it reasonable to make that supposition?
HMRC’s published guidance of 10 December gives just two examples of this.
One example is where an individual is not directly a member of the LLP in question but is a member of an LLP which is in turn a member of the LLP in question: in other words where he has contrived to avoid technically being a member of the LLP but has achieved substantially the same economic effect.
The second example is where the partnership has previously been a “mixed partnership” but the individual has resigned from the partnership in order to avoid its being a “mixed partnership” within the new rules. In that case the resignation is effectively ignored and the partnership is treated as continuing to be a “mixed partnership”. This part of the anti-avoidance rule plainly cannot apply if the resignation occurred before 5 December 2013; and for resignations on or after that date the question whether the resignation would have taken place “but for” the introduction of the “mixed partnership” rules is one of fact.
We now understand that HMRC consider that a partnership which was in existence on 5 December, has always been a PCP and continues to be one is not within the new rules. Furthermore, a new corporate partner joining such a PCP will normally also be outside the new rules provided it can be shown that the discussion which led to the new company becoming a partner proceeded on the basis that its position would be aligned with those of existing partners and that the adoption of the structure was not driven by a desire to avoid the new rules.
On the other hand, it seems at present to be HMRC’s view that a completely new corporate partnership established on or after 5 December 2013 may fall foul of the anti-avoidance rule. HMRC’s view seems to be that one would need to consider why, as a matter of fact, the corporate-only structure has been adopted. If the companies are newly formed for the purpose of acting as corporate partners, and there are no obvious reasons for having corporate members apart from a desire to avoid the tax which would come from being partners personally, the anti-avoidance rule might be triggered. Alternatively, if the partnership has been formed to carry out a particular joint venture involving individuals who have traditionally adopted a PCP for similar ventures in the past, then this would point in the other direction. We are not at all sure that HMRC’s view can be supported by reference to the draft legislation: but it is as well at least to know what HMRC’s view is.
Are property investment or property development partnerships affected?
Although HMRC’s main target in introducing the new rules seems to be businesses operating in the professional and financial services sectors, the rules are in principle capable of applying to all partnerships, whether trading, professional or investment. However, their application to property businesses raises particular issues.
As described above, the general rule is that where there is a “mixed partnership” (i.e. where the partnership includes both an individual and a company whose profits he has “power to enjoy”) the company profits are attributed to and taxed on the individual except to the extent that they represent a reasonable return on capital. So in the context of a property business, where a company may be advancing substantial amounts of capital, the amount of the “reasonable return” may be significant. However, recent changes to the rules on the taxation of “loans to participators” may create unwelcome tax charges which make “mixed partnerships” unattractive even for property activities.
More commonly, property partnerships will be pure corporate partnerships and the question will then be whether the anti-avoidance rule is engaged: is it “reasonable to suppose” that there are one or more individuals who would (personally) have been partners in the partnership had it not been for the existence of the new legislation? HMRC’s confirmation, above, about individuals who have traditionally adopted a PCP for similar ventures in the past may be helpful; and where the equity being invested in a property partnership business already resides in a company, that may well be a justification for running the business through a corporate partnership rather than one involving individuals as partners. Much will depend on the facts of any particular case.
Background to the changes
The first indication that corporate partnerships had attracted the attention of HMRC was in a Consultation Document first issued in May 2013. In outline the proposal covered two areas. The first was to recharacterise certain “fixed profit” members of LLPs as employees for tax purposes; the second was a measure aimed at partnerships and LLPs which included as members both individuals and companies in which the individuals have an economic interest (so-called “mixed partnerships”) with a view to taxing individual members on the profit of “their” companies. Consultation closed in August 2013.
The “Autumn Statement” of 5 December 2013 included the following announcement of HMRC’s considered response to the consultation process:
At Budget 2013, the government announced a review of partnerships primarily to counter the use of limited liability partnerships to disguise employment relationships and the tax-motivated allocation of business profits to corporate partners, which are generally taxed at lower rates than individuals. During the consultation, the government received new information showing the impact on alternative investment fund managers who operate as partnerships will be greater than anticipated. The government is confirming that it will take forward these proposals and the expected yield from the measure has now increased to £3.27 billion from 2013-14 to 2018-19.
The response is further explained by the following extract from HMRC’s “Overview of Tax Announcements” issued on 5 December.
Partnerships review: partnerships with mixed membership
The first element of the partnerships review measure will affect mixed membership partnerships where partnership profits are allocated to a non-individual partner in circumstances where an individual member may benefit from those profits. The second element will affect cases where partnership losses are allocated to an individual partner, instead of a non-individual partner, to enable the individual to access certain loss reliefs. The changes will take effect from 6 April 2014 with the exception of anti-avoidance rules concerning tax-motivated profit allocations. These rules come into force from 5 December 2013 in order to protect against risks to tax revenue.
Finally, on 10 December HMRC issued 117 pages of draft legislation and technical guidance: access it here if you dare. This also includes other proposals on partnerships including the re-characterisation of “fixed profit” partners as employees for tax and NIC purposes: see our briefing note on that aspect here.