Anti-avoidance and mixed partnerships

New rules tackle disguised employment in limited liability partnerships (LLPs) and tax-motivated allocations of business profits and losses in partnerships.

The legislation, which was introduced in Finance Act 2014, applies to mixed membership partnerships and LLPs, which are simply partnerships or LLPs that have, as partners or members, both individuals and persons who are not individuals - typically companies but also trustees or LLPs.

Different provisions deal with excess profit allocations and with excess loss allocations. A reallocation of profits to an individual member may take place when all or part of his/her profit share is diverted to a non-individual member who will pay less tax on that profit share, so that the diverted profits will be taxed on the individual.

Certain loss reliefs will be denied where partnership losses are allocated to an individual partner rather than a non-individual one mainly to achieve a loss relief. 

Excess profit allocation

The excess profit allocation measures have been introduced as new sections 850C to 850E of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005). The legislation applies where:

  • a partnership or LLP makes a taxable profit
  • a share of the profit is allocated to a non-individual partner
  • one of two specific sets of circumstances are met, namely

that the share of profit of the non-individual includes deferred profit of an individual member, or

that the share of profit of the non-individual exceeds its appropriate notional profit, that an individual member has the power to enjoy such profit share and that the profit allocation to the non-individual is made, also in part, for the individual to enjoy, and

as a consequence of the above, both the share of profit of an individual partner and the overall tax chargeable on the individual and on the non-individual are less than they would otherwise have been.


The case that refers to deferred profit arrangements includes circumstances where profits, which mean any remuneration or other benefits and returns, are not allocated to an individual member, but instead are held back for whatever reason, and are initially allocated to a non-individual member instead, with the result that the tax paid in that period is lower than it would have been if the profits had been allocated to the individual. Deferred profit arrangements are also those that include the possibility that events may mean that the individual may not actually receive the profits.

An example provided by HMRC of an arrangement caught by the legislation as deferred profits of an individual partner is as follows:

Kate is a member of XYZ LLP. She is awarded a bonus that is conditional upon the successful outcome of a project she has been involved in. The bonus is initially allocated to XYZ Corporate Member Ltd.

The rules on deferred profits are drafted in wide terms and may therefore catch profits diverted to an entity that an individual member may not control or that may never be received or enjoyed by her.

The other circumstances where the provisions on excess profit allocation apply are where a non-individual member’s profit share exceeds its appropriate notional profit and an individual member has the power to enjoy that profit share.

The appropriate notional profit defined in the legislation is the sum of two elements:

  • the appropriate notional return on capital and
  • the appropriate notional consideration for services. 

The appropriate notional return on capital is simply a commercial rate of interest on the capital contributed that will vary to reflect the level of risk involved. Any form of return received by the partner on the capital contributed, other than a share of profit, is deducted to arrive at the notional return.

The appropriate notional consideration for services represents the arm’s length value of any services provided to the partnership by the non-individual member less any amount received for those services which is not included in the profit share. If any services provided involve other members of the partnership, then those services are ignored to determine the notional consideration.

The power to enjoy the profit share of a non-individual is deemed either when:

  • the parties are connected or
  • certain enjoyment conditions are satisfied. 

The individual and non-individual partners are connected persons if they fall within the definition of section 993 of Income Tax Act 2007 (in most cases that would be when the non-individual member is controlled by the individual or persons connected to him), but they are not considered connected if they are simply partners in a partnership. For instance:

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

As A and B are only connected by being partners in the AB partnership, they are not caught by the excess allocation rules.

The enjoyment conditions look at whether the individual, or a person connected to him, is in a position to enjoy the benefit of the profit share allocated to the non-individual. The legislation is widely drawn but does not include all mixed partnerships.

Where the power to enjoy circumstances is met, the excess allocation rules will only apply if it is reasonable to suppose that the profits of the non-individual are higher because of the individual’s power to enjoy them. This is an important restriction in the scope of application of the legislation and HMRC provides the following example:

Oldco Ltd had been trading for many years. A few years ago P, the owner of Oldco Ltd, decided that he wanted to retire. He set up an LLP, whose members are P, Oldco Ltd and a number of individuals whom he 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 share that is commensurate with the work he does.

The facts show that Oldco Ltd 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 Ltd if P fully withdrew from the business, including as an LLP member). Looking at these facts, the legislation would not apply.

Where the excess allocation rules apply, an individual partner’s profit share is increased by the amount of his deferred profit or by the amount by which his profit is less than it would have been apart from the power to enjoy profits on the non-individual, as determined on a just and reasonable basis.

While deferred profits are simply reallocated to an individual, the profits attributable to the power to enjoy are only reallocated to the extent that they exceed the appropriate notional profits of the non-individual member, ie only the excess profits are reallocated.

A reallocation on a just and reasonable basis is also necessary where the same non-individual partner is allocated the profit shares attributable to a number of individual partners.

Where an individual is reallocated part of the profit share of a non-individual, the legislation provides for the taxable profits of the latter to be reduced accordingly. Specific legislation is introduced for non-individual partners subject to income tax or corporation tax. As computational rules differ between the two types of tax, discrepancies may arise in the reallocation and therefore to prevent them an adjustment may need to be made on a just and reasonable basis.

HMRC provides some general examples of how the mixed partnerships rules apply:

The membership of ABC LLP consists of three individuals, A, B and C, who decide that they want to retain funds in the LLP for working capital. In order to avoid the retained profits being taxed at higher income tax rates, they introduce a corporate member, ABC Ltd, which is fully owned by A, B and C.

ABC Ltd does not provide any services and only a nominal amount of capital. A, B and C work out what they wish to draw personally and allocate the balance of the profit to ABC Ltd. The profit share allocated is invested or retained in the partnership by the company member as additional partnership capital or advances.

The individual members are in a position to enjoy the sums allocated to their company.

The three individual members are taxed on an additional profit, split on a just and reasonable basis, equal to the profit share allocated to ABC Ltd, less a sum that represents an appropriate notional return on the nominal amount of capital introduced by ABC Ltd..

D is a member of DEF LLP. With the agreement of the other members, D introduces as a member, D Ltd, a company that is owned by his wife. D continues as a member, only now he does some work for the LLP through D Ltd. D Ltd provides only a nominal amount of capital. The only change is that the profit share, previously allocated to D, is now allocated partly to D himself, but mainly to D Ltd.

D Ltd is owned by the wife of D, so a connected person is in a position to enjoy the profits of D. D is taxed on an additional profit equal to the profit share allocated to D Ltd. While D Ltd is providing services to DEF LLP, the reality is that the work is such services as are being provided by D, another member. These services are ignored in determining the appropriate notional consideration for services. D Ltd provides no other services, so the appropriate notional consideration for services is nil.

When profits are reallocated for tax purposes they may stay with the non-individual member up to such point as they need to be passed to the individual. The legislation provides a rule to avoid such payment to the individual being taxed twice. A payment to the individual made out of the additional amount that the individual was taxed on is not taken into account in calculating the income of either the individual or the non-individual and is not regarded as a distribution for income tax purposes.

An anti-avoidance provision, section 850D, applies where an individual carries on work for a partnership or LLP and their role is effectively that of a partner or member but they are not a member.

For the anti-avoidance provision to apply a non-individual member should receive a profit share that the individual non-member has the power to enjoy or that represents his deferred profits and that it would have been reasonable to suppose that the individual would have been a partner in the absence of the excess profit allocation rules.

If the anti-avoidance provision applies the individual is treated as if he was a member of the partnership or LLP.

HMRC provides an example of the application of the anti-avoidance rule:

X, Y, Z and XYZ Ltd are the members of the XYZ LLP. In response to the new legislation, they decide that all the individual members should cease to be members of the LLP with effect from 6 December 2013 being replaced by their personal service companies.

X, Y & Z continue to work for the XYZ LLP, it is reasonable to suppose that they would have continued to be members but for the introduction of the legislation.

Under S850D, X, Y & Z are treated as members and the mixed membership partnership legislation applied accordingly.

Their share of the firm’s profit, determined under the mixed membership rules, is chargeable to income tax for the tax year in which the relevant period of account ends. Assuming this period straddles 6 April 2014 (the date the legislation comes into effect), then this period is split into two notional periods with the latter having a commencement date of 6 April 2104. Only the profits attributable to this latter period will actually be reallocated to X, Y & Z.

The mixed partnership rules apply from 6 April 2014. There are special rules when a period of accounts begins before that date and ends on or after it. In such a case the period of accounts is split into two notional periods, one ending on 5 April 2014 and the second commencing on 6 April 2014. The mixed partnership rules will apply to the profits attributable to the second notional period.