Service Company Use Under Threat

September 17, 2013

Partners have today been given yet more reasons to dread the coming tax year.  Already facing the prospect of junior partners being taxed as employees and potentially harsh tax treatment for firms with corporate partners, fresh proposals were announced today by Danny Alexander at the Liberal Democrat conference to crack down on the use of service companies by partnerships and LLPs and to “close a loophole that allows private equity shareholders to siphon money out of their firm”.

Service company arrangements have to date been accepted by HMRC and can offer a small marginal return for firms, particularly in respect of salary costs.  This is of particular importance to professional services firms, which typically have large numbers of highly paid employees and are structured as LLPs. Although the specifics of the proposed changes have yet to be announced, it is likely that the transfer pricing rules which enable service companies to achieve tax savings will be modified to, at the very least, eliminate that saving.

It is not yet clear what Danny Alexander was referring to when he talked about closing a loophole for private equity shareholders to siphon money out of firms, but it suggests a continuation of the approach adopted in the recent HMRC consultation aimed at limiting the use of corporate members.

The overall thrust of government policy in 2013 appears to be to discourage partnerships and LLPs from including limited companies in their structures, in order to ensure that partners are subject to income tax rather than corporation tax.  The underlying issue is the ongoing disparity between corporation tax rates and personal tax rates, which the Government seems unlikely to address.  Although overall levels of taxation can end up broadly similar between partnerships, LLPs and companies, there are a number of circumstances in which a company may prove the better option from a tax perspective.

Many firms may be able to avoid some or possibly all of the proposed changes if they are willing to revisit their partnership structures, but it is clearly unfortunate that firms are being diverted from developing their businesses.  Some partners will unavoidably suffer more tax as a result of what is proposed.


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