Partnership tax doesn’t need to be complicated. Partnerships, including limited liability partnerships (LLPs) are transparent for tax purposes. This means that the partnership itself is not subject to tax: any profits are instead taxable on the partners.
Generally, for tax purposes each partner is treated as receiving their share of the income and expenses of the partnership as they arise. This treatment is overridden in particular cases by anti-avoidance legislation intended to prevent partnership structures being used to avoid (or reduce) tax. This factsheet looks at two such provisions: the rules re-attributing profits in ‘mixed member’ partnerships and the ‘salaried members’ rules applying to LLPs.
Mixed member partnerships
A mixed member partnership is one which includes both individuals and non-individuals (most commonly, but not necessarily, companies, and referred to hereafter as ‘corporate partners’) as partners. Since 6 April 2014, partnership taxation anti-avoidance rules apply to mixed membership partnerships where profits are shifted from individual partners to corporate partners to reduce the overall tax payable. These rules apply to both partnerships and LLPs.
The intention of the rules is to prevent (for example) profits being shifted from an individual to a corporate member which he (or a member of his family) owns. Without these rules, profits would be taxed on the corporate partner at a lower rate, and could then be extracted tax-efficiently (for example, distributed to a spouse paying a lower rate of income tax). The anti-avoidance provisions, therefore, are intended to reallocate the diverted profits to the relevant individual.
The provisions are broadly drawn, so should be considered even where tax avoidance is not the driver behind a particular profit sharing structure. In broad terms, they will bite when an individual has a partnership profit arise for a period and “it is reasonable to suppose that” either:
- Amounts representing his “deferred profit” are included in the profit share of a corporate member, and both his profit share and the tax he would pay are reduced as a result; or
- The profit share of the corporate partner is greater than the “appropriate notional profit”, and the individual has the “power to enjoy” the corporate partner’s profit share (and his own profit share and tax are lower as a result).
For the purposes of the first test, deferred profit includes any amounts conditionally due to the individual – including amounts that may never, in fact, become payable.
For the purposes of the second test, the corporate partner’s “appropriate notional profit” is the total of the “appropriate notional return” on any capital contribution (calculated as if the capital contribution were an arms’ length loan) and the “appropriate notional consideration” for any services the corporate partner provides to the partnership.
It is worth noting that the legislation only requires reasonable supposition that one of these two tests are met: there does not need to be definitive evidence that profits have been shifted. The potential impact of the rules should, therefore, be considered by all mixed member partnerships, unless the corporate and individual partners are wholly unconnected.
LLPs – salaried members
The salaried members rules are intended to identify members whose terms of service more closely resemble an employment relationship rather than self-employment. These rules apply only to UK LLPs, and not to general partnerships or to limited liability partnerships formed overseas.
With regard to partnership tax, where an individual is deemed to be a salaried member, they are subject to PAYE and Class 1 National Insurance contributions (NICs) on their income from the LLP. The LLP will also be subject to Class 1 NICs in respect of the salaried member’s remuneration, but can claim a tax deduction for the cost of employing them. In effect, the payment to the member is treated as employment income for tax purposes.
An individual is treated as a salaried member where all of the following three conditions are met:
The individual performs services for the LLP in the capacity of a member, and it is “reasonable to expect” that the remuneration payable by the LLP for those services will be wholly, or substantially wholly (assumed to be 80% or more), “disguised salary”.
Disguised salary is remuneration that is either fixed or, if it is variable, it is not calculated by reference to, or in practice affected by, the overall profits or losses of the LLP.
Individuals will be caught by this condition unless more than 20% of their variable remuneration is linked to the overall profitability of the business. It is not sufficient for it to be linked to the performance of the individual, branch or team.
Condition B is that the mutual rights and duties of the members and the LLP do not give the member significant influence over the affairs of the LLP.
This is interpreted by HM Revenue & Customs (HMRC) to mean the role played by the individual and whether that individual is “in business” or merely “working for the business”.
Influence over a part of, or a branch of the LLP, rather than the whole, is also insufficient. Many large partnerships and those with hierarchical or management structures are likely to find that only a few partners will fall outside this condition. HMRC has confirmed that influence does not necessarily mean sitting on the LLP management board.
Condition C is that the individual’s capital is less than 25% of the disguised salary from the LLP in the tax year concerned.
This is the amount the individual has invested under the LLP agreement and does take account of any subsequent changes. However, it does not include amounts that the member can withdraw, eg undrawn profit or short-term loans.
Where a member leaves or joins the partnership part-way through the year, the capital contribution is pro-rated accordingly, for the purposes of this test.
If any one of these conditions is not met, the individual will continue to be treated as self-employed for tax purposes (and will, therefore, the partnership tax payable will only be on their share of the income and expenses arising in the partnership).
If you have any questions on these specific partnership rules, on partnership tax or indeed tax services within our firm more generally, please get in touch with your usual Saffery partner, or contact Jason Lane.
This factsheet is based on law and HMRC practice at 1 May 2019.