The Finance Act 2014 is introducing changes to the law regarding the profit allocation in mixed partnerships. The new rules will operate for periods of account beginning on or after 6 April 2014. Periods straddling 6 April 2014 will be split into two.
Mixed partnerships are partnerships, including LLPs, where the partners or members include both individuals and non-individuals (such as companies and trusts).
In short, the objective of the new legislation is to prevent what HM Revenue & Customs (HMRC) perceive to be unfair allocation of profits.
Profit allocations
Where HMRC believe that an excessive amount of the profit has been allocated to the non-individual, the new legislation provides for a reallocation of the excessive profits otherwise apportioned to a non-individual partner, on a 'just and reasonable basis' to the individual partners. The allocation of profit to a company is regarded as excessive if one of two conditions is met.
- Condition X – The profits represent the deferred profit of an individual member.
- Condition Y – The profit share of the non-individual exceeds the appropriate notional profit and the individual has the power to enjoy the non-individual's profit.
In the second condition, the appropriate notional profit share of the partnership is based on:
- what is regarded as a notional return on the company's partnership capital; and
- the arm's length rate for any services the non-individual supplies to the partnership. As evidenced in the HMRC guidance, HMRC consider that services also include the use of equipment and the rent of land.
Mixed partnerships, where the corporate member has little or no substance or investment in the partnership, are likely to fall foul of the new legislation.
But where the corporate member brings something to the partnership, such as capital investment, services, land, a tenancy or plant and machinery used by the partnership, the share it receives will need to be considered in detail as to whether it is in excess of an arm's length rate.
Loss allocations
Excess loss allocations will now also be reversed, where the main purpose of the profit share allocation is for an individual to receive the losses instead of a company. There is no need for any connection between the individual and the company for the loss allocation anti-avoidance rules to apply.
Taking care
The new rules should not apply if profit allocation has been carried out on an arm's length basis, or if all partners are individuals or any non-individuals are removed from the structure.
Incorporation of the partnership could be considered as an option but care should be taken where the trade is moved into the existing corporate partner entity, as to whether this crystalises a tax charge.
It is prudent to work on the assumption that existing structures will come under review by HMRC so current structures and potential tax changes should be considered in order to minimise uncertainty.
We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. code: 15/11/2014 exp: NTD197
