Further to the announcements in the Autumn Statement, draft legislation has been released alongside a guidance note by HMRC, detailing the new partnership tax rules which are proposed to come into effect from 6 April 2014.
There are two main strands to the rules, one which just applies to limited liability partnerships (LLPs) and one which applies to all “mixed membership” partnerships, e.g. those whose partners include both individuals and companies.
1. Employment status of LLP members
The proposed rules regarding employment status apply only to LLPs, and not to other forms of partnership.
The rules are aimed at preventing tax loss through “disguised employment” where HMRC considers that an individual has been made a member of an LLP to take advantage of the tax and National Insurance contributions (NIC) savings available to the self-employed (in particular from the avoidance of employers’ NIC) and the individual’s role is in the nature of an employee rather than that of a partner.
Where the new rules apply, the individual will be regarded as a “salaried member” and will be subject to tax and National Insurance in the same manner as employees. The LLP will be liable to employers’ NIC and will be able to treat payments to the individual as an allowable deduction when calculating the LLP’s taxable profits or losses.
An individual will be regarded as a salaried member if all of the following three conditions are met:
· The individual provides services to the LLP in return for what is substantially (80% or more) “disguised salary”. “Disguised salary” refers to a fixed profit share, or where the profit share is variable but the variations are not linked to the overall profit or loss of the LLP, and
· The individual does not have “significant influence” over the affairs of the LLP (ie. is not involved with its management), and
· The individual’s capital contribution to the LLP is less than 25% of the disguised salary received by the individual during the relevant tax year.
Comment
The proposed new rules will bring into question the status of many fixed profit share LLP members. We will be happy to review arrangements for potentially affected LLPs, to determine what changes can be made to preserve the self-employed status.
2. Mixed membership partnerships
The second part of the proposals, which can potentially affect all partnerships with a mixture of individual and corporate partners, is aimed at preventing partners from gaining a tax advantage through the artificial manipulation of profit and loss shares.
HMRC’s concern for profitable partnerships is that, by allocating profits to corporate partners rather than to individuals, the tax rate on profits can be reduced by up to 27%.
Where the anti-avoidance rules apply HMRC may seek to tax profits as though they had been allocated to the individual partners, therefore ensuring the profits are subject to higher rate Income Tax.
Whilst we have referred to corporate partners below, the legislation is drafted widely to include all “non-individual” partners to stop the planning simply being shifted to other structures.
HMRC may take counteraction measures concerning the allocation of profits where all of the following conditions apply:
· The corporate partner receives a profit share which exceeds a normal commercial reward for capital and services provided to the partnership, and
· An individual has the “power to enjoy” the profits of the corporate partner (this will apply for example where the individual holds shares in the corporate partner), and
· It is reasonable to suppose that the profits allocated to the corporate partner are higher than they would have been but for the individual partner’s interest in the corporate partner, and
· The total tax liability payable by the individual and corporate partners is reduced as a result.
Under additional anti-avoidance measures, the rules are extended to apply to cases where a partnership has been changed from a “mixed membership” partnership to a “corporate only” partnership in response to the above proposals.
HMRC may also take counteraction measures to deny relief where losses of mixed partnerships are allocated to individual partners pursuant to tax avoidance arrangements.
Comment
Mixed membership partnerships should review their profit and loss sharing arrangements and consider whether or not they are vulnerable to challenge under the new rules.
Although the rules are intended to apply from 6 April 2014, they remain in draft at present and therefore may be subject to change prior to enactment.
Interestingly, the House of Lords has recently announced that it has formed a committee to consider the proposed new partnership tax rules, and we await their findings with interest.
