Proposed changes to taxation of LLPs irk advisers

by Calum Fuller

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06 Sep 2013

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Arms Linking Together

THE PROSPECT of government reform to partnership taxation is clearly not something filling the professional services industry with joy.

The government is determined to put a stop to the current rules, which allow junior employees to be classified as a partner for tax purposes, when in reality their job is unchanged and they hold no decision-making power, equity or capital risk. Under the proposals, this will no longer be possible.

The review also aims to tackle the manipulation of profit and loss to create a tax advantage, which is typically achieved by allocating profits to some partners and losses to others with a view to that partner obtaining a reduction in tax liability by way of income tax reliefs or capital gains relief.

But despite the government's conviction, advisers are unconvinced by the idea, with some suggesting the measures could "do more harm than good".

In a report produced by BDO, 77% of just more than 100 respondents felt the two-test approach to determine self-employment was either unnecessarily bureaucratic or unfair, because it gave HMRC more than one opportunity to reclassify a partner as an employee.

As far as the tests are concerned, the government is suggesting that in order to determine if someone should be a salaried employee, they will examine the degree of control the LLP has over the individual; the amount of economic risk borne by the individual; the requirement for personal service; the extent to which the individual can profit from sound management; and the individual's entitlement to a share of profits or surplus assets if the LLP were wound up.

Not only that, just 18% of respondents believe that the specific tests proposed by HMRC were the most effective way of determining self-employment. Of the 24% of respondents from the accountancy profession, the figure drops to 17%.

More than anything else, though, 83% believe that, if implemented, the proposals will damage the attractiveness of partnerships and LLPs. Hardly a ringing endorsement, then.

Of course, for firms engaged in disguised employment, it would not be too great a wrench for LLPs to become compliant - simply re-designating personnel from partner to employee or promoting them in genuine terms - but mixed membership partnerships may have to review their structure, which could be more painful. That said, the changes are not designed to impinge on commercial decisions, so if firms have recorded their motives for their structure, they may be spared the trouble.

That said, the reaction from accountancy has been incredibly critical, ranging from "blunt", through "complex", and "deeply flawed".

In particular, many are concerned the consultation provided insufficient detail on how the proposals would operate in practice, and query whether the commercial purpose of such structures is adequately understood.

Then there is the possibility of unintended consequences. Some suggest that the measures may harm competition; impede international expansion and generational ownership change; holds the potential to encourage financial irresponsibility and; encourage HMRC to engage in prolonged scrutiny of firms as it works to meet its targets.

For its part, the government claims around £300m will be raised as a result of the changes, something which many feel does not justify the move.

The big question, then, is whether the concerns are heeded, with some suggesting the government may simply press ahead and introduce the rules.

The likelihood of that is a matter for debate, and it is unlikely to become apparent until George Osborne delivers this year's Autumn Statement, but there is little doubt professional services will continue to provide vociferous opposition and would open the government up to serious criticism.

Indeed, MHA MacIntyre Hudson tax partner Nigel May noted it "would truly call into question whether there is any reality whatsoever to pre-legislation consultation".

Consensus on a viable alternative, though, has not been reached. According to BDO's research, 28% wanted to continue with normal employment status rules (i.e. contractual terms and conditions), which they suggested were better criteria, and 26% preferred HMRC to rely on relevant historic case law. As it stands, it appears to be a straight choice between the status quo and the new proposals; a situation few are enamoured with.

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