Partnerships: What Does The Future Hold?

At Budget 2016, the government announced that it would launch a consultation into how partnerships calculate their tax liabilities. The consultation document was issued on 9 August 2016 and comments were invited by 1 November 2016. 

The consultation applies to general partnerships, limited partnerships, limited liability partnerships (LLPs) that are carrying on a business with a view to profit and foreign entities classified as partnerships for UK tax purposes. 

Partnerships are generally not taxed and are transparent for tax purposes. This means the partners are taxed on their share of the partnership profit. Where the partners are individuals, the profits are calculated under income tax rules. Where the partners are companies, the profits are calculated according to the corporation tax rules. Throw non-resident partners into the mix, and there could be four computations to arrive at the partnership profit for tax purposes. 

The government has identified the following areas where it considers that the tax rules may be unclear or inappropriate:

Several reasons are cited for the proposals, including ensuring that the rules fit with modern commercial practice, removing uncertainty and reducing the scope for taxpayers to avoid or delay paying tax.

The Office of Tax Simplification pointed out in its report that partnerships are diverse and can range from small, simple businesses to complex multi layered financing structures. However, all partnerships are currently subject to a one size fits all approach.

This proposal will generally affect limited partnerships (LPs) and LLPs. Clarification is required because HMRC is finding that the names of partners or members registered at Companies House do not always accord with the partners reported on the partnership tax return. Commonly, this will be where the person named at Companies House claims that they are acting as agent or nominee for another, although the government considers that partners cannot act in this capacity. 

To rectify this, the government proposes that a person will be treated as a partner for tax purposes if they are notified to HMRC as a partner in the partnership return, effectively ignoring the Companies House record.

There is a growing trend for partnerships and LLPs to be used within business structures. This is particularly prevalent within investment funds, although these are considered separately within the consultation document.

The government states that it is committed to partnerships retaining their transparent status, but it is concerned that the ultimate economic and beneficial owner of the profit share is identified. It proposes that that the ultimate owners are treated as partners of the bottom tier partnership for income tax, capital gains tax and corporation tax.

Translucent LLP has members with the following profit shares: A (an individual) 10%, B (an individual) 10% and Clear LLP 80%.

Clear LLP has members with the following profit shares: A (an individual) 20%, B (an individual) 10%, D Ltd (a company) 20% and Look-through LLP 50%.

Look-through LLP has members with the following profit shares: A (an individual) 20%, B (an individual) 20% and C Ltd (a company) 60%.

If Translucent LLP were to report the profit shares of its ultimate owners, it would report the following:

While there is clarity concerning how the profits of Translucent LLP flow through to the ultimate owners, complexity is increased. Does this mean that Clear LLP and Look-through LLP need to adjust their own profits for profits generated by partnerships lower down the chain when preparing their partnership returns to avoid double counting? The consultation document is silent on the reporting by any partnership other than the one at the bottom of the chain.

This proposal assumes that the partnership at the bottom level has full information about the partners/members of partnerships further up the chain. The consultation document goes on to suggest further proposals where this is not the case.

As mentioned above, it is common for partnerships to form part of an investment fund structure. These funds can have large numbers of partners, some of whom may be non-UK resident or other entities that are not taxable. While the government has indicated a willingness to amend the legislation to better cater for such partnerships and reduce complexity, the consultation did not make any proposals for how this might be achieved, and instead invited ideas from respondents.

As part of their reporting, partnerships are required to provide unique taxpayer references (UTRs) for all partners, including non-resident partners who will normally have tax liabilities in respect of UK trading or property business profits. This task will become harder if the proposal to provide details of all ultimate partners goes ahead. Recognising that all of the ultimate partner details and UTRs may be difficult to obtain in more complex structures, the government is seeking a workable solution that would protect the exchequer. One proposal put forward in the consultation document is to make a payment on account to HMRC in respect of unidentified partners, although ideas for other options were invited from respondents.

There is no legal requirement that profit sharing arrangements must be specified in writing. Even if there is a written agreement, this may be varied. To avoid partners disputing the allocation of profits made to them for tax purposes, it is proposed that any written partnership or LLP agreement will be the determining factor, unless overridden by notification to HMRC by the nominated partner of the partnership or LLP.

To avoid any manipulation by allocating certain items of income and expenditure to certain partners or by determining profit shares after the end of the accounting period, it is proposed that legislation will be introduced to state that the basis of allocating tax adjusted profit should be the same as the allocation of accounting profit between the partners. Partners would only share in the profits or losses for the period they were partners or members.

Currently, the profits of corporate partners’ subject to income tax are calculated as if the company is an individual. It is proposed that legislation will be introduced to provide that the profits of corporate partners’ subject to income tax are calculated as if a non-UK resident company is carrying on the business.

The current rules do not explain how to calculate the partnership profit or loss for a partner not within the charge to income tax or corporation tax (this includes cases where the partners are partnerships). If the nominated partner does not provide details of the ultimate partners, it is proposed that their share of profit or loss will be calculated as if the partner was a UK resident individual.

Although many simple partnerships will be unaffected, more complex structures or those that operate a flexible profit sharing policy should follow how these proposals develop.