Chapter 2: Partnerships-General Background
8. This chapter sets the scene for the next three
chapters. It begins with a brief overview of the different types
of partnership and of how the members of partnerships are taxed.
And it goes on to outline the main findings and recommendations
of the interim report of the OTS's Review of Partnerships.
What is a Partnership?
9. The concept of a 'partnership' is one of the
earliest forms of business organisation and its origins go back
to the beginnings of commercial activity. The Partnership Act
1890, almost all of which remains in force today, consolidated
existing law and defined partnership as "the relation which
subsists between persons carrying on a business in common with
a view of profit"[2].
10. Partners in a partnership may be either natural
persons or legal entities such as companies, and a partnership
may consist entirely of natural persons, entirely of legal entities
or a combination of both (a 'mixed' partnership). There is no
limit on the number of partners in a partnership. A partnership
may exist between two or more persons whether or not they have
a formal partnership agreement.
11. The 'business' carried on by a partnership
can include "every trade, occupation, or profession"[3]
and the profits or losses from that business may be shared between
partners in any way they agree.
12. Some members of a partnership, often referred
to as 'salaried partners', may be entitled to a fixed share of
the profits prior to any allocation of profits to other partners.
Whether such partners are 'true' partners, or in fact employees
of the partnership, depends on the facts in question including
whether, in all other respects, the nature of their involvement
in the conduct of the partnership's business is that of a true
partner. There is no specific formula to determine status but
the decision is guided by case law.
Types of Partnership
13. There are three types of partnership: general
partnerships, limited partnerships and limited liability partnerships.
GENERAL PARTNERSHIPS
14. 'General' partnerships, sometimes referred
to as 'traditional' partnerships, are the sort of partnerships
envisaged by the Partnership Act 1890. Each partner can act on
behalf of the partnership in the conduct of its business with
binding effect on the other partners, and all partners have unlimited
liability for the debts of the partnership.
15. A general partnership is not a legal person
in England, Wales and Northern Ireland although it is in Scotland.
LIMITED PARTNERSHIPS
16. The concept of a 'limited partnership' was
introduced by the Limited Partnerships Act 1907 and it allows
a person to be a 'limited partner', whose liability for the partnership's
debts is limited to his or her capital contribution to the partnership.
A limited partnership must consist of at least one general partner,
whose liability is unlimited, and one limited partner; limited
partners must not be involved in the management of the partnership's
business.
17. In most other respects limited partnerships
are subject to the Partnership Act 1890 and, like general partnerships,
are not legal persons, except in Scotland.
LIMITED LIABILITY PARTNERSHIPS
18. Limited liability partnerships (LLPs) were
established by the Limited Liability Partnerships Act 2000. They
are 'bodies corporate' with legal personality separate from their
members. They enable each partner to limit his liability for the
partnership's debts to an amount (usually the capital they have
invested in the LLP) agreed with the other members of the LLP.
19. Like general partnerships, LLPs can be formed
by two or more (natural or legal) persons, including other LLPs,
carrying on a business as defined above. LLPs therefore offer
the limited liability benefits of the company combined with the
organisational flexibility of general partnerships and have become
a very popular way of organising business arrangements and transactions.
Partnership Facts
20. In 2011-12 there were some 420,000 partnerships
of one form or another, accounting for about 10 per cent of the
total number of UK businesses. Partnerships are predominantly
very small: 90 per cent had three or fewer partners and less than
one per cent had more than 50. HMRC estimate that, of the partnerships
operating in the UK, some 23,000 (about 5 per cent of all partnerships)
had a corporate member. Of these just over half were mixed member
partnerships and the remainder consisted of non-individual partners
only.[4]
21. Partnerships cover a very wide range of commercial
activities from small husband and wife businesses to international
professional service businesses and City-based vehicles investing
in property development or venture capital activities.
Taxation of Partnerships
22. The title of this section is, in one sense,
a misnomer in that partnerships are not liable to tax in their
own right on the profits and capital gains generated by their
business activities. UK tax rules 'look through' the partnership
to the individual partners or members who are then taxed on their
share of the partnership's profits and gains at their marginal
tax rates and according to whether they are individuals or companies.
This transparency applies even where the partnership is a separate
legal entity, as is the case for Scottish partnerships and for
LLPs.
23. This means that the total amount of tax and
National Insurance Contributions (NICs) collected in respect of
any given partnership's income and gains depends on the individual
tax liability of each member and on the relative share of each
in the profits, losses and capital gains of the partnership.
24. For non-corporate members of general partnerships
and limited partnerships, tax liability is governed by whether
they are 'true' partners or whether they are employees. However,
for tax purposes all LLP members are treated as partners, and
therefore as self-employed, even if they would be treated as employees
in a general partnership.
25. The issue of employment status has significant
tax consequences for both individual members and the partnership.
A partner is deemed to carry on a personal trade or profession
and his or her share of partnership profits or losses is calculated
according to income tax rules. Profits are taxed at the partner's
marginal rate of income tax—20, 40 or 45 percent—and
NICs are payable at the self-employed rate of 9 per cent on profits
up to £41,450[5] and
2 per cent thereafter. The partnership pays no employer NICs since
the partner is not an employee.
26. An employee is liable to income tax on his
or her earnings (with less generous expense deductions) at the
same marginal income tax rates as the partner, but pays NICs at
the employee rate of 12 per cent on earnings up to £41,450[6]
and 2 per cent thereafter. The partnership pays employer NICs
at 13.8 per cent on those earnings[7]
and collects income tax and NICs from employees under PAYE. And
employment status confers certain rights and obligations on both
the employee and the partnership (as employer).
27. Tax liability on the share of the profits
allocated to a corporate member of a partnership is calculated
using corporation tax rules, including reliefs not available to
individuals, and tax is payable at the corporation tax rate—23
per cent for 2013-14, but due to fall to 21 per cent next year
and 20 per cent the year after.
28. As for capital gains, the rules provide that,
where a business is carried on in partnership, capital gains tax
(CGT) is charged on the partners separately. The same applies
to corporation tax on chargeable gains for company members of
a partnership.
29. These differences in tax treatment arise
from the structure of the UK tax system and the current default
assumption that every individual member of an LLP is a self-employed
partner. They give rise to very substantial opportunities for
minimising the tax and NIC liabilities of both partners and the
partnership and for the partnership to reduce its employment law
obligations. These tax arbitrage (and avoidance) opportunities
lie at the heart of the changes proposed by the Government in
the draft Finance Bill 2014.
30. Turning to tax administration, partners must
report their profits from the partnership business on an income
tax or corporation tax return as appropriate. And, although it
is not liable to tax in its own right, the partnership (or rather
a partner nominated to do so) must make a 'partnership tax return',
using income tax rules to compute the share of profits allocated
to individual partners and corporation tax rules to compute profits
allocated to corporate members. Where chargeable capital gains
are made they must be reported on the chargeable assets page of
the partnership tax return.
Review of Partnerships: Interim
Report
31. Against this rather complex background, the
Office of Tax Simplification (OTS) was commissioned in 2013 to
carry out a comprehensive review of partnership taxation. The
terms of reference of this review covered the range of taxes applying
to partnerships and included the legislation itself, the administrative
processes and the guidance provided by HMRC and complexities surrounding
the different types of partnership.
32. The interim report of the OTS review was
published on 22 January 2014 and we heard evidence from the Tax
Director of the OTS at around the same time. Given its terms of
reference, the report and its recommendations are necessarily
quite detailed and technical.
33. The report was not based on a survey, but
on interviews, meetings, seminars and the like carried out between
September and November 2013, on written submissions and on intensive
desk research in the OTS and on data analysis in HMRC. It paints
a very interesting, and sometimes surprising, background picture
of the scale on which the partnership form is used to organise
business in the UK, of the size distribution of partnerships,
and of the wide range of activities, from corner shop to multi-million
pound property development, which partnerships of one kind or
another undertake.
CONCLUSIONS
34. The main findings of the report were that:
· notwithstanding the size of their contribution
to the UK economy, policymakers seem to pay scant regard to the
effect on partnerships of tax policy changes. So, for example,
the Government's strategy for developing a competitive UK business
tax environment focuses entirely on corporate tax, sometimes at
the expense of partnerships;
· although a case can be made for a separate
tax code for partnerships, which perhaps distinguished between
small and large partnerships, there appears to be no appetite
for the disruption and uncertainty such a major reform would entail;
and
· the most common concern among partnerships
and their advisers was the absence of a mechanism, other than
through a corporate partner, for retaining profits for commercial
purposes, including the growth of the business.
35. The interim report concluded that "HMRC
and the tax system generally needs to evolve a more supportive
and constructive approach to partnerships"[8]
and in particular that:
· the 'one size fits all' approach of partnership
tax law and of tax administration leads to extra burdens and complexities
for small partnerships as compared with sole traders carrying
on businesses of a similar size;
· the tax system needs to take a more strategic
approach to partnerships rather than allowing their tax environment
to develop merely as a consequence of policies and administrative
arrangements designed for sole traders or companies;
· HMRC needs to coordinate more effectively
its work with partnerships, including its support functions, such
as guidance notes, which are not currently consolidated; and
· HMRC needs to take steps to change the
widespread conviction that its view of partnerships is that they
are primarily a vehicle for the reduction or avoidance of tax
liabilities.
RECOMMENDATIONS
36. The Report's recommendations are divided
into 'short term fixes', medium-term proposals and suggestions
for longer-term investigation.
37. The short-term fixes are intended to provide
"useful benefits, mainly for small firms, for modest effort
on the part of (mainly) HMRC"[9]
and include: republishing a model partnership agreement; producing
a single consolidated manual with clearer, up-to-date guidance
for partnerships; simplifying the SA and CTSA tax returns; and
developing free tax return software for small partnerships.
38. The OTS's main recommendations for the medium
term, which "should be taken forward, presumably through
formal consultation, in the near future",[10]
are that HMRC should:
· update the statements of practice for
computing the capital gains made by partnerships;
· ensure that double taxation agreements
deal properly with partnerships so that credit for foreign tax
is not lost;
· simplify the rules for accounting for
any non-trading income, such as interest, received by partnerships;
· review the penalties for late filing of
partnership returns and for failures to notify changes of status
for VAT purposes; and
· put in place arrangements for monitoring
and responding to the development of new business structures involving
partnerships.
39. The Report also suggests that there is significant
scope for HMRC's digital programme to offer further simplification
of administrative processes for partners and partnerships, including
submitting tax returns and partners' expense claims.
40. Finally, the Report recommends that, in the
longer term, further work should be done to investigate "areas
where there is clearly a problem in need of simplification but
where the solution is not clear-cut"[11]
including:
· ways of further reducing the administrative
burdens of smaller partnerships, perhaps including removing the
requirement for them to file a partnership return, and of improving
their understanding of their tax obligations;
· how the 1890 Act partnership agreement,
which applies in the absence of a formal agreement between partners,
might be updated and publicised more widely;
· the scope for allowing partners to claim
personal expenses outside the computation of partnership profits;
and
· the scope for removing SDLT charges in
partnership reorganisations where no cash changes hands and for
reducing the complexities caused by adopting accounting periods
that do not correspond to the tax year.
41. The OTS's Interim Report was published shortly
after our inquiry had begun so that most of our witnesses had
had little time to digest and take a view on its conclusions and
recommendations. But it provided very useful background to our
inquiry and witness comments about it were very positive.
2 Partnership Act 1890, section 1(1). Back
3
Ibid., section 45. Back
4
All figures from Review of partnerships: interim report, OTS,
January 2014, Annex A. Back
5
Above a threshold amount. Back
6
Ibid. Back
7
Ibid. Back
8
Review of partnerships: interim report, OTS, January 2014,
page 6. Back
9
Review of partnerships: interim report, OTS, January 2014,
page 6. Back
10
Ibid., page 7. Back
11
Ibid., pages 7 and 8. Back
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