Forthcoming Changes to Tax Treatment of LLPs and Members

In its recent budget, the Government announced that HMRC would consult on changes to two aspects of the tax rules on partnerships in order to prevent tax loss arising from:

1. the disguising of employment relationships through LLPs; and
2. the manipulation of profit and loss allocations among partnership members to achieve a tax advantage.

HMRC has today published its consultation paper on these issues, setting out its proposals for change in these two areas. The outcome of this consultation will become law this year and take effect in 2014, so affected parties will have little time to deal with the changes. Despite HMRC’s insistence that its review of this area will have no impact on partnerships and LLPs which are used as Parliament originally intended, we anticipate that there will be a significant impact on professional partnerships and LLPs.

Removal of Presumption of Self Employed Status

The presumption of self employed status is important because it allows LLPs to be sure that their members will be taxed on a self employed basis, meaning LLPs do not need not to make employer’s national insurance contributions for their members nor enrol them in PAYE.

The consultation proposes that, in order for members to retain their self-employed status, they will need to take a significant economic risk in the event that the LLP makes a loss or is wound up and should have other rights, such as a variable profit share and an entitlement to a share of any surplus assets on a winding-up. This is in addition to their needing to pass the existing legal tests for membership.

The consultation suggests that an entitlement to a variable profit share will be ignored if it would not be more than 5% of the member’s fixed entitlement. If this is reflected in the final legislation, we anticipate that many existing fixed share membership arrangements will need to be revised to take this change into account.

Profit and Loss Allocations

It is clear from the consultation that the use of corporate members is coming under the microscope. For example, HMRC appears to have rejected the use of corporate members to ‘warehouse’ profits at corporation tax rates. The consultation specifically mentions the use of corporate members by large professional services firms and highlights its concerns with the allocation of profits to corporate members where that corporate member has made a negligible contribution to generate the firm’s profits. There will be no grandfathering for arrangements entered into before the outcome of the consultation is implemented.

We anticipate that the measures outlined in the consultation paper will require changes from many professional services firms, notwithstanding that many firms will have legitimate business reasons for their existing arrangements. Any firms which have fixed share partners or corporate members should review those arrangements in the near future to avoid unwelcome tax consequences.

Please do get in touch if you would like to discuss any of the matters raised in this newsflash.