Q&A: New tax rules pressurise partnerships

Following the announcement in Budget 2013, HMRC issued a consultation document on 20 May 2013 proposing new rules on partnership taxation where HMRC perceives ‘unintended inconsistencies’ that cause an unfairness and a distortion of the UK tax system.

What is covered?

The consultation covers two areas: (1) disguised employment, which affects LLPs; and (2) corporate member planning, which affects all partnerships, but targeting LLPs in particular.

The proposals are due to come into effect from 6 April 2014. With no grandfathering proposed, the rules in their current form will have a wide impact, particularly in relation to partnership structures containing individual and corporate members – and potentially even where the reasoning for the corporate member is benign, e.g. it is present for regulatory or commercial deferred compensation purposes. We expect many of HMRC’s proposals will remain intact.

What are the disguised employment proposals?

These only apply to LLPs, whose members are generally treated under an automatic legal presumption as self-employed. HMRC proposes to extend the employment tax rules to any individual member in an LLP who is a ‘salaried member’, i.e. a person:

• who would be regarded as employed by that LLP; or
• 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, and is not entitled to share in profits or surplus assets on a winding-up.

For the latter, any risk or entitlement that is reasonable to regard as ‘insignificant’ will be ignored. What is ‘insignificant’ will be determined in light of all circumstances and the total package of benefits available, but in general an entitlement to a profit share that for practical purposes would never be more than 5% of any fixed entitlement is unlikely to be viewed as significant.

Salaried members will be subject to employee NICs at 12%/2%, and their income tax will become collectable under PAYE. The LLP will become liable for employee NICs at 13.8%. Other provisions of the employment taxes code (e.g. employment-related securities) would also apply.

HMRC is also proposing a targeted anti-avoidance rule (TAAR) that will ignore arrangements with a main purpose of preventing the conditions from being met. Ignoring ‘insignificant’ risk or entitlement will also go some way to defeating artificial arrangements designed to circumvent the rules.

What are the corporate member planning proposals?

These target partnerships with a mixture of individual and non-individual partners, where profits or losses are allocated to a member that does not pay UK income tax (typically a corporate), and:

• where profits are allocated: (1) it is reasonable to assume that a main purpose of the partnership profit-sharing arrangements is to secure an income tax advantage for any person (this includes deferral of tax, as well as a reduction in tax); and (2) a UK income tax-paying partner has an ‘economic connection’ with the non-UK income taxpaying member to which the profits are allocated, such that he can directly or indirectly benefit from the profits that are allocated – in which case, the profits allocated to the non-UK income tax paying member will be treated as allocated for tax purposes on a just and reasonable basis to individual UK income taxpaying members;
• where losses are allocated: it is reasonable to assume that a main purpose of arrangements is to allocate a partnership loss to a partner, in order for him to obtain a reduction in tax liability through income or capital gains tax reliefs – in which case, no income tax or capital gains tax relief will be given for the relevant partner’s loss.

HMRC is silent as to what will define ‘economic connection’, but it is likely that its scope will be wide given HMRC’s examples.

The proposals also target profit transfer arrangements where it is reasonable to assume that a main purpose of the profit transfer is to secure a tax advantage – in which case, the payment by the transferring partner is taxed as if it were partnership profit. Again, the meaning of ‘secure’ in this context would be a grey area.

How do the corporate member planning proposals interact with regulatory rules, such as the AIFMD?

HMRC acknowledges the potential for interaction with regulatory requirements, but is largely dismissive that this will change the proposals. Enforced deferrals and clawbacks of compensation under the alternative investment fund managers directive (AIFMD) could lead to increased and upfront tax charges that are mismatched with the actual compensation.

Why introduce these rules?

HMRC announced some time ago its view that LLPs have been used to implement aggressive tax planning (sometimes poorly), and this has clearly been a source of aggravation.

The timing of the corporate member planning proposals is interesting, given that the Budget announced a general push for the UK to become a centre of global funds operations.

It is also interesting as a policy matter that HMRC is of the view that the imminent UK general anti-abuse rule may not catch certain disguised employment arrangements but that the TAAR should, because the schemes still represent ‘unacceptable tax planning’ – a theme in today’s politics.

The consultation closes on 9 August 2013.