An HMRC consultation document issued on 20 May 2013 – A review of two aspects of the tax rules on partnerships – sets out proposals for changes in two areas:
- Removing the presumption of self-employment for some LLP members; and
- Countering profit allocations where there is manipulation of profits to create a tax advantage.
The consultation is open until 9 August 2013 with the expectation that draft legislation will be issued late 2013. There will be a further consultation period before the changes are introduced on 6 April 2014.
The existing tax legislation deems an LLP member to be a partner for all the activities of the LLP (ITTOIA 2005, s 863). This gives LLP members their self-employed status. The Government considers that the continuation of this favourable treatment for an individual who, but for the legislation, would otherwise be employed by the LLP is unfair to other taxpayers and can create avoidance opportunities.
The proposals provide that an individual will be treated as an employed ‘salaried member’ of an LLP if either of the following conditions is met:
- The first condition is that the individual is a member of an LLP who would be regarded as employed by that partnership (using the employed/self-employed tests as set out in HMRC‟s Employment Status Manual); or
- The second condition is that the individual is a member of the LLP who does not meet the first condition but who:
(a) has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
(b) is not entitled to a share of the profits; and
(c) is not entitled to a share of any surplus assets on a winding-up.
A targeted anti-avoidance rule will be introduced to ensure that, in determining the tax status of the LLP member, no account would be taken of arrangements the main purpose, or one of the main purposes, of which is to prevent the first or second conditions from being met.
Who will be affected?
In recent years there has been an increase in the number of arrangements which use the flexibility of partnership profit and loss sharing to secure tax advantages. The proposals seek to address this by counteracting profit allocations in the following situations:
- Partnerships with mixed members (typically companies and individuals) where profits are allocated to a member subject to a lower rate of tax. The proposals seek to counteract this by making a ‘just and reasonable’ reallocation of part or all of the profits from the member who is not subject to income tax to members who are subject to income tax.
- Partnerships with mixed members where losses are allocated to a member that pays a high rate of tax. The proposals seek to counteract this by disallowing relief for such losses.
- Partnership arrangements where members reduce their profit entitlement in return for payments made by other members who will be taxed more favourably on those profits. The proposals seek to counteract this by taxing such payments as income.
These changes are likely to affect many partners and partnerships, with partnerships with corporate partners and professional LLPs whose members have limited risk most significantly affected. In many cases, profit sharing arrangements will need to be reconsidered and amendments made to partnership agreements.