HMRC is consulting on two aspects of the tax treatment of partnerships. The consultation is open from 20 May 2013 to 9 August 2013 with implementation scheduled for 6 April 2014.

Partnership structures offer a lot of flexibility and for this reason they are very popular as a business structure. According to business population estimates, there were an estimated 448,000 partnerships in the UK at the start of 2012.

The taxation of partnerships is a complex area: there is no separate tax code and so the legislation is spread over various taxes acts and statements of practice. For example the capital gains charging provision is based on an old Inland Revenue statement of practice dating back to 1975 (and not legislation).

Because partnerships have evolved and developed over the last 25 years, HMRC issued a consultation on 20 May 2013. That consultation, and the proposals contained therein are designed to prevent tax loss through the use of partnerships.

HMRC is focused on two key areas:

  • The use of limited liability partnerships (LLPs) to disguise employment relationships; and
  • LLPs and other kinds of partnerships that have mixed members.

Disguised Employment

Under current rules a member in an LLP is treated as self-employed. This is an automatic presumption. S863 ITTOIA 2005 provides that:

“for income tax purposes if an LLP carries on a trade, profession or business with a view to profit then all the activities of the LLP are treated as carried on in partnership by its members.”

The NIC position is subtly different and there is some doubt regarding HMRC’s automatic presumptions that a member will be self-employed for NIC purposes.

HMRC had previously stated quite categorically that salaried members in an LLP will be treated as self-employed for both income tax and NIC purposes.

The government is not seeking to interfere with the treatment of “true” partners but it does want to review the position for those members who are currently treated as self-employed, when in reality their engagement with the LLP is tantamount to employment.

The government proposes to remove the presumption that all individual LLP members are treated as partners and are therefore treated as self-employed for tax purposes. Instead, HMRC has proposed 2 tests to determine the status of a member and whether that person should be treated as an employee of the LLP for employment tax purposes:

1. The first test would reflect the well-established tests used to differentiate between self-employment and employment.

The first test would appear to go beyond asking whether the member would be a partner in a general partnership. As a general guide as to whether a worker is an employee or self-employed; if the answer is “'Yes” to all of the following questions, then the worker is probably an employee:

  • Do they have to do the work themselves?
  • Can someone tell them at any time what to do, where to carry out the work or when and how to do it?
  • Can they work a set amount of hours?
  • Can someone move them from task to task?
  • Are they paid by the hour, week, or month?
  • Can they get overtime pay or bonus payment?

If the answer is “Yes” to all of the following questions, it will usually mean that the worker is selfemployed:

  • Can they hire someone to do the work or engage helpers at their own expense?
  • Do they risk their own money?
  • Do they provide the main items of equipment they need to do their job, not just the small tools that many employees provide for themselves?
  • Do they agree to do a job for a fixed price regardless of how long the job may take?
  • Can they decide what work to do, how and when to do the work and where to provide the services?
  • Do they regularly work for a number of different people?

2. The second test comes from employment law.

These indications as to self-employment will depend upon whether the individual:

  • participates in the management of the LLP
  • is required to put capital at risk
  • has an entitlement to a share of the residual profits or assets of the LLP.

The effect of the member not being treated as self-employed will be that the employer will need to operate PAYE and pay employer’s NIC at 13.8%. The employee will also be subject to employment taxes on benefits in kind.

Mixed Members

The second part of the consultation document looks at partnerships with mixed members, where profits or losses are allocated to certain members to reduce tax. The government wants to ensure that “inappropriate partnership allocations to a company or similar vehicle cannot create tax advantages”.

This will affect LLPs and other partnerships where some members are chargeable to income tax and others are not, but where it can be assumed that:

  • a main purpose of the partnership profit sharing arrangements is to secure an income tax advantage for any person, or
  • a main purpose of arrangements is to allocate a partnership loss to a partner in order for them to obtain a reduction in tax liability through income tax reliefs.

The government is consulting on changes to the above arrangements for three groups:

  • partnerships with mixed members where profits are allocated to members who pay a lower rate of tax
  • partnerships with mixed members where profits are allocated to members who pay a higher rate of tax; and
  • partnership arrangements where members reduce their profit entitlement in return for payments made by other members who will be taxed more favourably on those profits.

For example, where corporate members receive allocations of partnership profit and then subsequently reallocate this to “connected” individual partners, that partner may pay no additional tax on the basis that such amounts are drawings and not profits.

The key issue is the degree of connection that must exist before HMRC consider the arrangements to be unfair.

This review of partnerships with mixed members is most likely to affect asset managers and hedge funds. It has become common for such firms to operate deferred arrangements regarding discretionary profit allocations (which may be subject to clawback). As partnership profits are fully taxable in the year in which they arise, the allocation to a corporate partner is the only realistic way many firms have of operating such arrangements without individuals being taxed on profits they have not yet received and may never receive.