HMRC has commenced a review of the tax rules for partnerships, which look as if they could be wide ranging, but on closer inspection may not cause GPs too many problems
The review is all part of the government's drive for fairness in tax, something that to tax advisers has never existed.
Limited liability partnerships
The thrust of the review is looking at limited liability partnerships (LLPs), which go as far as to remove the presumption of self employment for partners. The review also looks at the manipulation of profit allocations to obtain a tax advantage.
Most GPs will be unaffected by the attack on LLPs, as the restriction on LLPs being approved employers within the NHS Pension Scheme has meant that hardly any practices have become LLPs.
This contrasts with many accountants and solicitors, who have moved to LLPs. The objection is that individuals who are members of an LLP and taxed as a partner pay less tax than they would if they were an employee of the LLP. The suggestion is that individuals are being made partners simply to avoid tax and have no real partnership power or right to income.
The second issue, the allocation of profits to reduce tax is primarily directed at schemes involving individuals and companies that are partners in the business.
Employee or partner?
Turning to the first issue, HMRC are suggesting two tests which if the partner fails he or she will be deemed an employee. The first test is straightforward, ‘a salaried member of an LLP is a member (partner) of the LLP… who would be regarded as employed by that partnership’. The second test is ‘a salaried member of an LLP includes a member (partner) who:
- Has no economic risk in the event the LLP is wound up
- Is not entitled to a share of the profits
- Is not entitled to a share of the assets on a winding up.’
In the explanation of entitlement to a share of profits, HMRC state that a share of profits of less than 5% would not be significant enough. A number of GP partners have fixed shares of profits, or guaranteed minimum shares of profits, so now we know what element of the profits they need to receive to justify their partner status.
Allocation of profits
The second issue concerning the tax advantage of allocating profits is restricted to cases where the entitlement to profits are sold through partnership arrangements.
These apply to all partnerships, not just LLPs, but do not cover cases where family members use partnership structures to allocate profits between them efficiently.
You might be surprised by this, but the reason is that HMRC challenged a taxpayer in a now famous case known as Arctic Systems. In very simple terms, the husband transferred shares to his wife (who dealt with the administration of the business) and claimed the income she was paid was hers.
HMRC challenged this on the basis that this was just a means of shifting income, which the judge hearing the case agreed, but the judge also said that the shares transferred did more than transfer income, they passed rights and responsibilities and the challenge by HMRC failed.
The fact that this case is referred to in this review suggests that the same view is being taken to partnerships too. In fact, within the manuals given to Inspectors of Taxes by HMRC there is a section dealing with the allocation of profits. This states that profits need not be shared out in proportion to contributions of effort or capital, just how the partners agree between them.
The attack on profit sharing arrangements is targeted at professional partnerships where a partner that is also a company makes little contribution to the firm’s profits and receives a significant share of profits. HMRC proposes taking a just and reasonable basis of reallocating profits in these cases, but it is unlikely that GPs will be affected by these changes.
This review does provide some helpful insight into the thinking behind the challenges that HMRC is making on partnerships, and that is always helpful, but GP partners should be able to duck under this attack.
- Laurence Slavin is a partner at Ramsay Brown and Partners Chartered Accountants who specialise in the finances of GPs. www.ramsaybrown.co.uk