Changes to the way partnerships are taxed could spark a trend of wealth and fund management limited liability partnerships (LLPs) moving to incorporate.
This warning came from think tank New City Initiative (NCI), which found half of its members that are structured as LLPs would consider incorporating as a result of HMRC rules that come into force by 6 April.
The NCI counts well known boutiques such as Vestra, Stanhope Capital and Dalton Strategic Partnership among its members.
If the proposed tax changes to limited liability partnerships go ahead, it will mean some partners:
- are identified as employees for tax purposes unless they can demonstrate they have significant decision-making powers within the firm;
- are subject personally to the equity and capital risk of the firm; and
- have their own remuneration tied to the profitability of the business.
Change of status
The proposals also aim to prevent the allocation of profits to a non-individual partner (for example, a trust or corporate) as way to defer or reduce an individual member’s personal tax liability. The rules were initially designed for professional services LLPs rather than asset managers as a way to crack down on partners, often junior, who HMRC believes should be treated as employees.
Some executives are warning the rules could result in profound unintended consequences for the financial services industry, not least a shift away from a structure that reduces systemic risk and aligns interests.
‘I am very concerned about this legislation. I think it is anti-LLPs, anti-industry and I think it will cost the government significant revenues as it will force LLPs to consider moving away from the UK,’ said Magnus Spence, CEO of Dalton Strategic Partnership and chairman of NCI.
‘HMRC in general treats partnerships as exclusively avoidance vehicles. I think HMRC and the Treasury are really at risk of throwing the baby out with the bath water.’
He warns the rules do not take into account the fact that some partners in investment management businesses are not given a general share of profits but rather the profits linked to their own activities. He said in seeking to address a relatively small number of people who are abusing the system, legislators ‘run the risk of creating a monster’ in the form of a shift to incorporate or an exodus out of the UK.
So what are the advantages of incorporating? At a headline level, a shift could prove a no-brainer for some businesses, given that retained profits are taxed at 23% under corporation tax rather than 45%. However, the costs and longer-term consequences of the exercise should not be underestimated.
George Bull, national chair of the professional practices group at Baker Tilly, said several of his LLP clients are exploring whether to incorporate but he stresses there are complexities and costs.
‘Incorporating is a difficult and important thing,’ he said. ‘It produces an inflexible ownership structure and lots of businesses need the flexibility of an LLP and they would lose that.’
For LLPs that do change their contracts, ownership structure and legal documentation, the costs for a smaller organisation could amount to tens of thousands of pounds, with larger organisations paying hundreds of thousands.
‘That is why so many firms will retain the LLP status as much as they possibly can,’ Bull said.
2CG Senhouse Investments is one company that recently adopted a corporate structure. The decision was largely a result of the merger between Senhouse and 2CG, but given the choice of keeping Senhouse’s LLP structure or 2CG’s corporate status, management opted for the latter nine months ago on account of the likely changes to tax rules.
Charles Scott-Plummer, a director at the firm, said the government should be careful not to kill the partnership structure for tax reasons but should instead appreciate the governance benefits.
‘I think it is sad in many ways because the LLP and partnership structure is a very positive thing for an investment or finance business, how it ties everyone in and makes them responsible,’ he said.
However, Darren Oswick, a corporate tax lawyer at Simmons & Simmons, is not anticipating a wholesale shift to corporate structures. He suggests LLPs grappling with the proposals consider changing the terms of the partnership arrangement, for example, bonus terms or who sits on the management committee.
Perhaps the most important thing LLPs can do is have a plan in place and be prepared to move quickly.
‘Assess all of the options under the current rules, work out what is the least painful set of changes you need to make so that tax does not distort the current business plan,’ Oswick said.
‘And when the tax rules are published in their final form, be prepared to act quickly on the plans you are making now.’