UK: HMRC – Partnership Consultation – Two Avoidance Issues

Last Updated: 21 June 2013
Article by Michael Cant

Summary and implications

On 20 May HM Revenue & Customs (HMRC) released a consultation regarding the taxation status of some LLP members and the manipulation of profits and losses by partnerships. The consequences will be that:

  • targeted anti-avoidance measures will be introduced to prevent the use of limited liability partnerships (LLPs) to avoid national insurance contributions (NICs) and income tax;
  • in practice the current position of fixed-share or salaried partners in the legal and accounting professions are unlikely to be affected by the changes; and
  • HMRC intends to prevent the use of schemes that look to allocate profits or losses between partners so as to reduce tax.


The taxation of partnerships generally has been under scrutiny for a while, with the suggestion that some have been abusing the structures to achieve advantageous tax results, particularly in relation to NICs, income tax and capital gains.

The two aspects being consulted on now deal with aggressive schemes that address two unrelated issues where HMRC believes NICs and income tax are being avoided.

Issue one – Salaried Members

Upon the introduction of LLPs, some spotted the opportunity to re-badge employees to avoid NICs. This was often done by transferring existing employees to an LLP as members. Due to the statutory presumption that all members of an LLP are treated as partners, and hence self-employed, this was argued to achieve an NIC savings. In relation to some higher paid employees it was also possible to achieve an income tax saving.

Proposed changes

If an individual meets either of two conditions they will be classified as a Salaried Member and liable to income tax and class 1 NICs as an employee. The LLP would be liable to pay secondary NICs although the costs of employing the Salaried Member will be deductible.

The two conditions are that:

  • the Salaried Member would otherwise be regarded as an employee; and
  • the Salaried Member takes no economic risk and shares neither profits nor assets on a winding-up.

There would also be a targeted anti-avoidance rule (TAAR) introduced to allow artificial arrangements to be ignored if "the main purpose, or one of the main purposes" is to step outside either condition.

Issue two – allocation of profits and losses

There are various schemes being actively marketed which seek to avoid tax by allocating profits and losses between partners or members in an LLP with different tax characteristics so as to reduce tax. It is questionable whether all these schemes actually achieve the savings claimed and no doubt cases will follow before the courts. However, to put the matter beyond doubt, and to prevent further avoidance "Government considers that new legislation is now required to remove the risk".

Examples of the three different types of scheme are given in the consultation paper. Put briefly the three types of scheme are as follows:

  • Partnerships with mixed memberships – profits: these schemes allow income tax payers to obtain the benefit of lower corporation tax rates by involving a corporate member owned by the individual members.
  • Partnerships with mixed memberships – profits: profit deferral and working capital arrangements. To align long-term incentives and performance, profits are rolled up in a corporate member owned by individual members. At a later date the corporate member is dissolved. To fund working capital profits can be rolled up in a corporate member owned by the individual members.
  • Partnerships with mixed memberships – losses: these schemes focus on allocating losses in the early years against individual members who can set them against profits otherwise taxable at higher rates. In later years profits are allocated to corporate members owned by the individual members and taxed at lower corporate tax rates.

It is clear from this that HMRC has not, as it has in relation to issue one, identified the precise target for legislative changes. The questions it asks in relation to the three types of scheme are more open those asked in relation to issue one. A possible result of this is that whatever emerges by way of legislative change is likely to be complicated and wide in scope.

Interaction with the GAAR

If future schemes manage to negotiate their way around the legislation finally introduced they may still "fall foul of the GAAR". In stating this HMRC is clearly indicating its determination to block the sort of planning identified by both issues one and two one way or another.

Practical issues

  • Fixed-share or salaried partners in the legal and accounting professions are unlikely to be affected by the proposed changes in relation to issue one. Such partners generally do play a full role in their partnerships and both take risk and share profits, commonly as to 10 per cent of the element that is fixed. Such a partner would fall outside both conditions one and two.
  • Transferring a large number of low-paid employees to a limited liability partnership as members in order to avoid NICs was always likely to attract an HMRC challenge at some point.
  • In seeking to prevent avoidance in relation to issue two, HMRC may unintentionally inhibit the development of professional services. Will the changes eventually introduced impact the flow of external capital into professional services generally and, in the legal profession, the adoption of alternative business structures? There must be a danger that, in trying to prevent abuse, HMRC will block the development of genuinely commercial structures.


The new rules will apply from 6 April 2014 in relation to profits and losses arising on or after that date. Beware: "There will be no grand fathering for arrangements entered into before this date".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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