HMRC Tax Consultation of LLPs

Transcription

1 HMRC Tax Consultation of LLPs

2 HMRC Tax Consultation of LLPs Introduction On 20 May 2013, HMRC published a consultation document on changes to two aspects of the partnership tax rules to prevent tax loss arising: 1. from disguised employment relationships through LLPs; and 2. from certain arrangements involving the allocation of profits and losses among partnership members. This follows the Government s announcement at Budget 2013 that it is proposing to change the tax rules in line with its principles and objectives for fairness and flexibility in the tax system. The purpose of the consultation is to invite views on how to implement those changes and to seek information about how the changes would impact on businesses in terms of costs of compliance. 1. Disguised employment HMRC considers that there is currently an unintended inconsistency in the way that LLPs are treated which means that some LLPs are able to avoid their employment tax obligations. Current tax rules mean that individual members of an LLP are taxed as if they are partners in a traditional partnership, hence self-employed for tax purposes, and thereby obtain a more favourable treatment of income tax and NI contributions, while corporate members are liable to corporation tax. The policy aim is to prevent a member of an LLP benefitting from the default partner status if the terms of their engagement are tantamount to an employment. Thus, an individual member who meets either of the following two conditions will be classed as a salaried member and liable to income tax and primary NI contributions as an employee: (1) A salaried member of an LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership; and (2) A salaried member of an LLP includes an individual member of the LLP who does not meet the first condition but who: has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up; is not entitled to a share of the profits; and is not entitled to a share of any surplus assets on a winding-up. The LLP will become the secondary contributor and be liable to pay secondary NI contributions. A targeted anti-avoidance rule will be introduced to deal with any attempt to circumvent the proposed changes by introducing terms into the LLP agreement to disapply the legislation. The first condition It is intended that the first condition would apply to many members who are engaged on standard terms as part of a mass recruitment exercise or who have been employees of a company and then become members of a successor LLP on essentially identical terms. The second condition For the purpose of this condition, any risk or entitlement deemed insignificant will be ignored and what is insignificant will be determined in the light of all the circumstances, but in practical terms an entitlement of less than 5% of the profits is unlikely to be regarded as significant.

3 2. Allocation of profits and loss HMRC considers that there are an increasing number of arrangements which use the flexibility of partnership profit and loss sharing arrangements to secure tax advantages and plans to address three distinct types, namely: 1. partnerships with mixed membership profits i.e. partnerships with mixed members (companies and individuals) where profits are allocated to a member which pays a lower rate of tax 2. partnerships with mixed membership losses i.e. partnerships with mixed members where losses are allocated to a member which pays a higher rate of tax 3. partnerships with members with differing tax attributes i.e. partnership arrangements where members reduce their profit entitlement in return for payment made by other members who will be taxed more favourably on those profits Partnerships with mixed membership profits The consultation focusses on two particular categories, profit deferral and working capital arrangements. HMRC believes that if no action is taken, these types of arrangements, which are aimed at reducing the tax payable on partnership profits, are likely to proliferate in a way which would be unfair to those who operate partnership structures as intended.profit deferral arrangements, HMRC points to those occurring within the banking and hedge fund sectors, which according to HMRC, have the aim of aligning incentives with long-term performance so as to discourage the taking of risks and are most commonly seen in employment contracts. Under the LLP agreement, a proportion of profits are retained in the partnership until the deferred period expires and are initially allocated to a corporate member (in which the members hold an equity stake) in order to reduce the upfront tax charge. When the profits finally vest with the member, the corporate member is dissolved and the proceeds distributed to the member, with lower tax, if any, paid at that point. By working capital arrangements, HMRC is referring to those arrangements whereby profits are retained in the business to be used as additional working capital and post-tax working capital can be maximised by allocating profits to a corporate member that pays tax at a lower rate than individual members. The effect of such arrangements is that individual members are taxed only on the profits that correspond to the remuneration they need to draw from the business, while the remainder of the profits are taxed at the corporation rate. HMRC acknowledges in the paper the arguments that deferring profits avoids individuals being taxed on profits which they are unable to access and that retaining capital effectively gives access to cheap finance, but considers that that these arguments do not override the risks of unfairness and market distortion. Partnerships with mixed membership losses Similar to the above category, these arrangements make use of differences in tax rates applicable to different categories of member and HMRC gives a typical example of a partnership carrying on a business which gives rise to initial tax losses followed by later tax profits. In the initial loss making period, all losses are allocated to individual members to allow them to claim loss relief against their general income which would otherwise by chargeable at higher rates of income, thereby reducing their overall tax liability. In the profitable periods, the profits are allocated to the corporate member and therefore subject to lower corporation tax or possibly not within the scope of tax at all. The proposed changes are not intended to affect those entering into arrangements that are not tax-motivated, but are intended to deter arrangements that exploit tax treatment of mixed membership partnerships. The changes will apply where a partnership meets the mixed membership requirement and either the profit condition or the loss condition is met. Where the rule applies, the proposed changes will counteract any allocations to corporate members

4 in mixed partnerships where the purpose of the allocations of profits or losses is to secure a tax advantage. Partnerships members with differing tax attributes HMRC states that it has seen a number of schemes in which a new member contributes capital to a partnership or makes a payment to another member in return for receiving a new or increased share of profits, which is equal to the profit the transferring member would have been charged to tax as income. Thus, the member receives payment that is not taxed as income and the new member acquires the profits and pays less tax because of their particular tax attributes. The Government intends to introduce legislation in respect of an arrangement which would be deemed a profit transfer arrangement if it is reasonable to assume that the new member s entitlement to profit is in consequence of receipt of money by the transferring member which, absent the arrangement, the transferring member would have been charged to tax as income. Where the legislation applies, the payment received by the transferring member will be chargeable to tax in the same way as the relevant profits would have been taxed. Conclusion The Government proposes to introduce changes in the Finance Bill 2014 and in a National Insurance Contributions Bill to be introduced this year. The changes will take effect from 6 April Within the investment management industry, LLPs have commonly been a structure of choice and the proposed changes may have a significant impact on investment managers in the UK, precipitating changes to a firm s LLP agreement. The closing date for comments on the consultation is 9 August Should you wish to discuss any of the points raised in the above in more detail, please contact Claire Cummings at Claire.Cummings@cummingslaw.com or on

5 This document is for general guidance only. It does not constitute advice. June Brook Street, London W1K 5DB Neuhofstrasse 3d, CH-6340 Baar Regulated by the Solicitors Regulation Authority