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LLP and Partnership Tax Arrangements to be targeted by the Government
The changes are scheduled to come into force in April 2014 and may have a significant effect on the structure of existing LLPs or those businesses considering converting to an LLP.
The first change is to remove the automatic presumption of self-employment from members of a LLP.
Under the current system, LLP members are automatically presumed to be self-employed. As such, they receive favourable tax treatment with regards to both national insurance contributions and income tax. HMRC argue that, in reality, the role of many of these members is much more aligned to that of an employee. By way of example, as a self-employed member of an LLP, the requirement to pay employer’s NICs is eliminated which provides a significant tax saving.
In order to establish whether a member of an LLP should be treated as an employee or as self-employed, the Government’s consultation sets out two circumstances in which individual LLP members will, from April 2014, be treated as if they were employees of the LLP:
1. On the assumption that the LLP is carried on as a partnership by two or more members of the LLP, the individual would be regarded as employed by the partnership by reference to the normal tests of employment. These deal with matters such as control, the requirement for personal service, financial risk, the ability to profit from sound management, and so on.
2. Alternatively HMRC propose to treat a salaried or fixed profit share member as an employee if he or she is not an employee under the test above but is nonetheless someone who:
- Has no economic risk;
- Is not entitled to a share of the profits; and
- Is not entitled to a share of any surplus assets on a winding-up.
It should be particularly noted that arrangements for ‘junior partners’ will need to be structured carefully to avoid falling foul of the rules.
The second change is designed to stop the channelling of profits through so called ‘Corporate Partners’ in order to reduce the tax liabilities of individual partners. This second proposal could have a profound impact on the structure of LLPs.
This deals particularly with the allocation of profits and losses to different members in order to reduce tax. In most cases, these partnerships will involve ‘corporate’ (or ‘company’) members as well as individuals. In these cases, corporate members are subject to corporation tax, up to 23% of profits, whilst individuals are subject to income tax which as the top rate is 45% of earnings. Clearly, by diverting profits to corporate members, the overall tax burden is significantly reduced.
HMRC believes that in scenarios as outlined above, a high proportion of profits are allocated to corporate members who, in reality, make little or no contribution to the business and in many cases, some or all of the individual partners will own the corporate member and can therefore benefit from the profits allocated to it.
HMRC give the following examples which they say are not sufficient to avoid a counteraction under these provisions:
- It is unfair to tax individuals on profits in a period during which the individuals are unable to access them or if the partnership uses the profits to develop the business.
- Retaining working capital by means of these arrangements effectively gives access to cheap finance.
- The member may be taking risks in respect of the profits since, if the business fails, or the profits do not vest, the amounts may never in fact be received.
Importantly, the Government outlines that, if profit is made, all of the profits allocated to LLP members not subject to income tax (corporate members) will simply be reallocated to those who are subject to income tax.
When will these proposed changes take effect?
The changes will take effect from 6 April 2014 although in reality we will not have absolute certainty with regard to the new provisions until the summer of next year. It is not expected that the proposals will be substantially changed before enactment as the consultation merely invites views on the detailed legislative design and the detail of implementing the changes.
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