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HMRC wins first mixed membership partnership case at tribunal

14 February 2020

If your business operates through a partnership or LLP that has individual and non-individual members, such as a company, then you will benefit from the key points to note from HMRC’s success in the first tier tribunal case of Walewski that resulted in significant additional taxes for the tax payer.

What are the mixed membership partnership rules?

The anti-avoidance rules known as the mixed membership partnership rules were introduced in April 2014 and are broadly designed to counteract arrangements which divert an individual’s partnership profit share to a corporate member in order to access the lower corporation tax rates. 

The rules apply when the corporate member’s profit share exceeds a notional return, based on the value of services and the capital contribution provided by the company to the partnership, and an individual member has the ‘power to enjoy’ those profits. Where the corporate member’s profit share is attributable to such a power to enjoy, profits exceeding the notional return may be reallocated to the individual for tax purposes.

Three key points to note from the Walewski case:

Supporting evidence

Where a power to enjoy the corporate member profits that exceeds the notional return exists, alternative reasons given for allocating profits to a corporate member will need to be supported by compelling evidence in order to convince the tribunal.  Although the tribunal found the arguments to be unconvincing in this case, it should not be assumed that every case will fail, and it will be important to draw distinctions from the fact pattern in this case to your commercial position.

Here it was found that there was no commercial, physical or temporal separation of Mr Walewski’s activities and, rather than ‘wearing multiple hats’ to represent value of services for the corporate member, a better description was that he ‘wore one hat in multiple places’.

Execution and documentation

In determining the company’s capital contribution, the tribunal followed the statutory definition closely, meaning unallocated and undrawn profits could not be taken into account.  This highlights the importance of the procedures set out in the LLP or partnership agreement for allocating profits and the need to formally capitalise retained profits if the intention is for these to be treated as a member’s capital contribution.  Any amounts that do not meet the legislative definition will not give rise to a notional return.

General guidance

The notional return of 5% on the agreed capital contributions was not contested by HMRC. Although, strictly, the notional return on capital needs to be calculated on a case-by-case basis, this perhaps provides an indication of the level of return that HMRC would be willing to accept.  However, a higher rate of return may well be accepted if the rate used is supported by an economic benchmarking analysis.

Learnings from this case and future implications

All mixed membership partnership arrangements, whether currently under HMRC enquiry or otherwise, should be reviewed in this context. 

BDO has significant experience in this area. We can discuss the implications of the case to your business and provide assistance with preparing for or handling a HMRC enquiry. We can also help you to review your business structure and, where appropriate, provide advice on how it may be restructured.

For further advice, please contact Neil Williams, Jitendra Patel or your usual BDO tax adviser.