As announced in the 2013 Budget, the Government is consulting on changes to two aspects of the partnership tax rules.
The reason for this is to prevent an Her Majesty's Revenue and Customs (HM Revenue and Customs or HMRC) is a non-ministerial department of the UK Government responsible for the collection of taxes, the payment of some forms of state support and the administration of other regulatory regimes including the national minimum wage.... More perceived tax loss arising from disguising employment relationships through limited liability partnerships (LLPs), and from certain arrangements involving allocation of profits and losses among partnership members (any type of partnership not just LLPs).
This article outlines those proposals and suggests what you and your business should be doing in order to address them.
The current legal position is that members of an LLP are always taxed as self-employed partners. The presumption of self-employment applies regardless of the member’s involvement in the management of the business and risk exposure.
Being self-employed can achieve significant NIC and income tax savings both for individuals and the businesses they work for, hence HMRC’s wish to address this. It has been proposed that an individual who meets either of two conditions will be classed as a ‘salaried member’.
Broadly, the conditions that an individual LLP member must meet are either of the following:
- when considering HMRC’s Employment Status Manual the individual would be regarded as employed by the partnership, or where this first condition is not met
- an individual member of an LLP who
- has no 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 share of the profits; and
- is not entitled to a share of any surplus assets on a winding-up.
If either condition is met the LLP member will be treated as a salaried member.
In order to avoid clever redrafting of members agreements to get around these two conditions, it is proposed that a targeted anti-avoidance rule will be introduced to ensure no account is taken of arrangements, designed to prevent the first or second conditions from being met.
The impact should a partner be classed as a salaried member, is that he will be liable to income tax and national insurance – as though he was an employee. The LLP will become liable to pay secondary national insurance too.
Profit and loss allocation schemes
Under partnership law, it is not necessary for profit sharing ratios to be in proportion to contributions, effort or capital, to be the same from year to year, or for profits and losses to be shared in the same proportions. This flexibility is available for all partnerships not just LLPs.
HMRC are looking at arrangements which are designed to catch working capital and profit deferral arrangements, however they are far wider reaching and catch structures previously considered as fairly benign – given they were implemented with full reference to partnership and tax law currently in place.
The three arrangements (underlined below) being looked at are as follows:
Partnerships with mixed members i.e. hybrid LLPs are the main target, where profits are allocated to a member that pays a lower rate of tax. According to HMRC “the arrangements are clearly tax-driven because it is evident that the allocation of profits to the company would not occur if it were taxed at the same rate as the individual members.” However, the condoc also considers partnerships with mixed members where losses are allocated to a member that pays a high rate of tax and partnerships with members with differing tax attributes, i.e. arrangements where members reduce their profit entitlement in return for payment made by other members who will be taxed more favourably on those profits.
Broadly, the proposed counteraction for arrangements which fall under any of these arrangements is for profits to be reallocated to members who will pay a higher rate of tax.
Transferring a large number of low paid employees to partnership in order to avoid NIC’s was always going to attract HMRC attention and business which have done so will need to pay particular attention to these proposals.
It is not uncommon for a fixed-share or salaried member to have over 5% of his remuneration linked to partnership profits. Such a partner would fall outside both conditions one and two above, this should provide some comfort to partners in professional partnerships who are following the usual career path to full equity partnership.
Profit and loss allocation schemes
These proposals are far reaching and will catch the profit sharing arrangements of nearly all mixed partnerships. Once the proposals come into force, these mixed partnerships may not achieve their original objectives and it is therefore important that businesses exposed to these proposals review their position now and are prepared to implement an appropriate plan to mitigate any additional tax exposure.
Partnerships exposed to either aspect of the condoc should review their members’ agreements and working arrangements in order to consider their exposure and potential solutions.
We are monitoring developments very closely and are being engaged by our existing clients and others to maintain a watching brief, so that their business structures can be redefined as necessary to work around these new rules.
The formal consultation period has now ended and will be followed by draft technical guidance and legislation at the time of the Chancellors Autumn Statement. Any changes that come into force as a result of this process will become law from 6 April 2014 onwards, in relation to profits and losses arising on or after that date.
If you would like to arrange a consultation in order to review how you and your business arrangements may be effected by these proposals please do not hesitate to contact us.