LLPs: taxed today, gone tomorrow

Tax proposals on partnerships and LLPs will threaten the stability of professional firms within a fragile economy, says Peter Garry.

In these austere times we have all come to accept that governments of whatever political hue must balance the books one way or another. Danny Alexander’s [chief secretary to the Treasury] announcement at the Liberal Democrat conference targeting the use of service companies to reduce the overall tax burden, is but one of a number of recent anti-tax avoidance proposals likely to lead to new legislation.

Private equity partners may lose the advantage of having their profits taxed as capital gains. And the recently-closed HMRC consultation on taxation of LLP members is likely to result in many individuals who are currently taxed on a self-employed basis being taxed as employees.

It is no surprise when politicians target the perceived ‘fat cats’ to increase tax revenues. But if the perception on which such political decisions are based is incorrect, or if the political climate enables legislators to make the mesh of the new tax net too fine, there may be unwelcome political and economic fallout.

A recent survey by the Solicitors Regulation Authority (SRA) found that of the 10,950 SRA-regulated legal practices, one in 10 are showing signs of financial difficulty. Other professions are also under pressure. With each new assault on profits or ‘take home pay’ the next marginal group of businesses and individuals will succumb to insolvency. Others will only avoid financial difficulties by shedding partners and staff.

Diminishing revenues

For those wealthy private equity partners who might have to pay more tax, the risk is not only that those often internationally mobile partners can take their businesses and tax payments to competing jurisdictions where they will be treated more kindly, but also a knock-on effect will be that British professional practices and businesses will lose valuable clients who pay high levels of fees.

Apart from diminishing revenues across the board, professional practices and other partnership businesses now must decide what to do with their service companies (either ceasing to use them, or applying the required higher charge from the service company to the LLP or partnership, thus locking up yet higher reserves until future distribution, which is likely to be a pretty much pointless exercise but with ongoing administration and compliance costs).

They must also reconsider their ownership structure, and possibly rewrite their LLP deed or other governing documentation, so as to fit members into whatever mould is dictated by new tax legislation to enable members to be regarded by HMRC as self-employed, or alternatively bearing the exposure to employment claims and the additional financial and administrative burden involved in employing those members who used to be regarded as self-employed.

Businesses have spent valuable partner time and money putting their corporate and ownership structures in place. They will now have to spend more undoing or rejigging them.

For many years there has been a lack of connection between the status of partners and members for employment law purposes and for taxation purposes. Despite the current automatic deeming of LLP members as self-employed for tax purposes, it is perfectly possible for an employment tribunal in an appropriate case to find that an LLP member is actually an employee, or at least a ‘worker’, vesting such persons with rights that it was never intended by either side that they should have.

Provisions that would bring these two worlds into alignment would be beneficial. There is a high risk that the current proposals, which are aimed solely at raising additional tax revenues, will result in a swing past the point of alignment, replacing a presumption of self-employment for tax purposes with a presumption of employment, while still leaving the dividing line between the two unclear, and failing to address the non-integration between employment law and tax law.

Any tax that does not clearly delineate and justly target who is liable to pay it is a bad tax, not only because of the anomalies and unfairness that will inevitably arise, but also because of the increased cost of ensuring compliance.