Change in rules on the taxation of partnerships
By Claire Mascarenhas, Kinetic Partners – Further to HM Revenue & Custom’s consultation of 20 May 2013 on Partnerships: a review of two aspects of the tax rules, draft legislation was released on 10 December 2013 which will see major changes in the tax treatment of partnerships.
Partnerships, including limited liability partnerships (“LLPs”) have to date been the vehicle of choice for managers setting up in the UK affording flexibility around allocation of profits and equity in a tax efficient manner. The changes focus on four distinct areas which we outline below.
Partnerships: Salaried Members
The draft Finance Bill proposes to treat “salaried members” of LLPs as employees for income tax and national insurance purposes. Currently, partners of an LLP are automatically presumed to be self-employed and therefore not subject to PAYE or employers’ national insurance broadly at 13.8% of the gross salary. From 6 April 2014, there will be three conditions which, if met, will deem a partner to be an employee of the LLP for tax purposes.
The first condition looks at whether the remuneration the individual member receives is a disguised salary whereby the amount is either fixed or variable without reference to overall profits or losses of the LLP, or if in practice they are not affected by the overall profits or losses of the LLP. Remuneration based on an individual’s performance or how well an individual’s own portfolio has performed could be caught by these rules.
The second condition is met where the rights and duties of the partners do not give the partner significant influence over the affairs of the LLP. It is important to note that this condition applies to the business of the LLP as a whole, and if your LLP is split into different business streams, a member would need to have significant influence over the whole business for this condition not to apply.
The third condition is that the partner does not have at least 25% of their disguised salary for the year in question contributed as capital.
Anti-avoidance provisions have also been introduced to apply this legislation to individuals, who are not members of the LLP, but provide their services to the LLP through a third party e.g. a corporate member.
Where a member is treated as salaried under these rules, the LLP will be able to claim a deduction for the cost of the individual’s deemed salary.
These new rules come into force on 6 April 2014.
Partnerships: Mixed Membership
The second part of the draft Finance Bill proposals on partnerships seeks to prevent the allocation of profits to a non-individual partner, thereby reducing or deferring an individual member’s personal tax liability.
Where a partnership allocates profits to a non-individual member (e.g. corporate, or trust) and the allocation is deemed to be an excessive amount, from which subsequent lower tax liability the individual member of the partnership is able to benefit, the profit will be reallocated to the individual member and will be subject to income tax.
These changes also apply where an individual member’s remuneration has been deferred and are initially allocated to a non-individual member resulting in less tax being paid. In this case, the deferred profits will be reallocated, so far as is just and reasonable, to the individual member.
The rules also apply to counter excess loss allocations being made to individual members of mixed partnerships in connection with tax avoidance arrangements.
Although the press release states that these provisions have immediate effect from 5 December 2013, the draft legislation states that it applies to periods of account beginning on or after 6th April 2014. However, where a partnership has a period of account which straddles 6th April 2014 that period of account will be split into two, with 6th April 2014 onwards being treated as a separate period of account which will be subject to these new rules.
Partnership: AIFM-deferred remuneration
The draft Finance Bill also contains provisions for how HMRC will allow deferral in partnerships which are subject to the AIFMD remuneration provisions. For deferred profit allocations, the partnership can elect to be treated as a partner itself in order to pay the tax on the deferred amounts on behalf of the member. The partnership will pay income tax at a flat rate of 45%, and once any deferral conditions are met the subsequent amount allocated to the allocating partner will then be subject to tax, receiving a tax credit for the tax paid by the partnership.
If the deferral conditions are not met, the draft legislation does not currently provide for the tax borne by the partnership to be repaid.
Partnerships: Disposal of Income Streams
The last arm of the proposed partnership changes seeks to impose a charge on partners who transfer income streams or assets to other partners via the partnership when there is a tax advantage in doing so. This “disguised disposal,” as it is called, will be deemed to be transferred at market value where consideration received is substantially lower. The rules will come into force from 6 April 2014 for individual members and 1 April 2014 for corporate members.
Given the extent of these four changes, firms will need to carefully review their LLP structure to assess the risk of any individual member being treated as salaried and the use of corporate members. Consequently changes to LLP agreements and its structure may need to be implemented before the changes come into effect.
Other recent announcements
In a welcome move in line with the UK Government’s investment management strategy, HMRC have extended the legislation which currently treats UCITS resident in another state as a non-UK resident, to include Alternative Investment Funds.
The Government also announced in the Autumn Statement that legislation is to be introduced to prevent high earning non-domiciled individuals from avoiding tax by dividing the duties of a single employment into a UK and an overseas contract.
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