Tax and tax avoidance are currently high profile news items and all responsible businesses will be looking to ensure they comply with the letter and the spirit of the law, while ensuring no more than the right amount of tax is paid. In this note we highlight three areas of tax that could impact the amount of tax partnership businesses bear, and that merit a review of existing and future partnership structures and compliance procedures. We look at:
- The proposed cap on income tax reliefs.
- The impact of transfer pricing requirements.
- HMRC taskforces to tackle tax evasion and the focus on London Lawyers.
The proposed cap on income tax reliefs
A technical consultation was issued in July this year proposing to introduce a limit on ten income tax reliefs from April 2013 where relief is currently not limited. Those affected reliefs which may be particularly relevant to partnerships include:
- Trade loss and property loss relief against general income (overlap relief may consequently be affected).
- Early trade loss relief (available during the first four years of a business).
- Post cessation trade and property loss relief.
- Qualifying loan interest relief.
The proposal is to cap relief to the higher of £50,000 and 25% of an individual's total income.
If implemented as proposed, those individuals with one or more business activities other than the partnership business, may only be entitled to a restricted amount of loss relief in a year of loss when previously there could have been full relief.
Retiring partners may not get full relief for overlap profits (profits previously taxed twice).
Due to the potential restrictions on relief for qualifying loan interest, partnerships previously using financing derived from individual partners may need to increase the level of borrowings from non-partners, potentially leading to increased financing costs. With current relatively low interest rates the restriction is likely to affect those partners who have the capacity to borrow significant amounts for the partnership where the combination of results from partnership and other activities mean the cap on relief applies. However many more could be drawn into the trap of capped relief if interest rates rose without a corresponding increase in the relief cap.
Partnerships operating on an international basis using valve partners may need to consider whether existing valve partner arrangements are appropriate, to avoid situations where valve partners are left with uncapped relief.
Some examples of the potential tax implications appear at the end of this note.
Professional bodies and associations are making representations and draft legislation on the proposals is expected to be available in December this year. Responses to the consultation are due by 5 October 2012.
However in view of the short time before these arrangements are due to commence it may be appropriate to start reviewing partnership structures and financing arrangements now to assess potential impacts.
The impact of transfer pricing requirements
Transfer pricing (TP) for UK:UK transactions was originally introduced in 2004 to ensure the UK rules on transfer pricing applied both cross border and within the UK in a manner thought to comply with fundamental EU freedoms. It is now thought that these EU fundamental freedoms might be met without the need to apply TP to UK: UK transactions and HMRC are considering the implications of possible changes.
TP arrangements apply automatically to enterprises which are not small or medium (SME). Where TP arrangements apply, transactions between connected parties must be on an arms-length basis where one or both of the parties would otherwise obtain a potential advantage in relation to UK taxation.
Small or medium enterprises are those with less than 50 or 250 employees respectively, and which have either (or both of): turnover not exceeding €10m or €50m respectively; and/or a balance sheet total not exceeding €10m or €50m respectively). SME enterprises can, subject to other rules, elect irrevocably for transfer pricing requirements to apply to all transactions.
Some partnerships have corporate entities in their structures which recharge costs at a mark-up, thereby reducing partnership profits taxable at potentially high income rates while increasing corporate profits taxable at lower corporation tax rates. There are a number of other tax and non-tax factors to consider in such arrangements, but corporates are used successfully by a number of partnerships (for example the use of service companies). Those partnership businesses which are SMEs may have elected that transfer pricing applies, so that their tax computations reflect arms-length pricing. Invoicing arrangements may not have reflected arms-length pricing, and there may be a number of reasons for this.
If the transfer pricing rules for UK: UK transactions are changed, this may have implications for the effectiveness of the way some partnerships operate under the existing rules. While discussions on any changes are at an early stage and may result in further consultation, now may be an excellent time to review your business's related party transactions.
HMRC taskforces to tackle tax evasion, avoidance and fraud - London lawyers
On 18 September this year HMRC issued a press release announcing the launch of new taskforces to tackle tax evasion, avoidance and fraud in a number of specific business sectors, one of which was the legal profession located in London.
There have been a number of recent initiatives aimed at bringing the less compliant or more aggressive tax avoiders into line. These include a number of disclosure facilities for those who have previously evaded tax, the proposed general anti-abuse rule (GAAR), proposed strengthening of various anti-avoidance provisions and some high profile successes in the Courts against marketed tax avoidance schemes.
We have an expert team to assist individuals and businesses with the tax investigation and enquiry procedures and in ensuring your tax affairs are up to date. Please contact one of the team for a confidential discussion of how we can be of assistance.
Examples of the operation of the cap on income tax reliefs
2014/15 income: £675,000 from partnership.
£ (180,000) loss from property rental business (claimed for loss relief against general income).
Income tax relief cap in 2014/15 is the greater of:
- 25% of £675,000 (£168,750); and
Mr Jones can claim tax relief for 2014/15 property loss of £168,750. The balance of the property loss, £11,250 will be carried forward for use against future property rental profits.
The delay in obtaining loss relief could be more prominent where the second business generates results that are uncertain and could fluctuate significantly (for example an equine breeding business).
For those seeking to obtain relief for interest on loans to a partnership, if full relief for the interest is denied in any year, then there is an absolute loss of relief from tax on the portion not allowed as a deduction as a result of the cap.
Mr White retires from the partnership in 2017/18 and has overlap profits carried forward of £250,000.
With the cap on income tax reliefs, £55,000 of Mr White's overlap relief remains unused and is wasted.
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.