Proposed changes to the taxation of partnerships

HMRC Consultation document on the tax rules for partnerships

On 20th May, HM Revenue & Customs issued it's long awaited consultation paper on the tax rules for partnerships. This consultation was announced in the March 2013 budget.

The taxation of partnerships has been under scrutiny for some time, with the suggestion that they are not always purely for commercial purposes but are increasingly being used to achieve tax advantage.
The areas of particular concern relate to national insurance contributions (nic), income tax and capital gains tax.

The consultation is looking at two particular, but unrelated areas where HMRC believes income tax and nic are being avoided. They are disguised employment and Profit and Loss allocation schemes.

Disguised employment

Employment status has been in the spotlight for several years and HMRC has already introduced specialist officers to consider the status of self employed people to cut down on the perceived loss of tax revenue through the artificial take up of the advantageous tax and nic regime for the self employed.

There is a statutory presumption that partners in a partnership are self employed and they have always been taxed on a self employed basis. The Limited Liability Partnership Act 2000 introduced the Limited Liability Partnership from April 2001. The partners within an LLP are taxed like any other partners on a self employed basis.

Currently partners can be remunerated by means of a fixed, predetermined profit share equivalent to a salary and they are still taxed on a self employed. In some cases this has been taken further by changing employees, who have no part in the risk or operation of the business, to partners in the LLP in order to take advantage of the beneficial tax and nic position.

The aim is to prevent a member of an LLP benefiting from the default partner status if the terms of his or her engagement with the LLP are tantamount to an employment. This will be achieved by providing that an individual member who meets either of two conditions be classed as a “salaried member” and, in that capacity, will be liable to income tax and primary (Class 1) NICs as an employee.

The first condition states that a “salaried member” of an LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership.

This would be determined by referring to the status tests already in use.It is understood that an LLP agreement will not have the terminology or characteristics expected in a contract for services and so there is a second condition;

A “salaried member” of an LLP includes an individual member of the LLP who does not meet the first condition but who:
(a)  has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
(b)  is not entitled to a share of the profits; and
(c)  is not entitled to a share of any surplus assets on a winding-up.

Profit and Loss allocation schemes

It potentially links directly with the above in how different classes of partners are rewarded for their contribution, funding of the partnership and probably artificial arrangements involving companies with non-commercial arrangements on say transfer pricing and profit sharing or extraction.

There are a number of particularly aggressive arrangements that exist in the market. For example some structures are designed so that all revenue profits are earned in a company whilst all capital gains are earned in a partnership for the same business.

The proposed treatment is to reallocate profits for tax and nic purposes on a just and reasonable basis and to deny loss relief claims where these losses are considered to be articificial. 

Additionally buying and selling of partnership profits will be looked at to ensure that the transaction is not purely an attempt to switch income otherwise subject to income tax to a gain subject to tax at a lower rate.

The changes will take effect from 6 April 2014, with the government seeking views on these proposals for changing the partnerships rules by 9 August 2013.