Following the Budget on 19 March 2014, HMRC made some very minor changes to the new legislation for mixed partnerships in the 2014 Finance Bill and, to coincide with this, further guidance on the legislation for both fixed share partners and mixed partnerships has just been released.
Given that both aspects of the changes to the taxation of partnerships will take effect from 6 April 2014, this should be the final round of guidance from the Revenue!
Fixed share partners
The main points of note from the new guidance are as follows.
Condition C – deemed contributions
Experience continues to show that the most popular condition that practices are relying on for their members to retain self-employed status is Condition C – the requirement for the member to contribute at least 25% of their expected remuneration for the tax year as a capital contribution to the LLP.
The legislation allows a member to fail Condition C by committing to making a capital contribution to the LLP as at 6 April 2014, or at the date of joining the LLP for members appointed after this date. The previous guidance stated that this commitment needed to be “an unconditional requirement for that member to provide the capital”. The latest guidance appears to offer a relaxation in the degree of this commitment, now stating the condition will be failed where “the member has given an undertaking (whether or not legally enforceable) to provide a capital contribution to the LLP”.
Most of the practices looking to rely on Condition C but which cannot put the capital contributions in place by 6 April 2014 should already have paperwork in place demonstrating this undertaking by the member. Those that have not should act fast.
Condition C – Anti-avoidance
In order to fail Condition C the contribution made by the member must represent a real risk. Where funding arrangements are to be put in place to facilitate the contribution, care should be taken to not be caught by the anti-avoidance provisions.
The Revenue’s latest guidance reiterates that Condition C will not be failed where the practice, rather than the member, pays or otherwise bears the interest charge on a loan taken out to fund the contribution.
However, the guidance now goes on to confirm that if the practice simply pays the interest as agent for the member, the practice is not bearing the cost. In this situation, the interest paid by the practice would be classed as part of the member’s drawings in the accounts. Equally, where the practice pays the interest as agent out of a prior share of profit awarded to the member in return for the capital contribution, this will not be seen as the practice bearing the cost.
Arrangements where a practice reduces its own indebtedness to a third party lender, perhaps the bank, in consequence of the same lender advancing funds to the member to facilitate the capital contribution, do not fail Condition C. However, the Revenue have confirmed that where a practice’s overdraft reduces as a natural consequence of the contribution being made, then provided the practice’s borrowing limit is not reduced the anti-avoidance will not apply.
Condition A – relevant period
The new guidance explains in more depth, with additional examples, how the test in Condition A is applied to the “relevant period”. This is the period to which the member’s remuneration package applies. For most practices this will be a 12 month period, possibly the practice’s accounting year, at the end of which the member’s remuneration package will be reviewed and the test applied again.
However, in some cases a remuneration package may be set for a longer period, perhaps in relation to a project which will last for more than 12 months, in which case the test is applied in relation to this longer period and only reapplied once the member’s remuneration package is reviewed.
The latest guidance offers little new information on this condition, other than to clarify that individual members or groups of members with largely administrative roles will meet Condition B.
In our opinion, the minor changes to the new legislation for mixed partnerships should have no impact on any planning measures put in place by practices prior to the effective date of 6 April 2014.
Appropriate profit shares
The new guidance on this aspect of the changes elaborates on the level of “commercial” return that a non-individual partner (typically a company) may receive by way of a profit share on its capital contribution to the partnership. Only profit shares in excess of this commercial return will be reallocated back to individual partners.
The legislation states this return is to be calculated “at a rate which (in all the circumstances) is a commercial rate of interest”. The guidance states that the rate should reflect the level of risk involved, and that the rate paid to third party lenders will be indicative of the commercial rate. Of course, the level of security offered, if any, will be an influencing factor in deciding what a commercial rate is.
The guidance also explains the calculation of consideration for services that may be paid by way of profit share. Where the company provides services to the partnership, the company may receive a profit share representing the arm’s length value of those services. The Revenue state that, in most cases, they would expect the consideration to be cost plus a modest mark-up. Any amount paid by the partnership for those services, such as a service fee, is deducted in calculating the profit share.
It is important to note that the value of any services provided by the company involving any other partners is ignored.
The guidance makes it clear that the anti-avoidance provisions contained in the new rules, which deem an individual to be a partner in order to receive and be taxed on a profit share, took effect from 5 December 2013. This means that individuals who retired as partners on or after that date in an attempt to avoid the mixed partnership rules will be deemed to be partners for the purpose of these rules.
Finally, the guidance confirms that where a partnership’s accounting period straddles 6 April 2014, a separate accounting period is deemed to start on 6 April 2014 and end on the normal accounting date. The new rules then apply only to this deemed period, which means that any arrangements in place prior to 6 April 2014 should not be caught by the new rules.
This clarification, in particular for Condition C of the fixed share partner rules, is very helpful. For practices that have been working on the previous guidance, this will give comfort that there is nothing more to do in light of the fact that there are only a couple of days to go before the new rules kick in.