Is your business:
- operating in the UK in “Limited Liability Partnership” (“LLP”) form, or
- operating in the UK in any partnership form with a mixture of individual and non-individual (e.g. corporate) members?
If so: Important UK tax changes are scheduled for 6th April 2014, of which you need to be aware. It is anticipated that many LLPs and partnerships will be affected by the measures. Although the new provisions are described as being "anti-avoidance" measures, only a small proportion of those affected are likely to consider that the operation of their current structure constitutes “tax avoidance”.
You may need to consider taking action urgently.
Individual LLP members may become “deemed employees” for tax purposes
From 6th April 2014, certain individual members of UK LLPs who are currently taxed as “self employed” partners will become taxable as employees. This will require the LLP to operate the Pay As You Earn (“PAYE”) payroll tax system, and to pay and deduct Class 1 National Insurance Contributions (“NICs”), in respect of payments to such members.
The target of the rules is stated to be members whose role and remuneration is akin to that of an employee of the LLP, but the legislation makes no reference to employment characteristics, instead applying a new and artificial set of criteria to identify members who are to be taxed as deemed employees. If a member works in the business and satisfies all three of the following conditions, he or she will be taxed as an employee:
Condition A: it is reasonable to expect that 80% or more of the member’s total remuneration will be “disguised salary”, i.e. will not vary with or be affected in practice by the overall profit or loss of the LLP (e.g. it is fixed, or varies by reference to personal or divisional performance only);
Condition B: the member does not have “significant influence” over the affairs of the partnership (e.g. where there is a management committee of a large LLP, the member is not on that committee);
Condition C: the member’s level of LLP capital is less than 25% of the amount of "disguised salary" reasonably expected to be paid in each tax year.
Only one condition needs to be "failed" for a member to fall outside the new regime - all three must be met for a member to be taxed as an employee.
The detailed proposed rules and HMRC’s draft guidance on them are more complex than the above summary, and there are provisions designed to prevent circumvention of the new rules too. If you may be affected, it is important to take advice early. Mis-categorisation of deemed employees as LLP members from 6th April 2014 could lead to a rapidly escalating PAYE and NICs default expense from that time.
"Mixed” Partnerships - individual partners may be taxed on non-individual partners’ profit share
From 6th April 2014, where a partnership or an LLP includes both individual and non-individual (e.g. corporate) members, “excess” profit allocated to a non-individual member may for tax purposes be reallocated to individual members.
This may be the case where the non-individual partner’s profit share exceeds a return appropriate to its contribution of capital and services to the partnership. If one or more individual partners has the “power to enjoy” the excess profit allocated to the non-individual partner, then it may have to be reallocated for tax purposes to the relevant individual(s).
“Power to enjoy” is defined for these purposes widely, but is most obviously in point where an individual partner is indirectly interested in profit allocated to a non-individual partner, for example by being a shareholder in a corporate partner.
The reallocation is required where it is reasonable to suppose that the allocation to the non-individual partner is attributable to the individual's “power to enjoy” that profit, and has been increased as a result with a lower overall tax cost arising. (Corporation tax rates are lower than individual income tax rates.)
Alternative Investment Fund Management (“AIFM”) partnerships which are required by regulation to defer remuneration are given a special regime. Deferred awards can be allocated to and taxed on a corporate partner, with credit for the income tax paid allowed for the individual partner when the remuneration vests.
As with the LLP provisions, the full position is more complex than can be outlined here.
There are also other partnership tax reforms proposed which are less likely to have such a widespread impact. If you think your business may be affected, please do contact us for further advice.