The wait is over and finally we have the draft legislation and HMRC Guidance Notes implementing the planned reform of taxation for LLPs.
This edition of Partnerships Update focuses on how HMRC's plans have changed from the plans originally mooted and what this means for your LLP.
1. Salaried partners
The whole idea of introducing LLPs was to provide a corporate vehicle that would be taxed in the same way as an (unincorporated) partnership. Unfortunately the framers of the Limited Liability Partnerships Act 2000 went a bit too far in enshrining this principle. They introduced a provision, or one might say a 'quirk', that had the effect that individuals who are members of an LLP were to be always taxed as if they were partners in a partnership established under Partnership Act 1890 (i.e. a traditional partnership) - even if they were engaged on 'salaried partner' terms – ie on terms that were closer to employment terms so that under existing tax law they would be taxed as employees.
This has produced a perceived unfairness where a salaried partner of an LLP receives more favourable tax treatment than an individual who is an employee of a company, or even a salaried partner within a general (ie unincorporated) partnership, engaged on similar terms. The LLP is also not liable to employer's NICs on a member's profit share, unlike on an employee's salary. As HMRC saw it, LLPs were being used to disguise employment and to avoid employment taxes.
2. Profit allocations in mixed member partnerships
Profit sharing within partnerships can be flexible and this flexibility has in the past been used to generate tax advantages. Various structures have been used to allocate profits may be allocated to a low tax entity, such as a company, while individual partners taxable at higher rates ultimately receive the benefit of those profits in low-taxed or even non-taxable form.
3. Profit allocations for AIFM firm
One of the arguments used to justify the need for mixed partnerships was the need that some firms argue that they have to warehouse profits which cannot be paid to partners in cash as a result of regulatory requirements. In particular under the Alternative Investment Fund Managers Directive, AIFM firms are obliged to withhold elements of remuneration payable to certain staff (including partners or members of an LLP) and to make the right to receive this conditional or subject to clawback. Where these rules apply to employees (or to disguised employees, as discussed above), there is no particular problem as tax is payable only when the remuneration is paid out, but where the rules apply to members of an LLP, the tax treatment is tat all of the profit of an LLP gets to be taxed in the tax year applicable to the year in which the profits are made irrespective of whether such profits are paid out.
Click here to find out how HMRC's proposals for AIFM firms have developed >
4. Areas where no significant changes are proposed
- Loss allocation: HMRC had also identified
arrangements where losses are allocated to individual members to
enable them to secure relief at high income tax rates. The proposal
was that income tax relief would not be allowed where such
arrangements are in place.
HMRC has confirmed that they intend to press ahead with these new rules without significant change. - Asset disposals: HMRC also wanted to deal with schemes where, as a result of one partner transferring an asset to another partner in return for an allocation of profits, and as a result of the different tax attributes of these partners, the outcome is that one partner receives a payment that is not taxed as income in return for profits that would have been charged to tax as income. HMRC's proposal was that the consideration paid for the transferred profits would be subject to income tax (thus negating any tax benefit the transferor might have looked to achieve).
Again, HMRC plans to go ahead with this. Where a person disposes
of an asset or income stream through partnership and the main
purpose, or one of the main purposes, is to secure a tax advantage,
the new rules world impose an income tax charge on the person
making the disposal.
We hope you find this of interest.
The Partnerships Team at Field Fisher Waterhouse
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
