Winter 2013 Newsletter
Partnerships - a kaleidoscope of change?
HMRC issued a consultation document 'Partnerships: A review of two aspects of the tax rules' earlier this year. We are currently awaiting further response from HMRC and possibly draft legislation at some point in Finance Bill 2014.
This article outlines the potential scope of these changes and how these might affect you.
Salaried members of LLPs
An LLP (limited liability partnership) is an alternative corporate business vehicle that gives the benefits of limited liability but allows its members the flexibility of organising their internal structure as a traditional partnership. The LLP is a separate legal entity with liability for the full extent of its assets but which accords its members the benefit of limited liability. However, for tax purposes, the LLP is usually taxed as though it were an ordinary partnership with its individual members taxed on their profit share on a self-employed basis.
Individual members are taxed as a self-employed member even if their role in the LLP would ordinarily mean that they would be regarded as being in an employer-employee relationship. They may, for example, bear no risk within the LLP and enjoy a fixed salary which they are guaranteed to receive. HMRC are concerned this results in an individual member receiving a more favourable treatment in respect of their income tax and National Insurance Contributions (NIC) position compared to an employee of the LLP (or any other business) on similar terms.
From 6 April 2014 the proposals will prevent members of an LLP benefitting from the default position of self-employment status if the reality is that their terms of engagement amount to an employee-employer relationship. As a result, the salaried member will be liable to both PAYE and employee Class 1 NIC. Additionally, the LLP will have to pay employer NIC at 13.8%. These rules will apply where specific conditions apply.
Profit and loss allocation schemes - all partnerships
The principal arrangements under the microscope are where partnerships with mixed members or partners i.e. individuals and companies arrange the allocation of profits and losses in such a way that a tax advantage is obtained. Typically this means the allocation of sometimes substantial profits to corporate members that will pay a lower rate of tax rather than to an individual member. A corporate member may pay a 20% rate of corporation tax whereas an individual member may have an income tax rate of 40% or 45%.
Alternatively, where losses are incurred the arrangements are such that the losses are allocated to the individual member who will obtain relief at a higher rate of tax!
There may, of course, be sound commercial reasons for having a company as a member of the partnership. However, HMRC has seen an increasing number of such arrangements where it considers profit sharing ratios are artificial.
The proposed changes to the rules are intended to deter arrangements that exploit the tax treatment of mixed member partnerships. Subject to specific conditions being met, HMRC would be able to counteract the arrangements and allocate all or part of the profits that have been allocated to the corporate member to individual members with a restriction in tax relief in the case of losses.
The consultation document states that these rules would apply with effect from 6 April 2014 in relation to profits and losses that arise on or after that date.
As you can see these are fundamental proposals which could impact on you. We will keep you informed on any developments in this area and how they may affect you.