What is the issue?
The disguised remuneration rules were introduced in 2011 to counter tax avoidance in situations where an employment benefit trust (EBT) is used to make loans to employees as a way to provide remuneration (rather than salary) to avoid income tax and NIC. However, no rules addressing similar arrangements for sole traders and partnerships were created at that time.
From April 2017, the rules will be extended to create a new charge on ‘relevant benefits’ which are provided to self-employed persons, including partners. Not only will the new rules address future provision of relevant benefits, but longstanding arrangements could also be affected if they are not unwound by 6 April 2019.
How it will work
The new rules will apply where there is an arrangement connected to a self-employed person’s trade or a partnership to provide a relevant benefit to the individual (this includes a loan or any quasi-loan made to the individual or anyone connected to them). Along with the other tests, one of the following widely drafted ‘conditions’ must be met, either:
- A deduction is claimed for the payment in calculating the profits of the business or
- It is “…reasonable to suppose…” that there is some form of connection (direct or indirect) between the payment and the provision of goods or services in the course of the relevant trade.
Where the rules are met, the relevant benefit will be subject to income tax as profits of the trade in the year in which it arises.
The rules could have a retroactive impact for existing loans: the charge will be applied to the whole amount of the loan that is outstanding at 5 April 2019. When it comes to calculating how much of the loan is outstanding at 5 April 2019, rules introduced in Budget 2016 now mean that only loans repayments made personally by the borrower (rather than a third party) are deemed to reduce the balance of the loan.
The new rules are drafted very widely and although condition A is clearly aimed at avoidance arrangements, Condition B could affect a number of general operational arrangements for partnerships (ie where there is no tax avoidance motive).
One example of a potential problem is where a partner withdraws cash from the business in advance of being allocated profits, commonly known as their ‘monthly draw’: in such a case the new provisions could be read to treat the draw as a ‘relevant benefit’. While in many situations the amounts will be cleared by profit allocations that are taxable anyway, this will not always be the case.
For many new start up businesses structured through partnerships, it is often the case that profits are scarce in the early years and a partner (eg a corporate partner) will fund distributions to other partners. There are a number of ways this could be achieved, however, the new rules are likely to capture these arrangements and create a tax charge on partners receiving the benefit without permitting a deduction for the funding partner and even if the partnership makes a trading loss for the year.
The net effect of these rules on partnerships, particularly start-up partnerships, could be to put them in a similar position to loss making companies: where PAYE and NIC will have to be paid on employee salaries regardless of trading profitability. We doubt that this is the aim of what is intended to be anti-avoidance legislation. BDO is currently discussing the application of the proposed rules with HMRC and will be making representations on this issue.
Partnerships that have made significant loans to partners should review their position as soon as possible before 6 April 2017 and assess whether remedial action or changes to financing policies for future accounting periods are required.
For help and advice on partnership loans and any Partnership structuring issue, please get in touch with your usual BDO contact or Neil Williams.