Delay changes to tax status of LLP partners until 2015, says House of Lords Committee

Out-Law News | 12 Mar 2014 | 2:30 pm | 3 min. read

New rules governing how members of limited liability partnerships (LLPs) are taxed should be delayed until 2015 so that firms have sufficient time to adapt to the changes, a House of Lords committee has said.

Although a last-minute reprieve on the new rules, which are due to come into force next month, is unlikely, tax expert Catherine Robins of Pinsent Masons, the law firm behind Out-Law.com said that the new report echoed the concerns of many in the tax profession. The report was by a group of peers from the House of Lords Economic Affairs Committee, put together in order to scrutinise the provisions of this year's draft Finance Bill.

"It is good news that the Economic Affairs Committee has confirmed what the tax profession has been saying since December - that these changes should be deferred so that we can be sure that they properly achieve their objective," said Robins. "However, there seems little prospect of HMRC climbing down at this late stage, particularly when next year's election is going to mean that there will be a lot of pressure on space in the 2015 Finance Bill."

"It is surprising that HMRC was unable to give the subcommittee an indication of the estimated yield from the salaried partnership change alone. One suspects that the other less contentious changes represent the bulk of the estimated yield. As most LLPs will restructure, the salaried partnership change will probably raise little tax - but represents a considerable upheaval for the firms involved," she said.

New rules removing the presumption of self-employment from 'salaried members' of LLPs for the purposes of income tax and national insurance contributions (NICs) will come into force on 6 April, although the underlying legislation will not receive Royal Assent until later in the year. The change is intended to prevent companies and individuals from using this structure to disguise employment. LLP members treated as employees under the new rules would be liable for income tax and NICs in the usual way, while the LLP would have to pay employer NICs.

Once the new regime is in force, partners will have to satisfy one of three tests set out in the draft legislation in order to avoid being treated as a 'salaried member' and taxed in the same way as an employee. They must not receive a 'disguised salary'; or they must have 'significant influence' over the affairs of the partnership; or they must be making a capital contribution of at least 25% of their fixed pay to the LLP's capital.

During the course of the subcommittee's inquiry, nearly all of the evidence it received in relation to the legislative tests found that they failed to achieve the policy objective, according to its report. Private sector witnesses in particular preferred the removal of the presumption of self-employment and instead using tests set out in existing partnerships case law. Although it concluded that the better approach was "still open to question", the subcommittee said that postponing the changes would allow the legislation to be targeted better and give firms more time to adapt to the changes.

The subcommittee also raised concerns that the proposed changes would apply only to those LLPs registered in the UK, and not those formed outside the UK but conducting business here. In addition, bringing the changes into force from April rather than aligning them with firms' accounting periods would create practical problems for businesses, it said.

"Condition A set out in the legislation requires an assessment of whether it is reasonable to expect that at least 80% of a member's remuneration will be by way of a disguised salary," said tax expert Catherine Robins. "It is difficult to apply this for a tax year when all the firm's profit-sharing arrangements will be drafted by reference to an accounting period."

The subcommittee agreed with those parts of the new regime designed to prevent partnerships with corporate members from shifting more of the profits to those members in order to take advantage of legal loopholes. However, these proposals should be drafted "as precisely as possible" so that firms would not need to rely so much on guidance to infer how they would be applied, it said.

"The government is clearly right to look again at the taxation of LLP members as the legislation introduced in 2000 has failed to bring their tax treatment in line with that of general partnerships, and provided opportunities to avoid tax liabilities," said Economic Affairs Committee chair Lord MacGregor. "But the government has created difficulties by substantially changing the nature of the original proposals at a very late stage of the consultation process. Given that defects in the 2000 legislation have led to the present problems, it would be a mistake to run the risk again of not getting the legislation right."

"Nearly all of our witnesses felt that the tests in the proposed legislation would not meet the policy objectives. There is also the practical problem for many firms that the start date of April 2014 does not accord with their accounting periods and would take effect when the Bill will not yet have had its parliamentary scrutiny. That is why we have proposed delaying this part of the Bill until April 2015 in order to resolve the difficulties to which our witnesses have drawn attention," he said.