Over the past few months we have blogged about the issue of corporate entities and the benefits of a business considering different structures, which may include an LLP or a limited company. Limited liability partnerships (LLPs) are a popular choice for those providing professional services because although they may not be as tax efficient as a limited company, they offer greater flexibility.
It is common for LLPs to have a ‘secondary’ band of partners, usually known as salaried partners. These partners will typically receive a salary and may perhaps be allocated a small share of business profits, they are usually treated as self employed and HMRC have not generally challenged this status. Now however, in line with HMRC’s strategy to close as many ‘loopholes’ of (what it regards as) tax avoidance as possible, there are some important changes to be aware of.
As announced in the Budget, HMRC have begun a consultation process which is considering treating secondary partners as employees. They are particularly interested in targeting salaried partners whose main financial compensation is not dependent on business results and who do not bear the risks that main partners within an LLP do. Whilst this consultation is ongoing and we do not know what the implications will be, any additional tax charges that HMRC deems to be due in relation to secondary partners are expected to come into effect on 6th April 2014.
Tax planning advantages of corporate partners within LLPs
An LLP is a flexible structure but not necessarily the most tax efficient. As a result, since the introduction of the 50% rate (now reduced to 45%) for individuals earning over £150,000, the introduction of corporate partners has been a tax planning strategy in widespread use. The benefit of introducing a limited company as a partner to an LLP is that it enables a percentage of the profits of the LLP to be allocated to the corporate partner at the lower rates of corporation tax. The shareholders of the corporate partner will usually be the other members of the LLP, and this provides them with flexibility to extract profits from the limited company tax efficiently.
This strategy offers clear advantages for reducing tax liabilities, and HMRC are now looking closely at these arrangements, specifically with regard to Hedge Fund planning. We will have to wait until the end of their consultation process to find out exactly what changes will be implemented and whether these will have an impact on general trading LLPs. However in the meantime, HMRC have introduced new rules governing loans made within corporate partnership structures and these have an immediate impact on general trading LLPs. It is therefore important to be aware of these changes, so that you do not inadvertently create an unexpected (and potentially large) tax charge.
New rules governing loans made by corporate LLP partners
Where a member of an LLP is also a shareholder of the corporate member, and where that corporate member then loans funds to the LLP or its members, a 25% corporation tax charge arises on the company, which can only be reclaimed once the loan has been repaid. With effect from March 2013, this applies even where the loan is made on a commercial basis – a tougher stance on this practice since commercial loans were not previously targeted by HMRC. The charge is also extended to cover any contributions or benefits made by a corporate member to an LLP.
In the future therefore, in addition to avoiding such loans, it will also be important to ensure that corporate partner profit shares are paid by the LLP to the corporate partner when it becomes entitled to them rather than waiting, in order to avoid the outstanding profit share potentially being treated as a loan. Overdrawn partners’ loan accounts, which relate to individual members of LLPs who are also shareholders of corporate members, may also be caught by these new rules.
Our advice to clients who operate a business as an LLP and where that LLP has a corporate member is to discuss this situation with us directly to ensure they are not exposed to additional tax liabilities. For more information on tax planning for LLPs, please contact Lesley Stalker by emailing las@rjp.co.uk.