As a choice of business vehicle, partnerships offer a level of flexibility which continues to encourage their increasing use across a range of sectors beyond their traditional use by professions and small businesses. The other sectors include including hedge funds, film partnerships, the property sector and the corporate business world generally. The perception at HMRC is that, in some cases, this flexibility has been taken too far and "the misuse of partnership rules has become a feature of many avoidance schemes". The Chancellor has therefore announced an intention to consult, this spring, on new legislation designed to target the use of partnerships to artificially reduce tax liabilities. Two specific areas of review have been highlighted:
"The disguising of employment relationships through LLPs"
One concern is that employer NIC revenues are being lost as a result of the granting of LLP member status to individuals who would otherwise be employees.
HMRC intend to address this by removing the current presumption that LLP members are self-employed. No further detail has been announced but we would anticipate that this could be accompanied with a substance test for determining whether an individual is to be treated as a partner or an employee.
Any such substance test is likely to mirror the case law tests already applied to general partnerships and those applied for employment law purposes. These focus on "hallmarks of equity ownership" such as voting rights, capital contribution, exposure to losses and remuneration which varies in direct correlation to the results of the business.
Many LLPs would say that the commercial advantage of extending their pool of members has been the improved performance which has come from increased enfranchisement and this only comes with some degree of genuine equity participation. Therefore many will consider such a substance test to be reasonable and, indeed, anticipated. It is to be hoped that the test will be framed in such a way as to avoid uncertainty around the 'middle ground' and without discouraging such enfranchisement (particularly in light of the benefits, acknowledged in other announcements, of encouraging wider equity participation for those who work within a business).
"Countering the manipulation of partnership profit/loss allocations to secure tax advantages"
We will need to wait for the publication of the consultation document for detail as to what HMRC may have in mind. However there are two areas which we understand them to be considering.
The first is the use of corporate partners alongside individual partners.
Increased use of corporate partners is in part explained by commercial and regulatory complexities but often also by a desire by business to take advantage of the UK's low rates of corporation tax (scheduled to decrease even further following today's announcements). There is a wide spectrum of ways in which corporate partners can be used. However, it would seem that, at one end of the spectrum, there are arrangements which HMRC consider to be designed to artificially manipulate the rate differential between (low) corporation tax rates and (high) income tax rates.
The second area of likely focus, the subject of recent press attention, is the use of partnerships to allow wealthy individual investor-partners to benefit from tax incentives such as Business Premises Renovation Allowances (BPRA). While some of these partnerships will be genuine commercial property development ventures, HMRC perceives that some may be largely tax-motivated. We may well see extension of the loss restriction rules applicable to "trades" to businesses (of all sorts) to catch these arrangements.
The good news is the announcement of a consultation period which will minimise the risk of inadvertent adverse side effects for genuinely commercial business.
Small businesses may also benefit from a review of partnership tax rules by the Office of Tax Simplification also announced today.
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