Partnership and LLP tax planning strategies to be stopped

HMRC have issued proposals to close down two planning structures. One structure uses a LLP to move employees to self employment giving a national insurance saving, the other using the flexibility of the way tax on partnerships is worked out using the profit allocation of partnerships and LLPs to reduce the amount of tax on profits.

These clampdowns were announced in the March 2013 budget and we now have a HMRC consultation document giving detail of the proposed changes to the tax rules.

This tightening up will affect existing planning arrangements.  Anyone using a structure that will be affected should review it for the impact of the proposed changes and take action in advance of next April.  Although HMRC’s document is a consultation we expect the changes to be much as set out – there may be amendments to small points of detail and you may wish to hold off making final decision as to post April 2014 action until the draft finance Bill 2014 is issued in December.

Salaried members of LLPs

Any individual who is a member of an LLP is treated as self employed.  There’s no similar rule for partners in a partnership so, very much depending on the facts, a salaried partner in a partnership may be taxed as an employee for both income tax and NIC purposes. 

HMRC proposes to eliminate this disparity by adding qualifications to the rule which deems members of LLPs to be self-employed.  LLP income of “salaried members” will be taxed as employment income.  A “salaried member” of an LLP will be an individual who, were the LLP a partnership, would be regarded as employed by that partnership.  Individuals who would not be a “salaried member” under that general test will then have to pass a second test, requiring consideration of three factors.  Failure on either test will trigger re-characterisation of income.

The consequences of re-characterising will be:

• the salaried member’s income from the LLP will be assessable as earnings subject to PAYE and Class 1 NIC,
• the LLP will have to account for employer class 1 NIC on that salaried member’s remuneration and operate PAYE, complying with the RTI rules (this may accelerate time of payment of tax), and
• the LLP will be entitled to a deduction in computing its taxable result for what will become an employment cost when these rules apply.

It’s likely that attempts to get round these new tests will be blocked by a targeted tax avoidance rule.

Profit and loss allocation schemes

The second proposed change will apply to a partnership of any type, including a LLP, which has both individual members fully subject to UK income tax and one or more members whose profit share is subject to tax in another way, e.g. a company, or is not subject to UK tax.

If this proposed new rule applies, the partnership or LLP income assessable on the partners who are individuals will be increased on a just and reasonable basis to negate the tax advantage achieved. What is “just and reasonable” may be a matter of dispute between HMRC and the taxpayer.