Partnership tax changes

Partnership tax is changing.

HMRC has encouraged several changes to the taxation of partnerships in recent years. The Finance Act 2013 introduced schedule 30, and the Finance Act 2014 has curtailed perceived tax avoidance using partnerships.

Partnership legislation is simple. Most UK partnerships are formed under the Partnership Act 1890, which defines a partnership as ‘the relationship which subsists between persons carrying on business together with a view of profit’. 

A partnership formed under this act is not a separate legal entity, although a partnership formed under Scottish legislation is. UK tax legislation treats both types as fiscally transparent; the profits are attributed to the individual partners.

A variation of the usual partnership is a limited partnership formed under the Limited Partnership Act 1907. These contain some partners whose liability is limited to the fixed amount of capital contributed and cannot take part in the management of the partnership, and must contain at least one ‘general’ partner who manages the business and has unlimited liability. 

A limited partner is not entitled to income tax relief for interest on a loan incurred for investment in the partnership, nor are they entitled to loss relief against other income and gains to the extent that it exceeds £25,000 (although this does not apply to prevent loss relief against profits from the same trade).

Limited liability partnership

More recently, the Limited Liability Partnership Act 2000 introduced the concept of the limited liability partnership (LLP) - a hybrid entity. 

The LLP is a body corporate, with registration obligations similar to those of limited companies, and its financial results are filed on a public registry. 

Its taxation, however, has until recently been similar to that of a partnership, with the profits  attributed to the partners for fiscal purposes. This is changing.

General partnerships

There is no income tax legislation applicable to a general partnership. Income tax is assessed on the partners in accordance with their profit-sharing allocations. These are outlined in the partnership agreement and, in the absence of an agreement, the Partnership Act 1890 provides that profits or losses should be shared equally.

Capital gains tax (CGT) is slightly more difficult because of a similar lack of specific legislation. Unless the partnership agreement provides differently, each partner is deemed to have a share in the partnership assets. 

Section 59 TCGA 1992 provides: ‘Tax in respect of chargeable gains accruing to them on the disposal of partnership assets shall…be assessed and charged on them separately, and any partnership dealings shall be treated as dealings by the partners and not by the firm as such.’

Statement of Practice D12 introduces a ‘roll-over’ when intra-partnership transactions occur, but this is non-statutory. 

Section 286(4) TCGA 1992 applies to ensure that partners (normally treated as ‘connected persons’ for CGT) should not be treated as connected so long as transactions between them in the case of partnership assets are ‘bona fide commercial transactions’.

Thus, intra-partnership transactions on a purely commercial basis are not necessarily subject to market value rules. However, if they are on a commercial basis but involve a third party who is ‘connected’ with one of the partners (a relative, trustee of settlement etc), market value will apply. This will also apply to a bargain not at arm’s length.

Corporation tax

Previously, partnerships were not normally concerned with corporation tax, but this has been changed by the Finance Act 2013, schedule 30. This expands section 455 Corporation Tax Act 2010, which taxes loans to participators. 

Where a close company makes a loan or advance to a participator and the loan is not repaid within nine months of the accounting period, the company is liable to a charge to corporation tax at 25 per cent of the outstanding loan. 

New legislation applies for loans or advances made to a partnership or LLP after 19 March 2013; where such a loan is made to a partnership or LLP in which a participator or associate is a partner or member, they will now be caught by the charge. It was previously thought that section 455 did not apply to a partnership, but schedule 30 has put this beyond doubt.

Mixed partnerships

New legislation is seeking to deal with the situation where a partnership contains both individuals and non-individuals, eg a company. The definition would also include a trust or LLP, but these are less likely to be involved.

Section 850C to 850E Income Tax (Trading and Other Income) Act 2005 (ITTOIA), together with consequential changes to Income Tax Act 2007 (ITA), deals with the situation where losses are incurred and allocated to individual partners. 

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The Giles partnership is a farming partnership whose partners are Farmer Giles (10 per cent share), Giles Junior (10 per cent share) and Giles Ltd, owned by the partners (80 per cent share).

Year 1:

Profits £500,000 shared Farmer Giles £50,000, Giles Junior £50,000, Giles Ltd £400,000. Top tax rate on profits (ignoring allowances): 40%, 40%, 20%.

Year 2: Profits £25,000 shared Farmer Giles £2,500, Giles Junior £2,500, Giles Ltd £20,000. In year 2, Farmer Giles and Giles Junior can declare a dividend to supplement their income with no further tax or national insurance charge.

The partnership also owns two new Range Rover cars, with mixed private and business use. Since Farmer Giles and Giles Junior are partners and thus self-employed, they are not taxed on a benefit in kind as they would be if the cars were owned by the company.

Aims of legislation

The new legislation seeks to attribute profits to a member of the partnership (LLP or other) where the profits have been sheltered in a non-individual member. Similar issues arise where losses have been attributed to the individual members in preference to the corporate members.

The provisions attack the allocation of profit where:

  • an individual member has been allocated a share of the profit or a zero amount (but not a loss); and
  • there is a non-individual member of the partnership which has also been allocated a share of profit; and
  • it is reasonable to suppose that the individual’s deferred profit is included in the non-individual’s profit share and the relevant tax is lower than it would otherwise have been. ‘Deferred profit’ means any remuneration, benefits or returns which have been deferred in the profit allocation, and the ‘relevant tax’ is the amount that would otherwise be charged on the income in the absence of this provision;
  • the non-individual’s allocation of profit is in excess of the appropriate notional profit; and
  • the individual has the power to enjoy the non-individual’s profit share; and
    it is reasonable to suppose that the whole or part of the non-individual’s profit share is attributable to the individual partner’s power to enjoy and both that partner’s profit share and tax amount are lower than they would have been, but for the provision; and
  • the result is a saving in tax.

In this situation, section 850C(4) of ITTOIA requires that the individual’s profit share be increased by so much of the non-individual’s share as it is reasonable to attribute to:

  • the deferred profit share or
  • the power to enjoy.

The amount allocated will be on a ‘just-and-reasonable’ basis.

The legislation allows the non-individual member of the partnership to be allocated a share of the profits without disturbing them. This share is capped at the sum of:

  • a return on capital equivalent to a commercial rate of interest on the capital contributed by the non-individual to the firm (less amounts paid in respect of this which are not parts of its allocation of profits), plus
  • a return for services provided to the firm by the non-individual (but not involving any other partner of the firm) priced on an arm’s length basis,
  • the individual’s power to enjoy the non-individual’s profit share if they are connected under section 993 ITA 2007 (definition of connected persons), or
  • any of the following enjoyment conditions are met, including any connected persons such as the individual’s spouse:
    • Some or all of the non-individual’s profit share is in fact so dealt with by any person as to be calculated at some time to accrue for the benefit of the individual, whether in the form of income or not.
    • The receipt of the non-individual’s share of the profits operates to increase the value of assets held by or for the benefit of the individual.
    • The individual receives or is entitled to receive at any time any benefit provided out of the non-individual’s profit share.
    • The individual may become entitled to benefit from the non-individual’s profit share by the exercise of one or more powers of any person.
    • The individual is able to control (directly or indirectly) the application of the non-individual’s profit share.


In order to prevent avoidance in the run up to the implementation of these provisions, new section 850D applies the same rules where the individual is not a partner in the firm, but performs services personally for the firm, and it is reasonable to suppose that the individual would have been a partner in the firm had it not been for new section 850C. 

This is extended to include where the individual is a member of another partnership associated with the firm (ie it is a member of the first firm).

Where this condition is met, the individual is treated as a member of the first firm and the above provisions are applied in the same way.

Excess losses

New section 116A ITA 2007 amends the relief available under ITA 2007 for trade losses to prevent relief being given for losses where the allocation of loss to the individual arises wholly or in part as a result of relevant tax avoidance arrangements.

Examples from HMRC guidance

Mixed partnerships

Example 20:

The INV LLP has a property business. It has 15 individual members, including X. In addition to being an individual member, X is also a member as trustee of the XXX settlement.

The INV LLP is a mixed membership partnership as it has 15 individual members and X in his capacity as trustee of the XXX settlement.

Appropriate notional profit – return on capital
The appropriate notional return on capital is simply a commercial rate of interest on the capital contributed. This is not a specific rate as the appropriate commercial rate will vary:

  • The commercial rate will reflect the level of risk involved.
  • Where the level of capital varies during the relevant period of account, the notional return must be calculated from time to time and on these varying amounts.

Example 21:

B Ltd has invested £10,000 in the ABC LLP. It receives no return on this other than its profit share.

ABC LLP is paying 2 per cent on loans on the commercial market, reflecting its good credit rating. This represents a commercial rate, so B Ltd has an appropriate notional return on capital of £200.

Appropriate notional profit – payment for services

In almost all cases, the notional consideration should be no more than the cost to the company in providing the services plus a modest mark-up.

Example 22:

Continuing with Example 21, B Ltd is a member of ABC LLP and provides advertising services for ABC LLP. The work is carried out by A, who is also a member of ABC LLP. B Ltd provides no other services to ABC LLP.

B Ltd is treated as providing no services as the only service provided involves a member of the LLP. Therefore, the appropriate notional consideration for services is nil.

Power to enjoy – connected

A is connected to B if it meets the general definition in tax law, apart from being a member of the same partnership.

Example 23:

A and A Ltd are members of A LLP. A controls A Ltd.

As A controls A Ltd, A and A Ltd are connected and, as such, A has the power to enjoy any profits of A LLP which are allocated to A Ltd.

Example 24:

A and B Ltd are partners in the AB partnership. A has no interest in B Ltd, which is wholly owned by B, who is not connected to A.

A and B Ltd are only connected by being fellow partners in the AB partnership. As such, they are not treated as connected and the excess profit allocation rules do not apply to them.

If the particular facts show that any economic connection between the individual and non-individual members does not result in profit being shifted from the individual partners to the non-individual, the mixed partnership legislation will not apply. One example is where the non-individual partner has been carrying on the trade for many years before it is transferred to an LLP.

Example 27:

Oldco Ltd had been trading for many years. A few years ago P, the owner of Oldco Ltd, decided that she wanted to retire. She set up an LLP, whose members are P, Oldco Ltd and a number of individuals whom she hoped would take over the business.

Oldco Ltd receives the profit share agreed when the business was transferred to the LLP. This share reflects its founding role in the business and is based on the fact that it contributed the business to the LLP. P receives a small personal profit that is commensurate with the work she does.

The facts show that Oldco receives a profit share reflecting the fact that it transferred its business to the LLP (and that the same profit share would have been received by Oldco if P fully withdrew from the business, including as an LLP member). Looking at these facts, the legislation would not apply.

Salaried partners of LLPs

New legislation that applies to salaried partners of LLPs came into effect from 6 April 2014. It only applies to partners in LLPs and not to general partnerships. It is in sections 863A to 863C of ITTOIA 2005 and overrides section 4(4) of the Limited Partnership Act 2000, which provides that LLP members are self-employed. 

The rules are applicable to tax only and do not reflect employment law. It is unclear how they will affect the profits of LLPs with overseas tax liabilities.

Disguised remuneration

The aim of the legislation is to counteract what is regarded as ‘disguised remuneration’ and sets out three conditions which all have to be met before the legislation applies:

Condition A - disguised salary
Disguised salary is remuneration that is:

  • fixed; or
  • if variable, varies without reference to the amount of the LLP’s profits or losses; or
  • is not in practice affected by the LLP’s profits or losses.

The remuneration must be reviewed annually, by 6 April. If it is reasonable to conclude that where 80 per cent or more is disguised remuneration, condition A will apply.

Condition B - whether the member has significant influence
Significant influence is another determining factor and refers to strategic influence over the partnership affairs as a whole – not just a department for which the member has responsibility. There is no guidance on the meaning of ‘significant’.

Condition C - capital contribution
This condition looks at the capital contributed to the partnership by the member. Is there a significant investment in the business and therefore a chance of rewards and risk of failure?

The amount of capital is based on the amount specified in the LLP agreement and does not take into account any amounts that the partner may be called upon to contribute at a future date or undrawn profits unless they have been converted into capital. This condition is met if the capital contribution is less than 25 per cent of the disguised salary.

In order to give partners time to make the necessary arrangements, a firm commitment in place to make a sufficient contribution within three months will be taken into account to determine whether condition C is met. Where an individual becomes a member after 6 April 2014, a two-month period will be allowed to provide the capital, subject to a firm commitment to do so.

It is important to remember that all three conditions must be met for a partner to be treated as an employee.


C LLP was founded by two individuals: A and B. A and B are entitled to the residual profits, they make all the major decisions and they have invested all but a nominal amount of the capital. The other members receive a fixed monthly sum plus an annual discretionary bonus, typically 20% to 30% of the first charge. The other members are all salaried members, satisfying conditions A, B and C. While the bonus is sometimes more than 20 per cent of the reward package, it is discretionary rather than linked to  profits.

After a while, C and D start to take on more of the work done by A and B, and their terms change. They will receive a lower monthly sum and will receive a share of the profits. A reasonable estimate is that about 25% to 30% of the rewards will be profit share. They will also take part in all major decisions. Conditions A and B are no longer met, so they are no longer salaried members.

Where a member’s status changes during the year, new sections 863 E and 863F set out the formula for ascertaining the appropriate amount of the capital contribution.

Financial implications

The basic tax charge will not be increased as a result of this legislation but there will be a charge to tax on benefits in kind, as a result of the reclassification. There will also be an increased charge to national insurance contributions (NIC).

The employee will suffer a cashflow disadvantage by coming within the PAYE rules and will be charged Class 1 NIC, rather than Class 2 at £2.75 per week and Class 4.

An employee earning £100,000 per year will pay Class 1 NIC of £5,232 for 2014/15, whereas a self-employed person would pay a total of £4,358 in Class 2 and 4 NIC. Whereas the tax would have been paid on 31 January in the tax year and 31 July after the end of the year, the tax will now be paid monthly throughout the year.

The allocation of profits now taxed as salary will have no tax effect on the remaining partners, but the cashflow will be disadvantaged. The difference for NIC will be significant, with an extra £12,702 on each £100,000 salary, together with an additional charge on benefits in kind.

Anti-avoidance legislation deals with the situation where remuneration is dealt with through associated persons. Where there is a conflict, the legislation in section 850D will take precedence over the regulation in section 863.