On Tuesday, HMRC published details of planned tax changes to UK limited liability partnerships (LLP), a popular private equity structure.
The LLP structure provides individuals tax breaks for taking on the risk of being a self-employed professional part of a business partnership. But the UK tax authority believes some partners are reporting as self-employed when they are actually more akin to an employee of the firm, and thus unfairly capturing tax advantages meant for true partners of the business.
Under the proposals, a GP must have at least 20 percent of their pay tied to the financial performance of the LP in order to file as self-employed. A partner with “significant influence” over the affairs of the partnership, or whose capital contribution to the LLP is at least 25 percent of their annual salary are also legitimate partners in the eyes of the HMRC.
Private equity firms should see that any junior-level LLP members meet one of those three tests, advised law firm King & Wood Mallesons SJ Berwin in a client memo.
HMRC has also openly criticized private equity LLP structures that allow fund managers to reinvest profits the partnership makes, via a corporate member, at the corporate tax rate rather than the higher income tax rate as individual investors.
The draft rules aim to prevent this by taxing individual LLP members who claim any of the excess profit generated from the investment strategy. Specifically, the HMRC will take issue with profit allocated to a corporate member that represents more than a “reasonable” return on its investment in the partnership (or more than reasonable remuneration for services that it provides to the partnership).
However, legal sources are still unsure as to the impact on private equity if the changes to the tax treatment of a corporate LLP member become law. “These provisions are a headache. What has been drafted is not particularly clear and leaves things very much open to interpretation, which is always an unsatisfactory position for anti-avoidance rules,” says one UK-based tax lawyer.