Partnership consultation: Change ahead
Following announcements made in the Budget, a consultation was released on 20th May to consider some of the areas within the partnership rules which HMRC consider are being used for tax avoidance.
The suggested changes set out in the consultation can be split into two main areas:
- the presumption of self-employment for members of LLPS; and
- the perceived manipulation of profits and losses in 'mixed' partnerships.
The consultation proposes to remove the deemed self-employment status from LLP members. This will put members of a LLP into the same position as partners in a traditional partnership.
The consultation provides for a member to be treated as a 'salaried member' (i.e. taxed as an employee) if they would be regarded as such if the entity was a traditional partnership. HMRC already have guidance on when someone will be treated as an employee and the tests for a 'salaried member' are expected to be similar. Employment status depends on a number of factors, but traditionally the two most important factors have been control and financial risk.
Additionally, it is proposed that even if a member would not be caught under the partnership test above, they will be treated as a salaried member if there is:
- no significant entitlement to a reward related to profitability (other than a fixed entitlement);
- no right to surplus assets on a winding up; and
- no significant downside if the LLP makes a loss (i.e. loss of capital or claw back of drawings).
According to the consultation, anything less than a 5% share will be treated as insignificant and will be disregarded for the purpose of this test.
The consultation states that the proposals are not intended to catch those who are promoted to 'member' status as recognition for their professional knowledge and personal skills at an appropriate point in their career: even where junior members are substantially rewarded by a fixed profit share.
Profit and loss allocation schemes
HMRC plan to tackle schemes involving LLPs and traditional partnerships with mixed members. The schemes work by taxing profits on the lower rate member (normally a company) or allocating losses to the highest rate taxpayer (an individual on high income).
The consultation points out that such structures allow profits which are to be retained in the business for working capital to be allocated to the corporate member of a partnership, in order that they are not subject to income tax until they are withdrawn from the business. The consultation describes this as an 'exploitation of the differences between corporation and income tax rates'.
HMRC do accept that there may be other reasons for setting up mixed member partnerships and use the following examples:
- flexibility for external investment;
- the ability of partners to transfer their partnership interest by transferring shares; and
- the impracticalities of transferring assets from a company into a partnership in some situations.
HMRC intend to introduce a power to reallocate profits to the higher rate taxpayer (and losses to the lower rate tax payer) in cases where:
- the scheme has been entered into for a tax advantage; and
- there is an economic connection between the company and the partners/members (i.e. the partners/members are shareholders in the company).
The consultation period will close on 9th August, with responses to the consultation published in early Autumn. Any new rules coming into force as a result of the consultation are expected to appear in Finance Bill 2014.
It is important to note that at present this is just a consultation and it may well be 'watered down' before it hits the statute books. In the meantime, if you have any concerns about your structure, please contact any of those individuals listed at the end of this article.