Tax Guide: Proposed Changes to the Tax Arrangements of LLPs and Partnerships


LLP and Partnership Tax Arrangements to be targeted by Government under new proposals:

The Government has outlined proposals to tackle the tax arrangements of LLPs in order to "level the playing field in the tax treatment of all partnerships." The changes are scheduled to come into force in April 2014 under the Finance Bill and a National Insurance Contributions Bill and could have a significant effect on the structure of existing LLPs and those firms considering converting to an LLP in the near future.

LLP Tax Changes Guide Image

The first change is to remove the automatic presumption of self-employment from members of a Limited Liability Partnership (LLP). This has been widely expected following statements made in the Chancellor's Budget 2013.

The second change was not so widely predicted and is designed to stop the channelling of profits through so called 'Corporate Partners' in order to reduce the tax liabilities of individual partners. This second proposal could have a profound impact on the structure of LLPs...

Tax Guide: Proposed Changes to the Tax Arrangements of LLPs and Partnerships:

To Download and Print your free guide - click here or click on the adjacent image

To view the official HMRC consultation document (Partnerships - A review of two aspects of the tax rules) and to comment, simply click here. Please note that comments close on 9th August 2013.

An outline of the main proposed changes:

1.Targeting of Disguised Employment under LLP - Salaried and fixed-profit share members of LLP's:

Under the current system, LLP members are automatically presumed to be self-employed. As such, they receive favourable tax treatment with regards to both national insurance contributions and income tax. HMRC argue that, in reality, the role of many of these members is much more aligned to that of an employee. By way of example, as a self-employed member of an LLP, the requirement to pay employer's NICs (13.8% on earnings above the secondary threshold) is eliminated which provides a significant tax saving.

In order to establish whether a member of an LLP should be treated as an employee or as self-employed, the Government's consultation sets out two circumstances in which individual LLP members will, from April 2014, be treated as if they were employees of the LLP:

1. On the assumption that the LLP is carried on as a partnership by two or more members of the LLP, the individual would be regarded as employed by the partnership by reference to the normal tests of employment. These deal with matters such as control, the requirement for personal service, financial risk, the ability to profit from sound management, and so on.

2. Alternatively HMRC propose to treat a salaried or fixed profit share member as an employee if he or she is not an employee under the test above but is nonetheless someone who:

  • Has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
  • Is not entitled to a share of the profits; and
  • Is not entitled to a share of any surplus assets on a winding-up.

For the purposes of the second condition, any risk or entitlement will be ignored if, having regard to all the circumstances and in particular the total economic rewards available or likely to be available to the member, it is reasonable to regard the risk or entitlement as insignificant.

It should be particularly noted that arrangements for 'junior partners' will need to be structured carefully to avoid falling foul of the rules.

The consultation document also indicates that any artificial changes to partnership agreements to try to avoid these new rules will be clamped down on.

2. Profit and Loss Allocation Schemes - Government to  attack hybrid LLP/corporate partner arrangements:

The second proposal for consultation could have significant effects on existing partnerships. It deals particularly with the allocation profits and losses to different members in order to reduce tax. In most cases, these partnerships will involve 'corporate' (or 'company') members as well as individuals. In these cases, corporate members are subject to corporation tax, 23% of profits, whilst individuals are subject to income tax which as the top rate is 45% of earnings. Clearly, by diverting profits to corporate members, the overall tax burden is significantly reduced.

HMRC believes that in scenarios as outlined above, a high proportion of profits are allocated to corporate members who, in reality, make little or no contribution to the business and in many cases, some or all of the individual partners will own the corporate member and can therefore benefit from the profits allocated to it.

In theory it could be argued that corporate members provide a useful means for LLPs to warehouse profits at a low tax rate, particularly where those profits need to be reinvested in the business.
In reality, it is plain to see why HMRC might believe that the structuring of an LLP, whereby nearly all of the profits are taxed at the corporate rate, is simply designed in order to secure a lower rate of tax.

Moreover, it is hard to see how it will be possible to convince HMRC that the gaining of an income tax advantage was not the main motivation for introducing a corporate partner. HMRC give the following examples which they say are not sufficient to avoid a counteraction under these provisions:

  • It is unfair to tax individuals on profits in a period during which the individuals are unable to access them or if the partnership uses the profits to develop the business.
  • Retaining working capital by means of these arrangements effectively gives access to cheap finance.
  • The member may be taking risks in respect of the profits since, if the business fails, or the profits do not vest, the amounts may never in fact be received.

Importantly, the Government outlines that, if profit is made, all of the profits allocated to LLP members not subject to income tax (corporate members) will simply be reallocated to those who are subject to income tax.

It should also be noted that the Office of Tax Simplification has been appointed by the government to conduct a review into the taxation of partnerships. The initial review will be carried out by Autumn 2013 to identify the major complexities in partnership tax and recommend priority areas for a more detailed review.

When will these proposed changes take effect?

The consultation period closes on 9 August 2013. Draft legislation will then be published in late 2013 at which time there will be further consultation. Legislation will be introduced in the National Insurance Contributions Bill 2013 and the Finance Bill 2014 which typically will receive Royal Assent in June/July next year. The changes will take effect from 6 April 2014 although in reality we will not have absolute certainty with regard to the new provisions until the summer of next year. It is not expected that the proposals will be substantially changed before enactment as the consultation merely invites views on the detailed legislative design and the detail of implementing the changes.

For more information or to arrange a free consultation:

Should you require more detailed information about the proposed changes outlined above or to arrange a no obligation appointment, please contact LLP specialist Tim Adcock, Tax Partner on
tel: 0151 255 2300 or 01244 323 051. Alternatively, email: tim.adcock@mitchellcharlesworth.co.uk.

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