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New partnership tax rules could squeeze profits

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10th Dec 2013
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Accountancy firms will need to review their partnership structures to prepare for new rules designed to stop employees in limited liability partnerships pretending that they are self employed to avoid tax.

Junior partners are most vulnerable to having their self-employment status removed, which could increase costs and reduce profits for partnerships.

"A lot of junior partners will be wondering why they should bother being partners with no employment rights. It gives them a tax charge, but no rights - so they might as well be employees," commented AccountingWEB's Rebecca Benneyworth, who devoted considerable attention to the issue in her Autumn Statement/Finance Bill 2014 impact report for BTCSoftware.

Draft legislation in the 2014 Finance Bill, published earlier on Tuesday, will remove the automatic presumption of self-employment for partners in limited liability partnerships (LLPs).

The measure to prevent “disguised employment” was first aired in the 2012 Budget and received a negative response from tax advisers during  consultation this year. But that had little effect on the final legislation, which HMRC predicts will raise just over £3bn in tax by 2018-19. Some tax experts were surprised that the detailed legislation was tougher than expected.

The new rules will also make it harder for “tax-motivated allocations of business profits or losses in partnerships”. The rules will also apply to mixed-membership partnerships, where some members are from companies; and tax-motivated disposals of assets through partnerships, HMRC said.

A number avoidance schemes that were closed down in recent years involved misuse of partnership rules, HMRC said.

LLPs were set up in 2000 to protect accountancy firms from potentially big lawsuits or losses.

Previously, partners had unlimited liability for any losses or legal claims for damages from disgruntled clients. All of a partner’s assets (salary, house, shares and car) were at risk.

Under the new legislation, which is due to start on April 6 next year, partners will have to satisfy at least one of three tests to prove they are true partners in a business, and retain the tax advantages the self-employed have over employees:

  • Test 1: at least a quarter of their pay must be dependent on the profit made by their partnership
  • Test 2: the partner must have contributed at least 25% of their “fixed pay” to the firm’s capital
  • Test 3: prove that they have significant influence on the overall partnership. 

If partners are deemed to be employees then employer’s national insurance contributions at 13.8% is due and other employment-related tax rules, such as benefits in kind and share scheme rules, will apply. 

PwC tax director Mark Saunders said that the new tax rules for partnerships are tougher than expected.  

He understood the need to have clearer distinction between partners and employees, as there have been some partnerships set up purely to avoid tax and NICs. 

But the new rules could make a big financial difference to junior partners who do not always have a guaranteed profit share and may have minimal voting rights. This may make it harder for them to convince HMRC that they are self employed under the new legislation.

"We're likely to see even junior partners trying to justify that they have significant influence on the partnership, and it will be hard to prove either way with something so subjective,” Saunders said. 

“Unfortunately, although the people affected will no longer be treated as partners for tax purposes, they won't get the employee law protections of ordinary employees, such as statutory redundancy pay.  So it is all bad news for the salaried partners who are unexpectedly caught."

Nigel May, tax partner at MHA MacIntyre Hudson, said the government has replaced one anomaly - the HMRC treatment of LLP members as self employed - with a different rule to establish members of LLPs as employees from any other case.

“This is hardly a contribution of coherence to the tax system and one suspects [it] is motivated by HMRC having been singularly poor in succeeding in arguments that someone is as a question of fact employed not self employed,” May said.

Still, the government has once concession to partnerships since its consultation. It has dropped a plan to base its test on employment status partly on its vast employment status manual.

These documents, are just HMRC’s interpretation of tax legislation (the definition of self-employment) and therefore would not have not been an objective test for deciding employment status, according to some tax experts.

Firms now have about four months to review their partner status. They can change their arrangements to comply with the new rules or accept that some partners will be taxed employees, said Colin Ives, partner at BDO.

One way to comply with the new rules is to require junior partners to pay 25% of their annual income into the firm – a “capital contribution”.

HMRC says that the new partnership tax rules will create a fairer tax system for business, although the overall impact on the economy will be “small”. It also said that the rules may result in an “increase in labour costs and a decrease in post-tax profits levied on selected partnerships in certain industries.”

Replies (22)

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By johngroganjga
11th Dec 2013 11:07

How does being self-employed "avoid" tax?  The only lightening of the burden is the removal of the "necessarily" in the expenses claim rules.  But if they are to all intents and purposes employees in substance anyway their "employer" will be paying all the expenses!

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By MJShone
11th Dec 2013 12:31

Employer's NIC John

It's the extra 13.8% NIC that makes the difference

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Replying to bendybod:
By johngroganjga
11th Dec 2013 12:39

NIC

MJShone wrote:

It's the extra 13.8% NIC that makes the difference

Yes of course I agree about NIC.  But headline says employees are avoiding tax.  If that's what they meant they should have said employers are avoiding NI.

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Replying to scalloway:
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By ted.henderson
28th Feb 2014 18:14

NIC a tax

NIC is a tax. Indeed it is a direct tax

At least our Chancellor thinks so, and I agree with him.

"Income tax and National Insurance should be merged in a "historic step" to simplify tax, Chancellor George Osborne has said.

Work to bring the two taxes together would take many years and start with widespread consultation, Mr Osborne said in his Budget speech."

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By dropoutguy
11th Dec 2013 12:34

I don't like

the use of that word "pretend".

It's inaccurate because limited liability partners were regarded as self employed under the law.

OK that's going to change, but let's not imply they were doing wrong.  What is this? The Guardian?

 

 

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By MJShone
11th Dec 2013 13:03

Sorry John - I was being thick!

Read it quickly and took your comment at face value.

 

 

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Mark Lee headshot 2023
By Mark Lee
11th Dec 2013 20:39

Going back...

Let's go back to when LLPs were introduced (in response to large law firm and accountancy firms' seeking a way to secure a form of limited liability without incorporating as limited companies). 

I don't think anyone knows why the LLP Act introduced a provision that said, effectively, if you are a member (partner) of the LLP then you cannot also be an employee. As a result many firms took the opportunity to 'promote' senior staff to 'member status' so as to save the 13.8% Ers NICs.

I am unsure whether such junior partners/members will have retained their employment rights on becoming members of the LLP. If memory serves it was quite possible to be an employee in law but a member of the LLP and thus taxable as such (with no Ers NIC payable)

I suspect that many LLP structures for other businesses then took advantage of this anomoly too.

This change makes the rules clearer as to who will be taxed as partners/members than previously. Firms will have to be very clear when promoting senior staff that they really will be involved as partners and not simply in name only.

If the pay of junior partners/members is recategorised as salaries in the LLP accounts, rather than as a share of profits, we could see reported reductions in firms' accounting profits next year.

 

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By excelaccountz
11th Dec 2013 13:27

Llp self employment
If IR35 was introduced to catch people setting up ltd companies to avoid paying tax & nic as an employee, then why not for for LLP?

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By Mark Lee
11th Dec 2013 14:55

That is indeed what these rules achieve

.

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By Montrose
11th Dec 2013 15:00

Junior partners

No where does  the draft legislation provide:-

Test 1: at least a quarter of their pay must be dependent on the profit made by their partnership 

What it says-and this is very different from a 25% test - is

"

the'disguised remuneration'

if it is variable, is varied without reference to the overall

amount of the profits or losses of the limited liability

partnership, or

(c) is not, in practice, affected by the overall amount of those

profits or losses.

 

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By the_Poacher
12th Dec 2013 07:21

Ni is now primarily a tax
NI is now primarily a tax on middle income earners. Successive governments have eroded the contributory principle so much that it's barely visible.

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By Ian McTernan CTA
12th Dec 2013 10:49

Employment Tax

It's high time HMRC admit that charging companies 13.8% of their employees' salaries for the privilege of employing them distorts the market completely as well as discouraging firms from taking on more employees.

They need to scrap NIC- anyone who still calls these 'contributions' is so far detached from reality they need to be committed.

How about they scrap the employer's charge, but with the proviso that employers MUST pass this amount on to their employees straight into their pay packets.  This would then yield more tax and employee's NIC (until we get around to scrapping the employee NIC, which is just another tax) to partially offset the cost, as well as boosting spending.  Net cost to employers would be NIL.

Then we can work on removing other forms of NIC including employee's NIC, then many of the artificial structures put in place to shift people from employee to self employed/ltd company/partner status would cease to be either needed or tax efficient.

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By adambl
17th Dec 2013 11:45

New LLP rules

 

How will these changes impact on LLP's where they are structured to remunerate business owners on a self employed basis up to the 40% level and the balance of profits to a ltd co which is also one of the partners of the LLP?

 

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Replying to atleastisoundknowledgable...:
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By vowlesj
27th Dec 2013 17:18

badly!

@adambl.  One of the changes is to try and avoid the situation you describe from happening.  If you haven't already, review your tax planning with someone who understands the rules.

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By danmould
17th Dec 2013 11:46

Corporate Members

The article says the legislation will also apply to mixed member partnerships, what about LLPs which only have companies as their members?

Is there any changes in legislation which says that this isnt allowed?

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By The Black Knight
17th Dec 2013 11:47

surely

Surely it depended on whether you were a salaried partner or a an equity partner. As to your status.

Many salaried partners (in a normal partnership) were unaware that they had all the risks but none of the rewards, or that they should be taxed and NICed as an employee.

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By DavidW878
17th Dec 2013 11:59

20% not 25%

The article recites that Test 1is that at least a quarter of their pay must be dependent on the profit made by their partnership.   The reference to "a quarter" is incorrect.

In fact the requirement is that the profit share must not be "wholly or substantially" disguised salary (which would include a fixed guaranteed amount).  HMRC have confirmed that they regard "wholly or substantially" as meaning "80% or more" - hence if more than 20% of total profit share is something other than "disguised salary" the new rules will not affect the partner.   Arithmetically, this means that the partner is OK if his "genuine profit share" exceeds 25% of his fixed entitlement: I suspect that that is where the confusion between 20% and 25% has arisen.

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By Jekyll and Hyde
17th Dec 2013 13:03

Is it likely to be adequately policed?

Is it going to be adequately policed and applied in the majority of cases or is it going to be similar to the IR35 legislation that almost everyone ignores, tries to get around and take out insurance to protect themselves against.

If it is going to be like the IR35 legislation and subjective, and not adequately policed by HMRC then I see this new legislation as a waste of time and resources for everyone. All that will happen is that the prudent tax payers will be penalised and the risk takers will carry on regardless. This only creates a unfair tax system.

I am not convinced this new rule will change much.

 

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Replying to Taxbreak:
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By The Black Knight
17th Dec 2013 13:22

NO

Jekyll and Hyde wrote:

Is it going to be adequately policed and applied in the majority of cases or is it going to be similar to the IR35 legislation that almost everyone ignores, tries to get around and take out insurance to protect themselves against.

If it is going to be like the IR35 legislation and subjective, and not adequately policed by HMRC then I see this new legislation as a waste of time and resources for everyone. All that will happen is that the prudent tax payers will be penalised and the risk takers will carry on regardless. This only creates a unfair tax system.

I am not convinced this new rule will change much.

 

I think NO is a given.

No one need worry about this legislation and perhaps ignorance is indeed bliss.

You would be lucky to find an inspector that has any clue about tax at all judging from the ridiculous questions we have had in enquiries recently.

And it does indeed create an unfair tax system.

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By johnruis
18th Dec 2013 14:22

Limited Partnerships

Is it clear that the rules will also apply to Limited Partnerships? I have clients whose other halves work in the healthcare industry under one of these arrangements, which to me seem designed to get round the minimum wage and other normal benefits such as holiday pay and sick pay. . They are also used in some specialist circumstances where "employment" status affects the need to be VAT registered.

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Replying to atleastisoundknowledgable...:
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By DavidW878
19th Dec 2013 14:17

Limited partnerships

The "salaried members" rules are specific to LLPs.  The "mixed partnership" rules apply to all partnerships.

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By wmark3000
23rd Dec 2013 14:26

P11D

It's also the loss of treatment of benefits in kind. Self-employed pay no P11D on cars for example.

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