The Draft Finance Bill 2014 - Economic Affairs Committee Contents


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 arrangements—for 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 easement—it is not a tax-raising provision at all—and 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 Association—we represent hedge funds—there 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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