Partnerships – Past Present And Future!

Alan Pink highlights the background and current state of play in partnership tax.

I don’t know if you’ve ever watched the progress of the demolition of a large building? If so, I wonder if you agree with me that the process often seems completely random and lacking in method? A large amount will be demolished virtually overnight, leaving odd bits still standing, and there doesn’t seem to be any obvious reason for doing things in the order they are doing them, or for the long delays between the different flurries of destruction. In a word, progress is desultory.

In the same way, HMRC’s approach to dealing with what they no doubt see as ‘abuses’ in the taxation of partnerships has proceeded slowly and on apparently fairly random lines. 

The first sign that HMRC were turning their attention to partnerships was an announcement in late 2012; and this was followed, in Finance Act 2013, by a change which principally affected limited liability partnerships (LLPs) with limited company members. The most important changes were:

With regard to the second of these sets of changes, it’s thought that one of the main targets of the new rules was ‘mixed’ LLPs and partnerships, where the limited company member has capital invested in the partnership, but the other, individual partners (who in this situation typically will also be shareholders and directors of the company) are overdrawn, i.e. they owe the partnership money. It is amazing, if one thinks about it, that it was possible to do this without any tax downside prior to March 2013 when these new rules came in. 

In 2014, another, and unconnected, wave of anti-avoidance rules relating to partnerships were introduced. One of these was aimed at preventing LLPs from making up basically menial staff into ‘partner’ status, and thereby avoiding PAYE and National Insurance contributions (NICs). Another major part of the changes in 2014 related to the allocation of profits between members, again in ‘mixed’ partnerships of companies and their shareholders. 

It seems that, prior to 6 April 2014, people were setting up such partnerships so that the individuals got the full benefit of being self-employed (for example, a much more benign NICs and ‘car benefit’ regime) whilst being able freely to allocate the profits of the business to a limited company, and thus enjoy the benefit of the lower corporate tax rate. HMRC’s attitude to this sort of planning was predictable. Rather than change the absurd rules under which self-employed people are massively favoured by the tax and NICs system as compared with employees, they aimed to take away the ability to make allocations of profit to the company partners. In other words, they dealt with the symptoms rather than the disease. 

So, what the 2014 changes did was to restrict the amount which you could allocate to a limited company when dividing the profits of a mixed partnership. The company could only receive an amount of profits which was commercially justifiable, either by reference to the company’s active input into the partnership, or by reference to the capital it had invested. Incidentally, wherever I am talking about a partnership in what follows, I am also referring to LLPs which, although bodies corporate, are taxed as partnerships.

Fast forwarding one year to Finance Act 2015, a major and unexpected change was put in place, which effectively changed companies which were members of partnerships into investment companies, thus denying individual shareholders entrepreneurs’ relief on any sale of the company concerned. This was the case, it should be stressed, even when the LLP or partnership, in which the company was a member, was a wholly trading one. So, this hit all kinds of commercial joint venture arrangements with an entirely arbitrary and major addition to the potential tax exposure. 

What happened next, in 2016, is instructive. Effectively the swingeing change mentioned above, brought in in 2015, was repealed, and with retrospective effect to 2015. In other words, this was an open admission that HMRC had cocked up. 

So, you see what I am saying about the apparently desultory and random progress of the HMRC changes relating to partnerships. Now we come right up to date, to the present day. 

HMRC published a document, accompanied by draft legislation, on 13 September 2017. There are 15 or so pages to the draft legislation – an amount of words which would have been sufficient, 40 or 50 years ago, to introduce a whole new tax. The promised legislation on partnerships was subsequently published in a Finance Bill towards the end of 2017 and is expected to become law shortly after the time of writing this article. Having waded through the sea of verbiage, it seems to me that this can be distilled into three main areas of change, as follows: