Beware Of Tax Changes Effecting Your Business

Sheila Berry, tax partner at UHY Hacker Young Manchester, says start-ups must be aware of plans for major tax changes for LLPs.

A LLP is a limited liability partnership in which some or all partners (depending on the jurisdiction) have limited liabilities. Read the full definition of LLP on Wikipedia.

Government plans to alter the tax arrangements of LLPs could have a major impact on the structure of thousands of start-up businesses in the future.find advice on tax changes

A recent HM Revenue & Customs consultation document proposes new legislation and changes to income tax to stop partnerships manipulating profit allocations to gain a tax advantage for the business or individual partners.

HMRC believes that LLPs are increasingly being used and marketed as vehicles to disguise employment relationships and avoid employment taxes.

It is common practice within professional LLPs for senior employees to be promoted to partnership status, a move which often results in their tax status changing from that of an employee to a self-employed partner within the partnership.

More often than not, such individuals are taken on a "fixed profit share basis" which could limit how much actual risk they have as self-employed individuals. Under the current system, LLP members in some circumstances may avoid both National Insurance contributions and income tax as they are no longer deemed to be “employed”.

However,  HMRC is seeing that in actual fact, nothing much may have changed in the relationship other than the fact that HMRC are in receipt of less national insurance, as the firm no longer has to fund secondary national insurance contributions. HMRC argues that, in reality, the role of many of these members resembles that of an employee.

The proposals, which follow comments made in this year’s Budget, include a challenge to the automatic presumption of self employment for some LLP members which might be disguising an underlying employment relationship, potentially bringing them within the scope of income tax and National Insurance.

This consultation is very important for LLPs and could have a major impact on how businesses are structured going forward due to the tax changes.

A key measurement for HMRC is how much risk a partner carries, especially where someone has been promoted to partner and attracted self-employed status, yet in reality little may have changed.

As such, their initial concerns seem to be centering around ensuring that there has actually been a bona fide transition from a master-servant relationship to one of personal accountability using the issue of financial risk as one such marker.

Salaried partners who shoulder no economic risk in return for a fixed share return may therefore face much higher employment taxes.

A further proposed change involves preventing businesses from siphoning profits through so-called “corporate partners” to help partners avoid higher rates of income tax.

It is common practice for some businesses to channel profits through corporate partners, which are effectively companies, to attract a corporation tax charge at 23%, rather than pay income tax at the top rate of 45%.

The government now plans to level the playing field by take any profits allocated to corporate partners and reallocating them to partners paying income tax.

LLPs across the country will await the outcome of the consultation documents with bated breath.  The consultation period ends on August 9, with changes scheduled to come into force next April, and any interested parties have the right to make representation until that date.

I would certainly urge start-ups to consider the structure of their company carefully and be ready to reconsider their plans in response to these possible tax changes.

Find out more legal advice for starting up your business.