James Bailey warns that new anti-avoidance rules may affect partnerships with individual and corporate members.
In the Autumn Statement in December 2013, closely followed by the publication of the draft 2014 Finance Bill clauses, HMRC continued their crackdown on certain types of tax avoidance involving partnerships that include both individuals and corporate members. These are referred to as ‘Mixed Partnerships’ by HMRC.
A ‘mixed partnership’:
A typical structure for a mixed partnership is one where you have (for example) three individuals, Mr A, Mrs B, and Mr C, who are in partnership with a company, ABC Ltd. The shares in ABC Ltd are all owned by Mr A, Mrs B, and Mr C – or sometimes by close relatives such as Mrs A, Mr B, and Mrs C.
The partnership is profitable, and if the profit was allocated only to the three individual partners, they would all be paying tax at 42% (including NIC) or even 47%. Profits allocated to the limited company, however, will be taxed at only 20%.
As a minimum, it makes sense for working capital requirements to be found out of the limited company’s profit share, and particularly where the shareholders of the company are the spouses of the individual partners and have no other income, a bigger share of profit allocated to the limited company will provide a much lower rate of tax overall.
Example – Partnership profit allocations:
Mr A is entitled, like his other two partners, to one third of the profits of the business, and his share is £100,000, which means he will be paying income tax at 42% on a significant slice of that profit. If instead, part of his share (say £38,000) was allocated to the limited company and then paid out in dividends to his wife (who, remember, has no other income), then that £38,000 would be taxed at 20% instead of 42% - a saving of over £8,000.
This is only one example of how mixed partnerships can be used to reduce tax liabilities. The new legislation is designed to stop it along with a number of other ‘schemes’.
Assuming the draft rules are passed next Spring, then (with effect from 5 December 2013 in certain cases), HMRC can step in and reallocate the way the profits are split for tax purposes.
Anti-avoidance conditions:
In the above example, all of the conditions for such a reallocation are met:
- Mr A has ‘power to enjoy’ the profits allocated to the company – because he is ‘connected’ to the company through his wife.
- There is no ‘commercial’ reason (apart from tax saving) for the company to be allocated such a share of profits – it has contributed little or nothing to the partnership’s business.
- It is ‘reasonable to suppose’ that if Mr A had not been connected to the company and able to enjoy a share of the company profits, his share of profit would have been £100,000, rather than £62,000.
The ABC partnership is clearly caught by the new rules, and so Mr A’s taxable income will be increased by £38,000, with the company’s reduced by the same amount. The same applies to the other two partners, assuming the same arrangements existed for them.
Note that it is only the tax liability that changes – the company still has its £38,000 and can still pay it to Mrs A (who will probably need to give it to Mr A to help him pay his increased tax bill!).
Practical Tip:
If you are a member of a mixed partnership, you should already be looking at what to do about these new rules. In some cases the solution may be to stop allocating significant profits to the company; in others, it may be that ceasing to be a mixed partnership by transferring the rest of the business into the company is the way forward.
