15 Aug 2013 03:40pm

The taxation of partnerships: the changes ahead

HMRC’s consultation on the proposed changes to the taxation of partnerships and LLPs closed on 9th August. The proposed changes have prompted considerable debate and raised concerns that, in clamping down on tax avoidance schemes at the more aggressive end of the spectrum, the government may end up also unfairly penalising businesses who have chosen to use the flexibility offered by partnership structures for legitimate commercial purposes.

Disguised employment

The first proposal is to remove the presumption of self-employment for members of LLPs. This will be achieved by introducing the concept of a “salaried member” who will be treated as an employee for income tax and NIC purposes. Employers’ NICs will be payable by the LLP and the costs of “employing” the salaried member will be deductible in the computation of the LLP’s profits.

This presumption has always seemed anomalous and there is evidence that it has been abused as a means of saving employers NICs, with businesses being conducted through LLPs in which all staff, no matter how junior, are members.

The concern for professional practices however is that there is considerable uncertainty as to how the new rules will apply to junior or fixed share partners.

In professional practices individuals are commonly promoted to partner (or member) to reflect their seniority and expertise, without seeing a significant change in their remuneration (albeit that they receive a fixed share of the profits rather than a salary) or their involvement in the business. The consultation paper indicates that the new rules are not intended to affect such individuals but the second limb of the “salaried member” test could well catch them. Under this test, an individual will be a salaried member if they have no economic risk and are not entitled to a share in the profits or surplus assets on a winding up. Risks and entitlements will be ignored if “insignificant”.

Such individuals could be left having lost their employment rights for employment law purposes (and there has been recent case law rejecting claims by junior partners for employee status) whilst being taxed as employees by virtue of the new rules. It is to be hoped that the guidance to be published by HMRC to indicate how the tests will be applied will clarify the position.

The artificial allocation of profits

The second proposal is aimed at the perceived artificial allocation of profits and losses by partnerships with corporate members and schemes involving the transfer of profits between members with different “tax attributes”.

Clearly there are some aggressive schemes of this type marketed which HMRC are legitimately concerned about. What is perhaps more surprising are the views expressed in the consultation document in relation to working capital and profit deferral arrangements.

In both types of arrangement profits are allocated to corporate members in the short term rather than to the individuals who ultimately expect to receive those profits. The reason for doing so is, of course, the short-term tax saving to be made in paying corporation tax rather than income tax. But the individuals concerned will pay income tax when the profits are ultimately distributed to them and in the meantime will not have the use of the money. Is it not reasonable in those circumstances to structure the business so as to minimise the tax payable until the individuals receive the money?

Not according to the government. The consultation document argues that such mixed member partnerships obtain an unfair tax advantage by virtue of being able to access more favourable tax treatment or obtain cheaper working capital than an almost identical partnership that does not have a corporate member. The arguments are unconvincing but there seems little doubt that this type of arrangement will be caught by the new rules.

What next?

It is intended that the new legislation will be included in the Finance Bill 2014 and will take effect from 6 April 2014.

Given the timescales, it is sensible for professional practices with different categories of partner and/or mixed membership models to begin reviewing their partnership arrangements, although it would be premature to implement any changes until we have a clearer idea of the scope of the legislation.


Scott Leonard Scott Leonard is a partner in the corporate and commercial team at Russell-Cooke LLP


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