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Law firm partnerships face challenges as Budget highlights clampdown on tax avoidance
What does the Budget mean for law firms? Well, the content of this year’s announcements echoed to the theme of clamping down on tax avoidance.
The question for most practices will be whether any new rules will affect all partnerships or only those engaged in arrangements to artificially reduce tax liabilities.
As a choice of business vehicle, the partnership offers significant flexibility. This is mirrored in partnership tax law, which is largely pragmatic and principles-based. However, the perception at HMRC is that this flexibility has been abused and, in its words, “the misuse of partnership rules has become a feature of many avoidance schemes”.
Therefore, the chancellor announced his intention to consult on new legislation on the use of partnerships to artificially reduce tax liabilities.
One concern is that employer national insurance contribution (NIC) revenues are being lost as a result of granting LLP member status to individuals who would otherwise be employees. HMRC intends to address this by removing the current presumption that LLP members are self-employed.
No further detail has been announced, but this could be accompanied by a substance test for determining whether an individual is to be treated as employed or self-employed.
Many law firms would say the commercial advantage of extending their pool of members has been improved performance through increased enfranchisement and this only comes with some measure of genuine equity participation, voting rights and capital contribution.
Many will consider a substance test to be reasonable, but it is to be hoped the test will be framed in such a way as to avoid uncertainty around the middle ground, without discouraging enfranchisement, particularly in light of the benefits of encouraging wider equity participation among those who work in a business.
We will need to wait for the publication of the consultation document for details as to what HMRC may have in mind on countering the manipulation of partnership profit and loss allocations to secure tax advantages.
However, one area we understand they are considering is the use of corporate partners alongside individual partners.
The increased use of corporate partners is, in part, explained by commercial and regulatory complexities, but often also by a desire to take advantage of the UK’s low rates of corporation tax, scheduled to fall even further.
There are many ways corporate partners can be used. Some may represent a tax-efficient way of retaining working capital for investment in growing the business and one would hope these arrangements will not be penalised.
However, at the other end of the spectrum are artificial arrangements, more likely to be caught by any changes.
The good news is the announcement of a consultation period that will help minimise the risk of inadvertent adverse side-effects for genuinely commercial businesses.