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UK Government Issues Consultation on Partnership Taxation – Possible Impact for Asset Managers and Investment Funds

June 12, 2013

On 20 May 2013, the UK Government officially launched its consultation on the taxation of partnerships. The consultation document sets out proposals that are intended to counter the perceived use of partnership structures for tax-avoidance purposes in two areas, namely (1) the presumption of self-employment for partners in limited liability partnerships (“LLPs”); and (2) the manipulation of profit/loss allocations by partnerships to secure UK tax advantages. The consultation closes on 9 August 2013, and any changes arising from the consultation are intended to take effect beginning 6 April 2014.

1. Tax Treatment of Members of LLPs

The first proposal seeks to remove the presumption of self-employment for certain LLP members. Under the current UK rules, individual members of an LLP are automatically treated as self-employed partners for UK tax purposes and thereby avoid paying employer’s national insurance contributions on the individual’s “salary” (contributions are currently set at 13.8%). The consultation proposes that members who are essentially employees (“salaried members”) should be taxed as employees for income-tax and national-insurance purposes.

The consultation document classifies “salaried members” as those who are employees under the existing tests of employment; or who have no economic risk should the LLP suffer a loss or be wound up, receive a fixed income and are not entitled to a “significant” share of the profits (either on an annual basis or on the winding up of the LLP). If an entitlement to the profits of the LLP accounts for less than 5% of that individual’s fixed entitlement, the consultation document indicates that this would be viewed as insignificant and so ignored for the purposes of determining whether that individual is a salaried member.

As noted in our previous alert , LLPs with properly drafted LLP agreements will hopefully be compliant with the proposed changes but a review is likely to be necessary to ensure that partners in the LLP have sufficient “badges” of self-employment (i.e., there are sufficient facts/evidence that the individuals are not technically employees). A targeted anti-avoidance provision will be included in the legislation to ensure that no account will be taken of arrangements one of the main purposes of which is to prevent the individual from being treated as a “salaried partner”.

2. Taxation of Partnership Profits

The second proposal seeks to counter the manipulation of profit-and-loss allocations by partnerships (including but not limited to LLPs) in order to secure a tax advantage for certain partners of that partnership. This arises from the perception that there has been an increase in the use of “mixed partnerships” (these are partnerships with a mixture of individual and corporate partners) as a tax-planning mechanism to take advantage of income-tax and corporate-tax rate differences and to allocate all disallowable items to the corporate partner. In the UK Government’s view, this has given rise to unfairness and market distortion in the UK tax system, which needs to be resolved by the introduction of new legislation.

There are three distinct types of arrangements involving partnerships with mixed members that are targeted by the consultation paper: (i) the allocation of partnership profits to corporate members that pay a lower rate of UK tax; (ii) the allocation of partnership losses to individual members who pay a higher rate of UK tax; and (iii) the reduction of profit entitlement in return for payments from other partners that are subject to a lower rate of UK tax on those profits. The proposed legislation, which is to apply where it is reasonable to assume that one of the main purposes of the arrangements is to secure a tax advantage, will counteract the tax planning by allocating the profits for tax purposes on a just and reasonable basis and disallowing loss relief. For example, where the income is allocated to a corporate member with which one or more of the individual partners have an “economic connection” (yet to be defined), that corporate partner will effectively be treated for UK tax purposes on a “look through” basis and the relevant individual partners taxed on their pro-rata share of the income attributed to the corporate partner. Conversely, if losses have been attributed to individual partners, income tax or capital-gains tax loss reliefs will be disallowed in respect of such losses.

The proposals are very widely drawn and will also capture partnerships that use a corporate member as a tax-efficient means for reinvesting in the business (i.e., to fund its working-capital requirements) or to enable the deferral of remuneration.

It is likely that the proposals will be implemented in some form, so it may be necessary for partnerships and LLPs to review how they fund working capital, their profit-allocation provisions and how they operate across jurisdictions in which their investors and partners/management teams are based.

3. What it means for Asset Managers and Investment Funds

Asset Managers that are formed as LLPs will need to review their LLP Agreements to ensure that all members of the LLP are genuinely self-employed and will not be taxed as employees for income-tax and national-insurance purposes.

In addition, Asset Managers that advise investment funds that are structured as partnerships (including but not limited to LLPs) with UK tax resident investors, may need to consider whether the profit/loss allocation strategy currently applied would result in those UK-resident investors being caught by the proposed anti-avoidance provisions and, if so, whether any changes to such allocations could cause difficulties for non-UK investors.
We will provide you with further updates as the consultation progresses.

For more information, please contact Jan Birtwell at jbirtwell@omm.com or Rachel Hawkins at rhawkins@omm.com.


This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Jan Birtwell, an O'Melveny partner licensed to practice law in the Supreme Court of England and Wales, and Rachel Hawkins, an O'Melveny associate licensed to practice law in the Supreme Court of England and Wales contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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