HMRC's proposals to change tax rules for LLPs.

As announced in Budget 2013, the consultation document Partnerships: A review of two aspects of the tax rules should not come as a surprise, the consultation period closes 9th August 2013.

The implications of the proposals may catch some organisations by suprise, 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.
Artificial profit/loss allocation

HMRC believes that this 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) and income streams are transferred to avoid tax.

For partnerships with mixed membership, tests are proposed to allow 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
Disguised employment

The document 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 HMRCs Employment Status Manual will be used. While this may sound like a catch all, lengthy process, it seems this is most likely to apply where in cut and dried cases - for example, where many ’partners‘ are created by switching a business from company to LLP status.

If the employment status tests are not relevant, HMRC would then seek to establish if the individual is:
• At financial risk if the LLP makes a loss or is wound up
• Entitled to a share of the profits
• Entitled to a share of any surplus assets on a winding-up.

Failing these tests will indicate employment and there will be specific rules to counter schemes artificially inserting partnership terms just to meet them.

For example, insignificant financial risks (e.g. a 5% profit share on top of a guaranteed salary) could be ignored. It will be interesting to see how this stance fits with the ruling in Tiffin v Lester Aldridge LLP.