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HMRC proposes new tax rules for LLPs

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31st May 2013
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BDO partners Colin Ives and Anna Jarrold, both specialising in private client services, examine the implications of HMRC's proposals to change tax rules for LLPs.

We had been warned in Budget 2013, so the consultation document Partnerships: A review of two aspects of the tax rules should not have come as a surprise.

However, the implications of the proposals may yet catch out some organisations, particularly as businesses whose current accounting period ends after 6 April 2014 will be affected in this financial year.

HMRC acknowledges that some of the arrangements targeted may not fall within general anti-avoidance but it still wants to block them with specific anti-avoidance rules.

There is no intention to target partnerships that simply converted to LLP status, partnerships where the profit sharing ratio is determined wholly on business grounds or family businesses (as in Jones v Garnett) where no value is exchanged for the artificial profit allocation. Nonetheless, a large number of businesses will be affected.

Artificial profit/loss allocation

HMRC believes that this is used for tax avoidance where partnerships with mixed membership (individuals and companies etc) allocate profits or losses between members to reduce or defer tax, and where members have differing tax attributes (exempt and non-exempt partners, etc) and income streams are transferred to avoid tax.

For partnerships with mixed membership, tests are proposed to allow normal commercial arrangements. However, where “it is reasonable to assume that the main purpose or one of the main purposes, of the partnership profit-sharing arrangements” is tax avoidance, the new rules may apply.

HMRC could then reallocate the profits for tax purposes to the partner that would pay the largest UK tax bill or simply deny loss relief claimed. Similarly, for members with different tax attributes, the proposals would effectively ignore the artificial profit allocation to a partner with a lower/zero tax profile, so that the transferor partner suffers the tax

Disguised employment

The document proposes removing the automatic presumption of self-employment for LLP partners to prevent ’disguised employment‘. Instead, two tests will establish if an individual member is, in reality, a ’salaried partner’ (liable to PAYE, employers’ and employees’ NIC).

Initially, tests from HMRCs Employment Status Manual will be used. While this may sound like a catch all, lengthy process, it seems this is most likely to apply where in cut and dried cases - for example, where many ’partners‘ are created by switching a business from company to LLP status.

If the employment status tests are not relevant, HMRC would then seek to establish if the individual is:

  • At financial risk if the LLP makes a loss or is wound up
  • Entitled to a share of the profits
  • Entitled to a share of any surplus assets on a winding-up.

Failing these tests will indicate employment and there will be specific rules to counter schemes artificially inserting partnership terms just to meet them.

For example, insignificant financial risks (e.g. a 5% profit share on top of a guaranteed salary) could be ignored. It will be interesting to see how this stance fits with the ruling in Tiffin v Lester Aldridge LLP.

The consultation closes on 9 August, so we all now have an opportunity to comment on the proposals. 

Colin Ives is a partner at BDO. He specialises in private client services, and is head of professional services tax at the firm. Anna Jarrold is also partner at BDO and former tax senior manager for Ernst & Young. She specialises in private client services, with sector experience in professional services

What are your views on HMRC’s plans? Is ever-more complicated anti-avoidance legislation the best way of solving the problems caused by differing tax rules for different entities?

Replies (8)

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By norstar
31st May 2013 15:02

HMRC playing God again

So if two partners reach a commercial agreement that the split of profits that year will be 75/25 say as one did most of the work, and where that happens to coincide with a tax advantage on paper, HMRC are allowed to decree that in fact, the profits should be split 50/50 to the highest taxed partner.

Seems a bit above their powers don't you think?

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By Richiejjj
31st May 2013 15:24

your example agreement implies a non artificial allocation though.

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By mikewhit
03rd Jun 2013 01:19

And yet ...

they aren't allowed to make similar decisions regarding transfer pricings to low tax subsidiaries ...

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By mikewhit
03rd Jun 2013 01:23

Interesting IR35 angle

So if the new rules would dictate an LLP member was an employee of the LLP for tax purposes, would that override (or swing the balance on) any IR35 status regarding the LLP working for a client ?

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By mikefleming3028
03rd Jun 2013 16:21

Partnerships and all that Jazz

Can anyone remember the 2007 Discussion Document on Income Shifting and the reasons HMRC gave for not proceeding with it, ie the economy was in such a state that they could not justify its implimentation,well is this not Income Shifting by the back door?  

Here is a small extract from that paper:-

INCOME SHIFTING WITHIN MODERN BUSINESSES

1.4

In recent years there has been a growth in the number of small businesses

establishing as companies. There are a number of reasons for this. For example, some

businesses find that their clients prefer to transact with a corporate body; for others, the

limited liability offered by a company is important. Partnerships, too, continue as a

common vehicle for small businesses.

1.5

However, the Government recognises that with the continuing growth of small

businesses using the corporate or partnership form there are greater opportunities to

shift income.

1.6

Where an individual establishes a business using a company structure, they may

decide to introduce another individual as a second shareholder. For small businesses it

is common for this individual to be a spouse, partner or other household member of the

first individual. There are often legitimate commercial reasons for doing this, for

example where the second individual contributes labour or capital to the business. In

these situations the Government believes that it is right for the distributions from the

company to reflect the contribution that both individuals have made.

Sound familiar?

 

 

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Replying to chatman:
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By mikewhit
04th Jun 2013 10:48

Joint tax returns

If the Tories followed the logic of their wanting to encourage stable family relationships, then they might consider couple joint income tax returns (USA, IOM ...): then the income shifting aspect would be rendered irrelevant, and all this fretting at HMRC would be over !

(Would also remove those child benefit anomalies)

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By North East Accountant
05th Jun 2013 08:26

HMRC target hits all

The HMRC consultation document keeps referring to schemes. Unfortunately, the tax avoidance boutiques have jumped on the LLP wagon and abused them leading to this new attack on all mixed structures. There are many genuine arrangements which will be caught by these new rules. If HMRC don't want people to take advantage of reduced company rates, increase them or even better reduce high personal tax rates. No chance!!

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By Martin Dore1
25th Jun 2013 12:18

Profit allocations matching ownership

What if the profit allocation (to a Limited Company lets say) matched the percentage owned by that Company and the Company had paid a commercial sum to aquire that holding.  Would the proposed legisaltion come into play then?

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