HMRC has published its draft legislation to clamp down on tax avoidance through limited liability partnerships

LLP rules unveiled

Making the UK’s tax system more competitive has been consistently trailed as the theme of the coalition’s fiscal policy, and although the cornerstone policy of getting to a 20% rate of corporation tax remains in place, clamping down on tax avoidance is still very much on the agenda. The Autumn Statement was in line with that, with many of the corporation tax measures relating to anti-avoidance.

In an earlier briefing (Journal, July 2013, 26), Christine Yuill wrote on HMRC’s consultation on the taxation of partnerships and LLPs. This focused on two perceived misuses of the existing partnership tax regime: first, removing the presumption of self employment for those LLP members who are “salaried members” in order to tackle the disguising of employment through LLPs; and secondly, counteracting the tax-motivated allocation of business profits or losses in mixed membership partnerships (typically a mixture of individuals and corporates).

On 5 December, the Chancellor announced the measures to combat these arrangements. The draft legislation is now available.

Member or employee?

As pointed out in the earlier article, HMRC is concerned at the widespread use of LLP membership to “disguise” employment relationships. HMRC consulted on identifying misuse by applying two conditions, the first based on normal case-led tests of employment status and the second focusing on financial risks and reward, which if either was met would result in the member being treated as an employee for tax purposes.

The draft legislation does not include the first condition and focuses instead on financial risk and reward. An individual member will be treated as an employee for tax purposes if each of the following three tests are met:

  • the member is to perform services for the LLP in his/her capacity as a member, and is expected to be wholly or substantially wholly rewarded through a “disguised salary” which is fixed or, if varied, varied without reference to the profits or losses of the LLP;

  • the member does not have significant influence over the affairs of the partnership; and

  • the member’s contribution to the LLP is less than 25% of the disguised salary.

  • The legislation is due to come into force on 6 April 2014.

Reallocation of “excess profits”

Draft legislation has also been published to address the way in which some mixed member partnerships/LLPs were being operated so as to allocate profits and losses according to partners’ individual tax circumstances, generally through arbitrage of different tax rates (the top rate of income tax for an individual being currently 45%, while the current rate of corporation tax is 23%). This change will impact professional partnerships as well as those in the alternative investment fund management sector who use mixed member partnerships/LLPs.

Legislation was expected following the consultation; however, the anti-avoidance rules around tax-motivated profit diversion have been brought forward to 5 December. Partnerships and LLPs with mixed members should review their structures in light of the draft legislation.

Essentially, the legislation allows for a reallocation of excess profits from a non-individual partner to an individual partner where the following conditions apply:

  • a non-individual is entitled to a share in profit;

  • that share is excessive (taking into account capital contributed and the level of risk and services provided);

  • an individual 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 or those arrangements.

There are also provisions to allow HMRC to reallocate profits between individual and non-individual partners if the diversion is tax motivated. Anti-avoidance legislation is proposed which allows any arrangements designed to get around the rules to be ignored.

While the concept of no artificial diversion of profits is simple, the legislation is complex and it will be interesting to see how HMRC operates the rules in practice. HMRC has been criticised for taking an approach which prejudices structures which were genuinely set up to accumulate profits for internal investment. The inability to do so tax-efficiently creates a serious disadvantage for the partnership/LLP model when compared with a corporate vehicle in certain circumstances.

As mentioned above, the profit diversion anti-avoidance provisions come into effect from 5 December 2013, although no tax charge can arise in relation to the new provisions until 6 April 2014.

The Author
Karen Davidson, legal director, Pinsent Masons LLP
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