Keeping ahead of the game is the best way to keep your costs under control and it’s no different when it comes to managing the tax costs that your partnership faces in the next few years. How is your firm dealing with the current risks outlined below?
Basis period reform
How your partnership responds to the basis period reforms will have a significant impact on your partners’ tax charges and the cashflow of the business, among the key issues to consider include:
- Modelling the cashflow impact of the change, (or updating our calculations for developments such as the introduction of the new Health and Social Care Levy).
- Should you be changing your account year end to 31 March (or would it now be better to align to the rest of the world on a calendar year). We explore the tax and commercial considerations of this here.
- How your funding requirements and any banking covenants are affected
- Managing the communication to the partners and their personal impact
- Assessing the impact of double tax relief in the transition period
- What action is needed (if any) to ensure each partner is able to get relief for their overlap profits
- How this change impacts any secondary partnership arrangements (for those partners with multiple interests)
- How your internal systems will need to be adapted.
International partnerships reporting arrangements
Many partnerships with a connected legal entity overseas have historically been permitted by HMRC to report the profits of such entities as if they were profits of an overseas branch of the partnership and include them in the UK partnership return. This has usually been agreed where the other jurisdiction requires the firm to use a specific type of legal entity under local law rather than a simple branch of the UK partnership.
While this administrative simplification has been accepted by HMRC in the past when businesses were profitable, HMRC is now challenging such arrangements where the overseas entity is loss making. It is concerned about allowing loss relief where there is no statutory basis for giving it for the losses of an overseas company.
If your partnership has be using the so-called ‘branch concession’ to report profits of overseas entities, it will be important to review your reporting arrangements to identify if loss relief has effectively been obtained in the past and how future reporting will be organised.
Salaried member rules
The salaried member legislation, effective from 6 April 2014, was an attempt by government to eliminate the NICs advantage where individuals are providing services on terms similar to employment.
A member of an LLP may be treated as a salaried member under the Salaried Members Rules if all of the three conditions (A to C) in sections 863B to 863D ITTOIA 2005 are met. The three conditions can be summarised as follows:
a. It is reasonable to expect that at least 80 per cent of a member’s share of profit is ’disguised salary’
b. The individual does not have ‘significant influence’ over the affairs of the LLP, and
c. The individual’s capital contribution is less than 25 per cent of the amount of the disguised salary it is reasonable to expect the member to receive.
It is important to remember that Condition C is tested at the following times:
- When M becomes a member of the LLP, and
- At the beginning of each tax year, and
- During the tax year if there is a change in M's contribution to the LLP, or other changes in circumstances which might affect whether the condition is met.
Once condition C is met, it continues to be met until the question has to be re-determined, ie either at the start of a new tax year or during the tax year because of the changes in M's contribution or changes in circumstances. An increase in M's contribution which would result in condition C not being met is treated as not having effect unless it is reasonable to expect that as a result of the increase, condition C will not be met for the remainder of the tax year.
As a reminder, when considering Condition C, where an individual becomes a member a two-month period will be allowed to provide the capital, subject to there being an undertaking to contribute the capital from the day of becoming a member. Otherwise, if additional capital is required, this will need to be in place in advance of the re-test date.
It should be noted, where an international corporate structure is involved, that, in order to fail Condition C, the capital contribution must be made to the UK LLP and not to another entity within the LLP's international corporate group. This is the position even if the parent entity of the UK LLP is to make a capital contribution on behalf of a member.
Partnerships with members with small capital contributions need to have a robust review regime in place to regularly monitor whether they fall foul of the Salaried member rules: an external review is the best way to test that your systems are fit for purposes and could withstand detailed scrutiny from HMRC.
Profit sharing arrangements
As your firm grows, financial arrangements are bound to evolve but this can bring risks when considering your profit-sharing arrangements. It is vital to ensure your profit-sharing arrangements follow the documented position in your LLP agreement.
The LLP agreement is a legally binding document and if the profit share allocations do not follow it, the firm could be subject to challenge - not only legally challenges from the partners but also challenges from HMRC related to resulting tax liabilities. An external check of proposed profit allocations before they are made is always sensible to help you avoid pitfalls.
Tax records for partners
HMRC is increasingly challenging partnership tax returns where the partnership has bought services for partners and claimed deductions in the partnership return. For example, where the external accountancy costs for a partnership include the cost of preparing the partners personal tax returns, HMRC will often challenge long-agreed apportionment arrangements of combined fees and suggest that a greater disallowance for partners individual costs (for their person tax return) based on a more sophisticated analysis of the actual work carried out and elated costs.
BADR replaced Entrepreneurs’ relief in April 2020 and HMRC is now carrying out checks to ensure that partnerships are recording and applying it correctly when partners leave – in particular to ensure that relief is not applied where the 2-year ownership requirement has not been fulfilled.
In both cases, partnerships that cannot show that their tax records are accurate risk a formal enquiry from HMRC on this any perhaps a much wider variety of tax issues.
Get a tax risk check from BDO
If you are not fully in control of these and all the other tax issues that partnership face, there could be hidden costs ahead to either put things right or in the shape of extra tax due to HMRC. We can help by providing and independent risk check of your tax reporting and tax cashflow forecasts for the years ahead to support your budgeting – well help you stay in control.
To discuss how we can help your partnership, please get in touch with Neil Williams, Professional Services Tax Partner.
Get in touch with our tax team