LLP tax changes hit hard
New rules for partnerships and LLPs will have a huge impact and it is now clear that implementation will not be delayed.
The spirit and timing of the tax changes appear to be at odds with other government priorities, including the (admittedly now stalled) programme of limited partnership legislative reforms launched “in order that the U.K. continues to enjoy the economic benefits of being the location of choice for fund managers” and the pressure on financial services businesses to defer remuneration to encourage more responsible behaviours.
Nevertheless, despite lobbying by industry bodies, implementation will not be delayed.
Some of the changes affect both partnerships and LLPs with a mix of individual and corporate members, by taxing profits allocated to corporate members as if it was income of the individual member.
So, if an individual and corporate member split profits 50% each, but the individual provides 80% of the services to the LLP, and the company 20%, then the 30% “excess” profit share is taxed on the individual at income tax rates when the individual is connected to the LLP (for example, because he or she controls that company).
The argument that private equity businesses use corporate members as a valuable tool to defer remuneration or to provide working capital for growth has fallen on deaf ears.
Another key tax change, for LLPs only, is treating members as employees for tax purposes if 80% or more of their remuneration is “disguised’ salary (i.e. fixed or not variable in relation to LLP profits), they do not have significant influence over the LLP’s affairs or their investment in the LLP is insufficient to represent real risk in the business.
All LLPs should urgently consider the implications of these proposals. It may be possible to act before 6 April. For example, to address the ‘disguised employment’ proposals many LLPs are asking members to contribute capital equal to more than 25% of the non-variable part of their annual profit share.
Affected members need to make a firm commitment before 6 April to contribute the additional capital, but HMRC guidance released on 21 February allows a three month grace period to introduce the cash if, for example, the bank cannot process loan applications and release cash before 6 April.
Implementing changes to address the new tax rules may not be straightforward. Any proposal to change individual remuneration agreements or impose additional risk will almost certainly be controversial. It will be important to explain the proposed changes and the reasons for them and ensure that the proposals are properly authorised and consistent with the individual rights of those affected. If not, an aggrieved individual might seek redress in one or more of the following ways:
- Resigning, causing disquiet and potentially entailing the loss of team members and/or clients;
- Trying to assert they are an employee and can claim constructive or unfair dismissal in the employment tribunal;
- Challenging the decision, on the grounds that it was improperly passed, an abuse of process (if for example, a majority imposed changes on the minority in order to protect their own interests) or even discriminatory. Discrimination complaints in the employment tribunal are open both partners and employees. Age discrimination may be relevant if the affected individuals are more likely to be of a certain age profile. Further, female partners who are possibly on a slower path to equity after having had children may assert sex discrimination;
- Refusing to comply with the changes, in effect forcing the LLP to consider whether there is power to expel.
The tax rules may result in significant additional tax costs, and for some taking action to manage the impact may be vital. With just days until the start of the new tax year, firms must act fast, but in their haste firms ignore good process and fairness at their peril.
This article includes additional input from Buzzacott and CM Murray.
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