UK: HMRC Review Of Certain Tax Treatments Of Limited Liability Partnerships And 1890 Partnerships Manipulating Profit And Loss Allocations?

Last Updated: 24 June 2013
Article by Rebecca Patrickson

On 20 May HMRC published a consultation document to review two aspects of the current tax treatment afforded to members of Limited Liability Partnerships and 1890 Partnerships:

(i) the presumption that members are self-employed for tax purposes, so called 'disguised employment', that is, HMRC's attempt to tackle their perceived abuse of membership of LLPs to avoid employment taxes (for further details please see ' LLP Members - Disguised Employment? )'

(ii) perceived manipulation of profit and loss allocations to generate a tax advantage by, for example, the use of corporate members by both LLPs and general partnerships.

This briefing note addresses issues arising from part (ii) of the Consultation.

The Current Position

In partnerships, each partner is charged to tax on the profits allocated to them in accordance with the profit sharing arrangements in place for that period rather than on the basis of profits drawn from or distributed by the partnership. Partnerships have a great deal of flexibility around the allocation of profit or losses between the partners, for example, profits and losses do not need to be shared in proportion to contributions of capital or effort.

The Consultation

HMRC now considers certain uses of this flexibility, in relation to profit and loss sharing arrangements to secure tax advantages, to be unfair. There are three types of arrangement that the Government plans to address:

1. LLPs and Partnerships with Mixed Membership – Profits

In this type of arrangement the partnership has both individual members and corporate members and profits are allocated to a corporate member that pays a lower rate of tax, allowing the individual partners to ultimately obtain the benefit of those profits (directly or indirectly) as a result of having an 'economic interest' in that corporate member. HMRC also highlights profit deferral arrangements and working capital arrangements through a corporate member as securing tax advantages by allowing individuals to access lower corporation tax rates but without the full tax consequences of operating as a company. The arrangements are viewed as purely tax-driven as the allocation to the company would not take place if the company was taxed at the same rate as the individual members.

HMRC proposes, that where: (i) a partnership consists of members who are persons within the charge to income tax e.g. individuals, and one or more members who are persons not within the charge to income tax e.g. companies or a non-UK resident; and (ii) the purpose of the profit-sharing arrangements is to secure an income tax advantage for any person, such part of the profits allocated to members not within the charge to income tax will be allocated to those members who are within the charge. The reallocation would depend on the economic connection between those charged to tax (e.g. if that is by way of shareholding, then the reallocation will be by reference to that shareholding). Quite how this reallocation would work is unclear from the consultation document.

2. LLPs and Partnerships with Mixed Membership – Losses

Losses are allocated to secure tax relief for individual partners against later profit share allocations which would otherwise be chargeable at higher rates of income tax. Where it is reasonable to assume that one of the main purposes of the loss allocation arrangements is to allocate a loss to a partner so that partner can obtain a reduction in tax liability by way of income tax reliefs or capital gains tax reliefs, HMRC proposes to withdraw the relevant income tax relief or capital gains tax relief that would have been available to the relevant partner for the period.

3. Partnership members with differing tax attributes

This relates to profit transfer arrangements where profits are transferred in return for a payment or asset outside the charge to tax and it is reasonable to assume that the main purpose of the arrangement is to secure a tax advantage arising due to the differing tax attributes of the transferor and transferee. In such cases the payment will be treated as income of the transferor (or its connected person) and chargeable to tax as if it were partnership profit.


The consultation dismisses some of the sound commercial reasons for adopting these mixed membership structures. For example:

  • the need to retain working capital does not, according the HMRC, override the 'unfairness' of allowing the partnership to benefit from the lower corporation tax rate, ignoring what most consider to be sound business practice in retaining profit for working capital requirements, in a sensible tax-efficient manner. It would seem to encourage businesses to seek debt solutions rather than having prudent working capital arrangements based on profits retention;
  • many businesses have 'converted' from a company to a LLP, with the company legitimately contributing the business to the LLP and the same forming its capital contribution to the LLP; and
  • another commercial reason for the use of a corporate member has been to properly keep separate the overseas tax liability of a parent entity based outside the UK from the UK tax net and the UK business from any tax liability which could arise in the parent entity's tax jurisdiction. Attacking this would seem to impact on the Government's stated aim of making the UK a global business centre.

The proposals being consulted upon significantly affect the flexibility of the LLP structure, which could be viewed as discouraging business and makes the UK a less competitive place to do business.

It should also be noted that HMRC's claim that such arrangements are 'unfair' appears to ignore the fact that there is little difference in the tax receipts for HMRC where corporation tax is paid and a later tax on dividends paid verses where income tax is paid by an individual member, save for the timing of those payments. The likely effect will be simply to drive business back to company structures, abandoning LLPs. That effective loss of diversity in terms of alternative corporate structures gives a negative outlook for the UK as a good place to locate your business as compared, for example, to the more flexible US LLC and C Corporation models.


It is proposed that the rules will apply with effect from 6 April 2014, giving partnerships and LLPs time to consider the potential impact of the proposals on their business. A review of your LLP Agreement and profit distribution arrangements should be undertaken but we also recommend that you consider whether:

  • your corporate member/partner performs a necessary function or service within the LLP/ partnership and is remunerated accordingly in relation to that function or service;
  • a change to the membership of the LLP or partnership should be made, for example, introducing all corporate entities and removing individuals;
  • the profit share payable to the corporate should be reduced or minimised; or
  • the corporate member should be entirely removed from the partnership or LLP structure.

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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