Partnership tax changes – three months left

HMRC salaried partner changes send shockwaves through LLPs

HM Revenue & Customs (HMRC) last week published draft legislation dealing with ‘disguised salary’ of LLP members, partnerships with individual and company members, and further anti-avoidance measures.

While HMRC has clearly listened closely to consultation responses, and amended some of the proposals to reflect this, we fear that innocent arrangements will be caught. Firms should take time now to understand how the changes will affect them, and decide what – if any – action is required.

The legislation will generally take effect from 6 April 2014, with anti-avoidance measures coming into effect from 5 December 2013 to catch any tax-motivated profit allocation structures.

Disguised salary

Under the draft legislation, a member of a limited liability partnership (LLP) will be treated as an employee for tax purposes if all the following conditions are met:

  • If an individual performs services for the LLP and the amounts payable by the LLP in respect of the individual’s performance of those services will be wholly, or substantially wholly, fixed, or if variable, variable without reference to, or in practice unaffected by, the overall profits or losses of the LLP (‘disguised salary’).
  • The mutual rights and duties of the members and the LLP and its members do not give the individual significant influence over the affairs of the LLP.
  • The individual’s contribution to the LLP is less than 25 per cent of the disguised salary.

Mixed member partnerships

New rules are to apply to LLPs and partnerships with individual and company members. The legislation will for tax purposes reallocate excess profits from a non-individual partners to an individual partner where the following conditions apply:

  • A non-individual partner has a share of the firm’s profit;
  • The non-individual’s share is excessive;
  • An individual partner has the power to enjoy the non-individual’s share or there are deferred profit arrangements; and
  • It is reasonable to suppose that the whole or part of the non-individual’s share is attributable to that power of arrangement.

HMRC have also restricted the ability to allocate income and capital losses between individuals and non-individual partners where it is tax-motivated.

What are excessive allocations to non-individual partners?

HMRC will seek to reallocate profits if it is seen as more than just and reasonable, which is in essence more than:

1.      An appropriate notional return on capital; and

2.      An appropriate notional consideration for services.

Our reaction

We are disappointed that HMRC have ignored many of our recommendations, in particular those that addressed commercial concerns. By introducing the changes on 6 April 2014, rather than allowing firms to implement the changes in the first accounting period following 6 April 2014, these changes will result in unnecessary complexities for firms. These could have been avoided.

In addition, HMRC have ignored profession-wide requests not to apply such a ‘broad brush’ approach which has, as predicted, caught so many genuine partnership businesses using the structures to accumulate profits for internal investment. This now gives the partnership model a very real disadvantage in comparison to the traditional corporate model.

This is particularly disappointing for the financial services sector, which has taken an active use in these structures, and it will be seen at odds with the objectives of the FSA Remuneration Code, which encourages rather than penalises deferred remuneration and long term incentive plans (“LTIPs”).

George Bull, chair of the professional practices group, Baker Tilly Tax and Accounting