Chapter 5: The Other Elements Of The
Partnerships Package
144. This chapter examines the evidence we received
on the other elements of the package of measures dealing with
partnerships: mixed membership partnerships; AIFM partnerships;
the anti-avoidance provisions against the disposals of assets
and income streams through partnerships.
Mixed Membership Partnerships
OBJECTIVES AND PRESENTATION
145. In their written evidence, HMRC explained
that the Government's objective for this measure was to secure
tax revenue and achieve fairer taxation by:
"changing the long-standing structural flexibility
of partnership profit and loss allocation rules to achieve tax
advantages on the profit and losses allocations strand. The main
focus has been on mixed membership partnerships where profits
earned by individual members are allocated to a company that they
control."[114]
They went on "This flexibility has been used
to generate tax advantages. For example, profits may be allocated
to a low tax entity, such as a company, while individual partners
taxable at higher income tax rates ultimately receive the benefit
of those profits in low-taxed or even non-taxable form."[115]
146. HMRC's evidence also emphasised that "The
mixed membership proposals will not be relevant to traditional
partnerships consisting wholly of individuals (or wholly of corporates),
nor where profit and loss allocations are made on a basis that
properly reflects the contribution made to the partnership by
the relevant members."[116]
147. In her evidence, Ms Knott underlined that
these changes were not purely about tackling avoidance "These
are structural changes, designed to ensure that the taxation of
partnerships and LLPs is fair and consistent and to prevent significant
tax loss."[117]
DRAFT LEGISLATION
148. The provisions in the draft Finance Bill
2014 aim to achieve those objectives. As outlined in Chapter 3,
they give HMRC the power to reallocate, on a just and reasonable
basis, profit shares where a partnership or LLP makes a profit
for tax purposes and a profit share is allocated to a corporate
partner, and either
(a) the company's profits represent the deferred
profit of an individual member and in consequence the individual's
profits and the overall tax liability are lower than they would
otherwise be, or
(b) an individual partner has the power to enjoy
the company's profit share and it is reasonable to suppose that
both the individual's profit share and the overall tax liability
are lower that they would have been in the absence of that power
to enjoy the company's profits
GENERAL REACTIONS TO THE PROVISIONS
149. A number of witnesses commented on the presentation
of these provisions. Some thought that they should not have been
portrayed as tackling avoidance. It is not clear whether HMRC
has changed its stance in this regard, but its present view is
that the provisions are about more than avoidance. Mr Whiting,
commenting on evidence on HMRC's attitude to mixed membership
partnerships gathered during the OTS review, concluded "Everybody
[including HMRC] recognises that there can be perfectly valid
commercial reasons for having a corporate partner."[118]
150. Mr Haskew commented on the incentives
created by differing tax rates
"We have a large disparity between income
tax rates and particularly marginal income tax rates,
potentially
62%. That compares to a corporation tax rate that will be 20%.
So there are huge distortions within the tax system."[119]
Professor Freedman agreed "that the ideal should be
to reduce the differences as much as possible between the different
types of taxation".[120]
151. Professor Freedman also thought that
you could not allow mixing and matching: "There are benefits
of having a partnership and there are benefits of having a corporation.
At the moment, that is the way it is, and you cannot let people
pick and mix the bits that they want, because that again will
just give rise to avoidance opportunities."[121]
Mr Herring[122]
agreed, as did Mr Murphy:
"You either choose to be a corporate entity
and therefore to be able to shield your retained profits from
tax, or you should choose the advantages of an LLP and accept
the consequences of the structure. What has quite clearly happened
is that a number of lawyers and accountants have decided to do
that mixing and matching. I think that is inappropriate."[123]
152. NCI adopted a pragmatic position "the
practice of using corporate partners to avoid or defer paying
income tax on partnership profits, although a longstanding and
accepted feature of partnership taxation, may not chime well with
the need for everyone to pay their dues to help repair the UK's
financial position."[124]
SCOPE: WHICH EXISTING ARRANGEMENTS
ARE AFFECTED BY THESE PROVISIONS?
153. Having established that, as well as possible
avoidance, the reason for the tax-motivated allocation of profits
is the underlying difference in tax rates, we heard evidence on
the extent to which existing arrangements are affected and how
common these arrangements are.
154. KPMG's view was that the introduction of
these rules
"is anticipated to cause difficulties for
many mixed partnerships because the legislation is intentionally
aimed at taxing commercial arrangements, as well as structures
specifically designed for tax avoidance. Examples of commercial
arrangements caught by the new rules include allocations of profits
to corporates for working capital purposes, investments, or deferred
profit arrangements."[125]
The Association of Chartered Certified Accountants
(ACCA) were also concerned about the restriction imposed by the
proposals on "accruing reserves at the same [tax] rates as
other limited liability trading vehicles."[126]
This was a common theme in the evidence.
155. ICAS pressed the point that "The HMRC
proposals would impact on legitimate commercial structures, particularly
with family businesses and farming businesses."[127]
Ms Charlotte Barbour, ICAS, emphasised this in relation to rural
and multi-generation businesses.[128]
The ICAEW were concerned that "The proposals fail to accommodate
the commercial and historic reasons why some businesses have a
mixed partnership structure. For example, many businesses hold
land within a corporate partner or use such a member to build
up working capital requirements."[129]
156. The CBI accepted the "policy objective
of preventing unfairness and market distortion by ensuring that
inappropriate, uncommercial and tax-motivated partnership allocations
to a company or similar vehicle do not create tax advantages."[130]
However they later commented that "The mixed partnership
proposals are very broad, and are likely to affect many legitimate
structures, in addition to those that are specifically targeted."[131]
157. Mr Murphy had a different perspective
on the issue of targeting:
"A number of anti-avoidance measures would
have come to me before these ones. For example, requiring the
withholding of tax at source on payment of profits to a corporate
entity
The other one would be to say, 'No, you cannot have
a corporate entity as a member and most certainly you cannot have
a corporate entity not tax resident in the UK as a member', but
that is the problem we have."[132]
158. Mr Michael Parker, National Farmers
Union (NFU), told us that
"It is primarily the mixed-partnership legislation
that could have an impact [on the agricultural sector]
We have gone from original proposals, which seemed to have a motive
test that one of the main reasons for the business structure was
tax avoidance, to something which is more around whether it is
reasonable to assume that a tax advantage has been arrived at."[133]
159. Mr Stevens said
"All the examples of allocations given in
the original consultation were to do with avoidance carried on
by a relatively small number of partnerships
It is my view
that counteracting that is wholly appropriate
The difficulty
I have is that the proposed legislation goes very much further
than is needed in order to counteract this form of avoidance."[134]
Mr Greenbank[135]
and Mr Herring[136]
agreed with the thrust of this and added their own gloss.
160. Mr Spence was concerned that these
provisions would encourage incorporation, potentially scoring
an "own goal"[137]
for the Government. Mr Nicholson was concerned with general
competiveness: "My concern in that area
is how this
fits with the government White Paper of March last year
it seems counter to the policy about retaining and attracting
asset management business."[138]
The BVCA also were concerned about the effects on UK competitiveness
and the implications for the strategy announced last March.[139]
NCI agreed, writing "HM Treasury needs to be very careful
that they don't throw the baby out with the bath water."[140]
161. A "potential tax avoidance"[141]
issue was put to us by War on Want and Change to Win. It concerned
the use of LLPs holding UK property for large multinational groups;
the partners in the LLPs appear to be companies, some of which
are non-UK resident. This evidence arrived very late in our inquiry
and we were unable to follow it up with any of our witnesses.
It is available in the usual way for anyone to peruse. HMRC will
have seen this evidence and will need to consider whether it merits
further investigation.
162. Responding to the points concerning the
arrangements affected by these provisions, Ms Knott stated that
"This is targeted on the tax planning we have seen. It is
not necessarily tax avoidance
That is why we have adopted
a wider approach."[142]
And later that
"The Government certainly accepts that there
can be legitimate business reasons for the use of corporate members
in partnerships. This measure seeks to address the flexibility
that has allowed for tax planning
This is not designed
as any kind of attack on those mixed member partnerships; it is
simply designed to get a fair and consistent tax outcome."[143]
163. Asked if she thought the proposals could
jeopardise the UK's competitive position she said "We would
hope that is not the case."[144]
When asked whether she thought these proposals might tip the balance
in favour of incorporation Ms Knott replied "We think it
could lead to some mixed member partnerships incorporating. I
do not agree that it will tip the balance against mixed member
partnerships, but there may be some who will wish to incorporate.
If that were to happen, that is factored into our costings."[145]
164. It seems clear from evidence from our private
sector witnesses that corporate member tax planning has been an
accepted part of business life for many years. Many see the practice
as a natural and rational reaction to the differences between
the taxation of corporates and individuals, and not as avoidance.
Whenever a practice is not challenged over a protracted period,
it becomes part of accepted commercial practice and the longer
it is allowed to continue the greater the likely outcry when the
law is changed to reverse it.
165. It seems equally clear from the HMRC evidence
that the Government's intention is that the proposed legislation
should encompass situations which the private sector would regard
as normal commercial arrangementsfor example, the allocation
to a corporate partner of profits which are for reinvestment in
the business and would be taxed at corporate rates. As HMRC put
it in its Summary of Responses document:
"The tax rules will not affect
commercial
uses as they will merely be an overlay that, in certain circumstances
and for tax purposes only, will result in part of the partnership
profits being reallocated to the individual member simply to remove
the tax advantage that results from such use."[146]
THE LEGISLATION: SPECIFIC ISSUES
166. In addition to the evidence around the general
scope of the provisions, we heard evidence on more specific issues.
Most of these centred on the apparent subjectivity in, and therefore
the uncertainty of, the draft legislation. KPMG thought that
"the legislation has been drafted with anti-avoidance
mainly in mind
This style of drafting is appropriate for
tax avoidance legislation, where a degree of flexibility is required.
However, where the legislation has a purpose of raising additional
tax from commercial arrangements it is not appropriate to have
such subjective tests. Such subjective concepts give rise to a
high level of uncertainty as to how the legislation applies to
a commercial situation. We believe that these should be removed
as they do not make good legislation."[147]
Others made similar points, including ICAS who thought
that "it is nevertheless an unwelcome move to have legislation
that is drafted in such a manner that guidance is required in
order to know how it will be applied."[148]
167. Mr Whiting thought that "one of
the difficulties will be judging when you have gone beyond what
is reasonable into what is excessive."[149]
Mr Parker was concerned about justifying the corporate partner's
role in the partnership.[150]
One issue for Mr Greenbank was that the legislation was "too
narrow"[151] to
encompass equity-type investments held by the corporate partner.
168. HMRC was asked about the allegation that
these provisions are too subjective. Ms Knott responded
"we do not think that the legislative tests
on mixed members are subjective
There are objective criteria
that will come into play. We also think that in practice it would
be pretty clear. If you have a situation where a corporate member
is connected to an individual member and the corporate member
is disproportionately remunerated, we think that will be pretty
clear in most circumstances. We do not think that the tests will
be too difficult to apply in practice."[152]
169. We acknowledge that it is open to the
Government to make structural changes of the kind proposed for
mixed partnerships to prevent or reduce tax loss, although it
should state its objectives clearly at the outset.
170. We are concerned, however, at the apparent
disconnect that can develop between business and HMRC over what
is acceptable for tax purposes. Had HMRC been aware of the scale
of the practice of profit shifting earlier and dealt with it then,
there might have been less resistance to the proposed changes.
We are also concerned by the loss of tax that can arise if potentially
unacceptable practices are not addressed as early as possible.
171. We are sure that all the points that
have been made to us on the drafting of the legislation will have
been made directly to HMRC. We strongly recommend that HMT and
HMRC consider them all very carefully with a view to tightening
the legislation so that it is drafted as precisely as possible
and the reliance on guidance is reduced.
172. If this can achieved in the time available,
we see no reason why the mixed membership proposals should not
go ahead with effect from 6 April, thus retaining most of the
yield from the partnership package.
AIFM Partnerships
THE AIFM LEGISLATION
173. During the consultation in summer 2013,
it became clear to HMT and HMRC that profit deferral using corporate
members of LLPs was very prevalent in the AIFM sector. The mixed
membership proposals would have a profound effect on this sector.
As a result, the Autumn Statement announced that the yield from
that part of the legislative package was increased by £1,920
million over the years 2015/16 to 2018/19.
174. Mr Paul Hale, Alternative Investment
Management Association (AIMA), and Mr Ji¾í Król
(AIMA) gave us some useful background on the AIMA and the AIFM
sector.[153] Mr Hale
told us that
"The AIFMD[154]
is in the process of coming into effect but many managers are
already operating similar deferment regimes for business reasons,
not least because there are investor pressures. Even if the managers
are not required under the rules in the directive to operate this
deferral regime, because they pass a series of proportionality
tests, they may fall into other regimes under other directives
or under voluntary arrangements, which will require them to operate
these deferral arrangements."[155]
175. Mr Hale said that his organisation
had been much involved in discussions with HMT and HMRC following
their becoming aware of the issues. "It should not have been
a surprise
because the very point had been identified in
submissions made to the FCA
[and] made in liaison meetings
with HMT and HMRC, and I am afraid to say that the right channels
of communication, quite clearly, had not been present."[156]
However, once they realised the position, Mr Hale told us
that HMT and HMRC were very receptive to the need to find a solution.
Otherwise managers would have to pay tax on monies that they might
not, and could not, receive for a long deferral period.[157]
176. Mr Hale confirmed that the provisions
in the draft Finance Bill which relate to AIFM business are "an
easementit is not a tax-raising provision at alland
is being developed with a considerable amount of input from our
organisation to provide a solution to a problem that arises because
of the AIFMD deferral regime."[158]
The essence of the arrangements that had been agreed for AIFM
partnerships and were built into the draft legislation were explained
to us by Mr Hale, who concluded "everybody, give or
take the vagaries of life, is happy."[159]
177. We asked HMRC what they had learned from
the consultation. With one exception, Ms Knott's response focused
on the AIFM sector. She said:
"We learnt a number of things. As I mentioned
earlier, we learnt about the application of the case-law tests
to LLPs. In this context, we learnt a lot about the extent of
use of these structures and the amounts of money involved in the
alternative investment fund sector. We also learnt a really important
point on alternative investment funds, which is that they were
having to change their behaviour because of the alternative investment
fund managers' directive. We actually put a specific mechanism
into the legislation to enable alternative investment funds to
comply with the directive, but in a way that had the correct tax
outcome."[160]
THE ADDITIONAL YIELD
178. We asked Mr Hale and Mr Król
about the additional yield of £1.92 billion from the AIFM
sector over the period 2015/16 to 2018/19 and whether they could
help us in identifying where that came from. Mr Hale told
us
"You will have to ask HMRC how they arrive
at those figures. I would also point out that, although we are
the Alternative Investment Management Associationwe represent
hedge fundsthere are other industries in the alternative
investment management sector, such as private equity firms, infrastructure
businesses and real estate firms which could be included in the
alternative investment sector, as referred to in the budget estimates
that were put out. The Revenue will have their reason for believing
that there is that money there. It seems a lot from our point
of view."[161]
179. Mr Hale did accept that
"there are or have been arrangements out
there for the avoidance of tax using corporate members. That is
why the profit-shifting rules have been brought in. They are capable
of being used by businesses across a wide range
Hedge fund
businesses have made money; therefore, the opportunity to look
at using these schemes would be there. However, what the likely
take would be if the rules are implemented and are effective,
I have no way of assessing."[162]
180. We asked most of our other witnesses whether
they could help us with identifying where the figure of £1.92
billion came from. None could help. We asked HMT and HMRC about
the costings. Ms Morgan gave us a general explanation of how costings
were arrived at but told us that she could not "go into the
detail of the exact nature of the assumptions made in that costing".[163]
Ms Knott explained to us that with partnerships "because
the structure is so flexible, it is possible for profits to pass
to the individual member. They may be allocated initially to the
corporate member, but there are ways in which they can pass to
the individual without tax being paid. So it is not just a deferral;
it can be a permanent loss of tax."[164]
However, she did not explain how.
181. Ms Knott explained the timing factors that
meant that the additional £680 million in 2015/16 was more
than one year's tax, but did not further enlighten us as to how
the yield had been computed. She did tell us, in response to a
specific question, that the large yield was a combination of the
scale of the funds involved and the number of partnerships. We
asked for notes to clarify the derivation of the £1.92 billion.
Two were produced, but with the exception of providing a figure
of 1,000 for the number of partnerships involved, they did not
offer any other information to assist our quest for a better understanding
of how this additional yield had been calculated.
182. We asked HMRC whether they had made any
estimate of the taxes lost in previous years through the allocation
of profits to corporate partners. Ms Knott told us "We have
not done that. As I said earlier, this is not an avoidance measure
so the tax is not lost to avoidance in that sense. We keep the
tax system under review and Ministers make decisions as to when
to introduce measures."[165]
183. We fail to understand why HMRC has been
so unwilling to provide more detail on how it has arrived at the
figures for the additional yield of £1.92 billion scored
in the 2013 Autumn Statement. Of course, we wholly accept that
HMRC is prevented from doing so if that would identify individual
taxpayers, or even smaller groups of taxpayers. But we think that
is unlikely to be the issue here.
184. We recommend that, within the normal
constraints of taxpayer confidentiality, HMRC should be more open
about how figures for yield from structural changes to the tax
system have been computed.
185. We are concerned that the additional
yield from the AIFM sector clearly came as a surprise to HMRC
and that it was not aware of the extent to which profit deferral
using corporate members was happening in the sector.
186. We recommend that HMRC should take additional
steps to become even more aware of developments in the businesses
from which it collects tax and particularly of practices to which
it might object. This would not only help prevent such practices
becoming embedded but, as seems to be the case with the Alternative
Investment Fund Management sector, may also prevent the loss of
a very large amount of tax.
Transfers of Assets and Income
Streams through Partnerships
187. HMRC's Technical Note and Guidance explains
this measure: "A number of avoidance schemes have sought
to manipulate the flexibility of partnerships to reduce tax by
exploiting the differing tax attributes of the members. These
'tax attribute' schemes involve the transfer of assets or income
streams through or by partnerships."[166]
188. We received little written evidence on this
measure. Those witnesses who commented on it in their oral evidence
thought that this type of situation was clearly avoidance and
should be stopped.
189. There was some discussion on whether tackling
this avoidance should have relied on the General Anti-Abuse rule
(GAAR). Mr Roy-Chowdhury thought not: "one of my concerns
about GAAR is that we need to keep it at the extreme, abusive
end. I would probably counsel against that".[167]
Mr Richards commented "Ministers and others are understandably
reluctant to say, 'I am going to rely on the GAAR'. You have the
uncertainty of the courts."[168]
Mr Stevens said "I do understand Ministers wanting to
be sure that they are stopping something that ought to be stopped."[169]
190. We agree with our witnesses that it is
entirely appropriate for the Government to introduce a targeted
anti-avoidance rule to stop avoidance by means of tax-motivated
transfers of assets and income streams through partnerships.
114 Taxation of Partnerships, HMRC, paragraph
8. Back
115
Ibid., paragraph 10. Back
116
Ibid., paragraph 16. Back
117
Q 117. Back
118
Q 11. Back
119
Q 46. Back
120
Q 19. Back
121
Q 20. Back
122
Q 89. Back
123
Q 36. Back
124
NCI, paragraph 1. Back
125
KPMG, further evidence, paragraph 11. Back
126
ACCA, paragraph 13. Back
127
ICAS, paragraph 12a. Back
128
Q 46. Back
129
ICAEW paragraphs 34. Back
130
CBI, paragraph 3. Back
131
CBI, Appendix A, paragraph 7. Back
132
Q 36. Back
133
Q 57. Back
134
Q 77. Back
135
Q 77. Back
136
Q 90. Back
137
Q 86. Back
138
Q 101. Back
139
BVCA, page 3. Back
140
NCI, paragraph 9. Back
141
War on Want and Change to Win, paragraph 2. Back
142
Q 125. Back
143
Q 125. Back
144
Q 125. Back
145
Q 126. Back
146
Partnerships: A review of two aspects of the tax rules, Summary
of Responses, HMRC, 10 December 2013, paragraph 4.34. Back
147
KPMG, paragraphs 12 and 13. Back
148
ICAS, paragraph 14. Back
149
Q 11. Back
150
Q 57. Back
151
Q 78. Back
152
Q 126. Back
153
Q 60. Back
154
Alternative Investment Fund Managers Directive-see chapter 3. Back
155
Q 60. Back
156
Q 61. Back
157
Q 61. Back
158
Q 60. Back
159
Q 61. Back
160
Q 129. Back
161
Q 62. Back
162
Q 62. Back
163
Q 127. Back
164
Q 127. Back
165
Q 127. Back
166
Partnerships: A review of two aspects of the tax rules: Technical
Note and Guidance, HMRC, 10 December 2013, paragraph 5.1. Back
167
Q 51. Back
168
Q 79. Back
169
Q 79. Back
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