Partnerships and LLPs Targeted in Finance Bill

Some members of partnerships and LLPs will face increased tax bills. This year’s draft Finance Bill targets both ‘disguised employment’ in LLPs, and arrangements in mixed partnerships taking advantage of the lower corporate tax rate.

At Budget 2013 proposals were announced:

  • to treat some partners of partnerships and members of LLPs as employees (resulting in their profits being treated as earnings for tax and, more importantly, NIC purposes) and
  • to override the normal rules for profit allocation for tax purposes where there are non-individual members of the partnership or LLP. 

Draft legislation in respect of both these areas is included in the draft Finance Bill 2014, along with explanatory notes and a Technical Note and Guidance.

Anti-avoidance – “mixed” partnerships- profit allocation

These rules are targeted at arrangements that seek to benefit from the lower rate of corporation tax by having profits subject to corporation rather than income tax. Broadly, the anti-avoidance provisions will apply when all of the following are present:

  • The partnership has a non-individual member or members (typically a company);
  • A non-individual member of the firm (usually a company) has a profit share;
  • The company’s profit share exceeds a commercial rate of interest on its contribution to the partnership;
  • The individual has the “power to enjoy” the company’s profit share (broadly the individual is connected to the company or can or will benefit from the assets in the company);
  • It is reasonable to suppose that the company’s entitlement to its profit share (or a part of it) effectively was directed to it by the individual;
  • It is reasonable to suppose that the total amount of tax payable by the individual and the company on the profits is lower than had the entire amount been assessed on the individual.

The anti-avoidance can also apply where deferred remuneration of the partner is directed to the corporate member.

The consequence of the anti-avoidance applying is that a greater share of the profits of the partnership are taxed on the individual rather than the company. In effect the partnership profit share assessable on the company is reduced to interest at a commercial rate on its contribution to the firm.

Although the anti-avoidance provision comes into effect on 5 December 2013, reallocation of taxable income from a company to an individual will only apply to income from 6 April 2014. Partners in a partnerships with a 5 April year end will be first subject to the rules for the year to 5 April 2014. For any other partnership year end, the period of account that includes 6 April 2014 is split in two and if the anti-avoidance provision applies the increased allocation of profits to partners will apply to the post 5 April 2014 part of the profits that are otherwise allocated for tax purposes to the company or other affected non-individual. However, any restructuring which takes place before 6 April 2014 to try to circumvent the new rules is susceptible to the anti-avoidance rules (e.g. an individual ceasing to being a partner), but the impact on profit allocations will only take effect from 6 April 2014.

Mixed partnerships will therefore need to be able to justify the commerciality of profit allocations from 6 April 2014 onwards.

LLPs – re-characterising members as employees (for tax purposes only)

The rules are more stringent than expected, and could apply in more situations that anticipated. The‘Salaried Member’ test sets out three conditions.  If all three are met, the individual will be treated as if they were an employee for tax and NIC purposes.  (In other words, meeting the conditions is bad news). The three conditions are as follows:

  • Condition A - this applies where 80% or more of the amounts payable to the individual are in the form of ‘disguised salary’. Its aim is to identify those members who are paid for their services without reference to the overall profitability of the firm (‘disguised salary’).  Examples of payments which will be caught as disguised salary are fixed sums, payment for piecework, a bonus based on the individual’s own performance or just one part of the business, guaranteed profits and non-refundable drawings. It does not catch advances of profit share.
  • Condition B – this applies where the mutual rights and duties of the members of the LLP do not give the member significant influence over the affairs of the partnership. As with Condition A, this test looks at the business as a whole. It is not enough that the individual may have significant influence over some part of the business; they have to have significant influence over the business as a whole. In large partnerships, this condition is likely to be met by only a small number of individuals.
  • Condition C – This applies where the amount contributed to the LLP by the individual member is less than 25% of the disguised salary he is expected to be paid for the whole tax year. This test is applied at the beginning of each tax year from 2014/15 onwards, when the individual becomes a member of the LLP if later, or in the event of a change (e.g. incapital contributed).

A LLP member who meets all of these tests will be taxed as an employee. The most significant consequence is that their profit share will be subject to class 1 NIC. In particular the LLP will have to pay 13.8% class 1 secondary NIC on the profit share. All other employment-related tax rules – but only tax rules – will also apply to the individual, such as those for benefits in kind and taxation of share schemes.

Until now there was an inviolable principle that a member of a LLP would be taxed as self employed (there was no such rule for partners in partnerships). The aim of the new anti-avoidance is to put LLPs and partnerships on the same footing.

LLPs set up purely to eliminate employers’ NIC by making individuals members, when they are essentially employees, will be affected. However, the impact could be wider than that and possibly affect “genuine” members of LLPs, for example fixed profit share members. They may have to show they have significant influence on the LLP’s affairs which for a junior member could be a challenge! 

An option to escape the new rules is for individuals to increase their capital contributions. However, the contributions must genuinely represent an investment in the business such that there is a real economic risk attached to the success or failure of the business. Capital contributions made under ‘arrangements’ to get around Condition C will be ignored where there is no intention that they have a permanent effect or give rise to economic risk.

Members affected will cease to be treated as partners for tax purposes from 6 April 2014. However in law they will remain as members of a LLP. Thus they will not come within employment law protections, such as entitlement to redundancy pay, minimum wage, unemployment benefits. With the NIC advantage lost, affected members may seek to resign from membership of the LLP and become (or revert to) employees.

HMRC estimate the change will raise additional taxes of over £1bn in its first year. The size of this sum shows it is expected to have a significant impact. 

Disposals of rights to income profits of a partnership

Anti-avoidance legislation effective from 6 April 2014 will counter schemes in which a member of a partnership (the “transferee member”) contributes capital to a partnership or makes a payment to another member (the“transferor member”) in return for the transferee member receiving a new or increased share of profits. The profit obtained by the transferee is equal to the profit forgone by the transferor member, who would otherwise have been liable to include the profit share foregone as subject to tax on income. The transferee member is either not taxed at all on the profit or is taxed at a much lower rate than the transferor member would have been. The transferee member’s receipt is not taxed. The transferor may be tax exempt, may have otherwise unused losses or reliefs, may be taxed at a lower rate or may be able to set the payment to acquire the income stream against the profit share (e.g. a bank).

The provisions affect transfers of assets with unrealised gains, as well as transfers of income streams noted above.


These proposals are far-reaching and firms potentially affected need to consider their implications as a matter of urgency.