Proposed tax changes for Limited Liability Partnerships from 6 April 2014

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The present position (prior to 6 April 2014)

A Limited Liability Partnership (LLP) is a hybrid: it has the status of an incorporated business, but LLP members (or partners) are considered to be self employed.  One practical consequence is that LLP members have unlimited liability.

Contrast this with an unincorporated business partnership where partners are personally liable for company debts if the partnership is unable to settle liabilities in full.

As mentioned above LLP members are considered to be self employed.  This has encouraged the promotion of salaried partners and staff to LLP member status to save employers’ National Insurance Contributions on their salaries and any associated benefits in kind.

LLPs can also have “mixed members” – individuals and incorporated concerns.  At present the top rate of corporation tax is 20% for smaller companies and the top rate of income tax 45% for individuals.  HMRC are therefore concerned that profit shares are being artificially manipulated to steer LLP profits towards corporate members rather than individuals.

Proposed changes from 6 April 2014

HMRC are looking to change the rules from 6 April 2014 to close the above tax planning opportunities.

Salaried members

LLP members, whom HMRC consider are not true, risk taking partners, will find themselves reclassified as “salaried Members” and will be taxed under the PAYE regulations as if they were employees.  Salaried members will also be subject to the benefit-in-kind regulations.  The new legislation will include a three part test to see if LLP members should be taxed as salaried members.  If all three parts apply then the member will be considered a salaried member.  As usual the definitions are full of ambiguities, but in a simplified format they are:

  1. Condition A: a member’s regular payments from the LLP have the characteristics of a “disguised salary” i.e. they are fixed and do not vary in line with actual profits and losses.
  2. Condition B: a member has no significant influence over the affairs of the LLP.
  3. Condition C: a member’s capital stake in the business is less than 25% of their expected reward package.

There are likely to be “grey areas” where interpretation will be somewhat difficult and uncertain but essentially, as long as LLP members can demonstrate that at least one of the three conditions does not apply to their circumstances, they will continue to be assessed as having a self employed status.

Tax motivated allocation of profits

The second significant change to partnership taxation (applies to LLPs and partnerships) will be legislation that will enable HMRC to unravel the allocation of profits between individual and corporate members if they decide that the main objective of the original profit allocation was to secure a tax advantage.

LLPs and partnerships that have corporate members, and the corporate members are owned or controlled by individuals who are also members or partners, will be particularly vulnerable.  HMRC will be on the lookout for excess profits being allocated to corporate members to shelter profits at lower rates of taxation.

Time to reconsider partnership tax planning?

LLPs and partnerships that operate on a solid commercial basis: where members’ and partners’ earnings are based on profits made, and where risk and reward are shared, should not be affected by the proposed changes.

Proving that your business has not been organised in order to secure a tax advantage may therefore be more difficult.

If you have any doubts or concerns about the way in which these changes may affect your business please do call us as soon as possible to arrange a planning meeting.

Sue Stephens, Personal Tax Consultant

John Elliott, Tax Partner