Business Finance: Peter Harrup on tax rules for partnerships

Peter Harrup of BDO

Peter Harrup of BDO - Credit: Archant

We had been warned in Budget 2013, so the consultation document Partnerships: A review of two aspects of the tax rules should not have come as a surprise.

However, the implications of the proposals may yet catch out some organisations – particularly as businesses whose current accounting period ends after 6 April 2014 will be affected in this financial year.

HMRC acknowledges that some of the arrangements targeted may not fall within general anti-avoidance but it still wants to block them with specific anti-avoidance rules. There is no intention to target partnerships that simply converted to LLP status, partnerships where the profit sharing ratio is determined wholly on business grounds or family businesses (as in Jones v Garnett) where no value is exchanged for the artificial profit allocation. Nonetheless, a large number of businesses will be affected.

HMRC believes that artificial profit/loss allocation is used for tax avoidance where partnerships with mixed membership (individuals and companies etc) allocate profits or losses between members to reduce or defer tax, and where members have differing tax attributes (exempt and non-exempt partners, etc) and income streams are transferred to avoid tax.

For partnerships with mixed membership, tests are proposed to allow for normal commercial arrangements. However, where “it is reasonable to assume that the main purpose or one of the main purposes, of the partnership profit-sharing arrangements” is tax avoidance, the new rules may apply. HMRC could then reallocate the profits for tax purposes to the partner that would pay the largest UK tax bill or simply deny loss relief claimed. Similarly, for members with different tax attributes, the proposals would effectively ignore the artificial profit allocation to a partner with a lower/zero tax profile, so that the transferor partner suffers the tax.

The document also proposes removing the automatic presumption of self-employment for LLP partners to prevent ‘disguised employment’. Instead, two tests will establish if an individual member is, in reality, a ‘salaried partner’ (liable to PAYE, employers’ and employees’ NIC).

Initially, tests from HMRC’s Employment Status Manual will be used but, if these are not relevant, HMRC would then seek to establish the level of personal financial risk (profit and loss share etc) as a member of the partnership: low risk will indicate employment.

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The consultation closes on 9 August, so we all now have an opportunity to comment on the proposals. However, I doubt that they will change significantly before taking effect next April so, if you think your business could be affected, take expert advice on possible remedial action as soon as possible.

: : Peter Harrup is a partner at the Ipswich office of accountants and busines advisers BDO.