LLPS UNDER ATTACK FROM HMRC
TAX
On Monday 20 May 2013 HMRC announced a consultation1
on a series of tax measures which, in combination with antiavoidance rules which came into force earlier this year, are
aimed at countering certain tax advantages obtained through
use of LLPs and other partnerships.
While some of the arrangements which HMRC have in their
sights are clearly tax avoidance arrangements which might have
been expected to have had a relatively limited shelf life in any
event, many of the proposals are more wide ranging and will
have an impact on many businesses which do not regard their
structures as aggressive.
Some of the existing flexibility of LLPs as business vehicles
will be lost and arrangements which aim to use corporate
members of LLPs for profit retention and to assist with deferred
remuneration are also likely to be severely restricted.
BACKGROUND
Since its introduction in 2000, the LLP has developed into the
vehicle of choice for owner-managed businesses in the financial
advisory, fund management and professional services industries.
As well as being a commercially flexible vehicle for dividing up
equity ownership, current year income and governance, LLPs
have also offered a number of tax advantages. This has also led
to their being used in other industries to try to access some of
this flexibility.
Corporate members
Historically, the quid pro quo for self-employed tax treatment
was that the partners were liable to income tax on their allocated
share of the profits of the partnership on an arising basis, whether
or not those profits were distributed. This made it more expensive
to retain profits within a partnership than a company.
However, as the income and corporation tax rates have diverged
(particularly since 2010), some businesses trading as LLPs have
introduced companies as members of their LLPs to achieve
a variety of tax advantages. These advantages derive for the
most part from allocating the profits of the LLP to the corporate
member so that those profits are subject to corporation tax rather
than income tax (and so are taxed at a much lower rate).
Typical planning would be to make allocations of profits to
the corporate member where cash needs to be retained for
regulatory or working capital or for other investment. Less
commercially driven schemes involved the cash subsequently
being accessed by the individual members of the LLP.
THE CONSULTATION AND CHANGES TO THE LAW
The landscape is changing quickly. One change has already
been implemented (via anti-avoidance rules introduced with
effect from 20 March 2013) and two further changes have now
been announced in the HMRC consultation, with any new law to
take effect from 6 April 2014.
Self-employed tax treatment
The consultation – disguised employment
One tax advantage of operating as an LLP (rather than a
company) is that the members are treated as self-employed
partners for tax purposes, with the result that employer’s
national insurance contributions (NICs), currently 13.8 per
cent, are not payable on their remuneration. Further, since
members of LLPs are not employees, LLPs offer the additional
advantage of taking members outside various anti-avoidance
regimes aimed at employees (including the employment related
securities and the disguised remuneration rules).
HMRC have announced that they intend to introduce new rules
to remove the presumption that an LLP member will not be an
employee for all tax purposes, but the proposals go further and
may deem members to be employees (through use of a new
concept of “salaried member”) in certain other circumstances.
Up until now HMRC have accepted that the law requires all
members of an LLP to be afforded this treatment even if,
on general principles, they would be treated as employees.
However, the increase in LLPs promoting relatively junior staff
to membership in order to access tax benefits (without their truly
having any exposure to the success or failure of the business
as a “true” partner might be expected to) has resulted in HMRC
taking action to change this approach.
ŠŠ The first condition is that, if the LLP were a normal
partnership, the member would be treated as an employee
of that partnership. This condition removes the automatic
presumption of self-employment for tax purposes, and
falls back on the common-law definition of an employee. In
practice under these tests most members of LLPs would
still be treated as self-employed (and in fact many advisers
have advised that it was best practice to meet these tests
even before the consultation in case of a change in HMRC
practice) and so this change may have limited impact
except in the more aggressive cases.
https://www.gov.uk/government/consultations/a-review-of-two-aspects-ofthe-tax-rules-on-partnerships.
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Under the proposed rules, LLP members will be treated as
“salaried members” (and so as employees and not selfemployed for tax purposes) if they satisfy one of two conditions.
ŠŠ The second condition potentially has a wider impact as it
states that an LLP member will be treated as employed for
tax purposes if he or she:
Therefore, the consultation document proposes that where
profits are allocated to a corporate member with which one or
more individual members have an “economic connection”, and
where an aim of the arrangements is to secure a tax advantage,
the profits allocated to the corporate member will be treated as
allocated for tax purposes on a just and reasonable basis to the
individual members.
-- has no economic risk in the event the LLP makes a
loss or is wound up (for example by being required to
repay drawings or by forfeiting capital); and
-- is not entitled to share in the profits of the LLP or to
share in any surplus assets on a winding up of the
LLP (i.e. has only a fixed salary or drawings).
An economic connection will be treated as existing where the
individual members are able to benefit, directly or indirectly,
from profits allocated to the corporate member. The basis
of reallocation will depend on all of the circumstances but
effectively corporate members will be looked through for tax
purposes. The proposed change would put an end to many of
the types of corporate member planning set out above.
HMRC have indicated that they will introduce an anti-avoidance
rule to catch artificial arrangements designed to meet the letter
of the law but not its spirit.
LLPs will therefore need to review their LLP agreements in light
of the proposed changes. Many LLP members (particularly
senior members) will be on risk for the performance of the
business and will have a genuine right to participate in the LLP’s
profits. Members falling within this class should be unaffected
by the proposed rules. Businesses that have structured
themselves as LLPs so that even junior employees are
members will clearly fall foul of the new rules. The more difficult
position will be where the LLP’s members include mid-level staff
or staff with high fixed drawings. In those cases, care will need
to be given to ensure that the new tests are satisfied.
HMRC seem to pre-empt some of the expected responses to
the consultation in the draft – for example noting that many of
these structures are intended to save up cash for regulatory
purposes or as part of a commercial deferral arrangement.
However, they believe that the high tax charges this gives rise
to are the natural consequence of being taxed as a partnership
and that businesses choosing to carry on business as LLPs
must accept all of the disadvantages of that choice (as well as
the advantages). HMRC may make concessions in these areas
in the consultation process but the current stance is that even
these arrangements will be caught.
The consultation – corporate members
HMRC propose to stop all corporate member planning where
one of the purposes of the planning is to reduce or defer
income tax liabilities. The changes will apply to profits arising on
or after 6 April 2014 (i.e. from next tax year).
In relation to deferred profit allocations, HMRC have indicated
their willingness to consider a relief for individuals where profit
allocations are forfeited at a later date or to allow affected
members to elect to be taxed as employees on deferred
amounts. While either result would not be as beneficial as
current planning using corporate members, it would nonetheless
be a welcome relaxation.
HMRC’s basic view is that individuals have a choice of business
vehicle. They can carry on business through a company, be
subject to corporation tax on retained profits but accept that all
executives will be subject to employment income tax and NICs
on their remuneration. Alternatively, they can carry on business
as an LLP, have the benefits of the added flexibility afforded by
partnerships and not be taxed as employees, but be subject to
income tax rates on all profits on an arising basis.
Finally, the consultation proposes two other changes to clamp
down on tax planning within LLPs:
ŠŠ To prevent arrangements whereby losses of an LLP or
partnership with both individual and corporate members
are allocated to an individual member rather than the
corporate member for tax planning purposes. HMRC’s
proposal is that the losses should simply be disallowed in
this situation. There is no suggestion in the consultation
document that anyone else would be entitled to those
losses. It would seem fairer (as for profits) for the losses to
be reallocated on a just and reasonable basis.
HMRC therefore regard arrangements where corporate
members are admitted to LLPs and are allocated profits which
will ultimately economically benefit the individual members (either
through shareholdings in the corporate members or through
recapitalisation or other mechanisms) as taxpayers having the
best of both worlds and HMRC want to put an end to that.
2
ŠŠ HMRC propose to counter certain other arrangements
that arbitrage different tax attributes of partners within
partnerships. In particular, HMRC want to counter profit
transfer arrangements whereby individuals effectively sell
profit shares to companies for tax planning purposes and
other arrangements where rights to income are diverted
through partnerships to those who are not subject to tax
on them (or who are subject to tax at a lower rate).
Loans to participators rules – with effect from 20 March
While the two changes referred to above are for the future, the
recent Budget contained changes to the loan to participator
rules which have an immediate impact on certain corporate
member tax planning strategies.
Specifically, a 25 per cent tax charge may arise in certain
circumstances on advances of cash by companies to an LLP
or other partnership (or where a debt otherwise arises) and on
other benefits conferred by corporate members to the individual
members. This tax charge can apply where an individual who is
a direct or indirect shareholder in the corporate member is also
a member of the LLP.
The old rules
The “loans to participators rules” apply where a close company
makes a loan or other advance of money to one of its direct or
indirect shareholders. In practice many corporate members of
LLPs will be close companies. Where such a loan or advance is
made, an amount equal to 25 per cent of the amount of the loan
must be paid to HMRC by the close company within nine months
of the end of the accounting period in which the loan or advance
is made. This is effectively a tax deposit, with provision for the
amount to be refunded if/when the loan or advance is repaid.
Under the old rules, HMRC accepted that where an advance of
money was made by a corporate member to an LLP in which
one or more of its participators was an individual member, that
advance would not be caught by the loans to participators rules
where the LLP was a bona fide arrangement. This is no longer
necessarily the case under the new rules.
The new rules
The new rules provide that where a corporate member makes
a loan or advances money to an LLP in which one or more of
its direct or indirect shareholders is an individual member
(or where a debt otherwise becomes outstanding), the loans to
participators rules will apply, and the corporate member will be
required to pay the 25 per cent tax charge over to HMRC.
In addition, wide anti-avoidance rules have been introduced
which catch arrangements where a close company is party to
tax avoidance arrangements (defined broadly) and as a result
of those arrangements a benefit is conferred on a participator
or an associate of a participator (including any members of the
LLP where a participator in the company is also a member).
CONCLUSION
In conclusion, most LLPs will need to take heed of the potential
changes to the rules:
ŠŠ any that have members who are not full “equity” members
with exposure to the performance of the business and
capital at risk may need to consider the new rules for
“salaried members”; and
ŠŠ any that have corporate members will need to consider
(i) whether the changes to the loans to participator rules
could already inadvertently affect their arrangements and
(ii) whether the retention of the corporate member post 6
April 2014 will have any tax effect if the changes come
into force as announced.
It is possible that HMRC may yet relax some of the proposed
rules in the consultation. They do, for example, recognise the
unfairness of members being taxed on profit shares which they
might never receive and suggest the possibility of a new relief to
avoid that situation. There may be other consequential changes
to relax the effect of these rules in certain circumstances.
However, it seems clear that most if not all planning to swap the
income tax rates for the corporation tax rate is likely to die with
effect from 1 April 2014.
CONTACT DETAILS
If you would like further information or specific advice please contact:
DAMIEN CROSSLEY
DD: +44 (0)20 7849 2728
damien.crossley@macfarlanes.com
MARK BALDWIN
DD: +44 (0)20 7849 2603
mark.baldwin@macfarlanes.com
MAY 2013
MACFARLANES LLP
20 CURSITOR STREET LONDON EC4A 1LT
T: +44 (0)20 7831 9222 F: +44 (0)20 7831 9607 DX 138 Chancery Lane www.macfarlanes.com
This note is intended to provide general information about some recent and anticipated developments which may be of interest.
It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.
Macfarlanes LLP is a limited liability partnership registered in England with number OC334406. Its registered office and principal place of business are at 20 Cursitor Street, London EC4A 1LT.
The firm is not authorised under the Financial Services and Markets Act 2000, but is able in certain circumstances to offer a limited range of investment services to clients because it is authorised and regulated by the Solicitors Regulation Authority.
It can provide these investment services if they are an incidental part of the professional services it has been engaged to provide. © Macfarlanes January 2013