The Government is proposing changes to the law regulating the taxation of partnerships to ensure that:
- People who, in practical and economic terms, are working as employees, but who technically are working as members of a limited liability partnership (LLP), are treated as employees for tax and National Insurance purposes
- Tax liabilities cannot be deferred or reduced by introducing a company as a partner (into either a traditional partnership or an LLP)
Although HMRC has published a single consultation document covering both issues, they are in fact quite distinct and are considered separately below. It is proposed that the changes recommended will come into force on 6 April 2014.
Disguised employment using LLPs
Although an LLP is a body corporate, section 863, Income Tax (Trading and Other Income) Act 2005 deems any trade, profession or business which it carried on, to be carried on in partnership by its members. It follows that every member of an LLP is taxed as if he was a partner even if, were he engaged on similar terms by an ordinary partnership, he would be taxed as an employee. For example, LLP members will be taxed as partners, even if they have fixed salaries, are not exposed to any financial risk, and take no substantive role in the management of the business.
In practice, LLPs are used to avoid employment status in two situations. The first is where workers are engaged on standard terms as part of a mass recruitment exercise, or where a firm’s existing workforce is transferred en bloc to an LLP. Here the principal objective is likely to be avoiding the employer’s secondary National Insurance contributions. The consultation document proposes that this should be countered by deeming the working to be an employee, if he would have been an employee, had he been engaged on the same terms by an ordinary partnership.
The second situation is where the objective is to avoid paying Class 1 National Insurance contributions for a small group of highly paid individuals. On the facts, it may be difficult to show that they would have been employees, had they been employed on the same terms by an ordinary partnership, and so they will be treated as employees if they:
- Are not subject to any economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
- Are not entitled to a share of the profits; and
- Are not entitled to a share of any surplus assets on a winding-up
‘Window dressing’ provisions – for example, a share of profits over a threshold unlikely ever to be achieved – will be ignored.
Allocating profits to a company
At its simplest, the members of a professional partnership may know that they need to retain some profits as working capital. Accordingly, they introduce a limited company as a partner, on the basis that the profit share allocated to the company will then be taxed at the lower corporation tax rate. More complex plans, sometimes involving changing profit shares from year to year, are also possible.
It is proposed to counter them all by providing that, if the main purpose, or a main purpose, of such an arrangement was to secure an income tax advantage for any person, then the profit allocated to the company shall be reallocated between the individual partners on a ‘just and reasonable’ basis.