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Mixed partnerships – a thing of the past?


Mixed partnerships have been a good way in which to retain the benefits of self-employed status for business owners, while reducing the tax burden on businesses. While there have been some attempts to limit the benefits (e.g. the ban on mixed partnerships getting the 100% AIA for plant and machinery investment), HMRC have been unable to upset the arrangements.

Until now…..

It was announced in the 2013 Autumn statement, and draft legislation issued shortly thereafter, to close down what HMRC describe as a structural weakness that has allowed businesses to artificially reduce their tax liabilities.

However, there are some very good reasons for having a mixed partnership. For example, retaining post-tax profits in a partnership will have incurred income tax and NIC if taken from the individual partners own profit share. This could reduce the available capital by up to 25% compared to funding it from a corporate partner’s share.

Companies can issue debentures as well, and this has not been available to individual business owners. This can help to reduce the cost of borrowing.

Risk minimisation is another good reason for having a corporate partner. For example, moving the employees into the company can help to protect the personal wealth of the business owners from spurious or even justifiable action under employment protection legislation. One of my clients is actively exploring this as we speak, following a wholly spurious claim by an ex-employee with emotional and mental health issues

What are the new rules?

HMRC now have the ability to increase the taxable profits of any partner in a partnership where:

  • There is a non-natural partner i.e. a company, and
  • The individual has the “power to enjoy” the profits allocated to the company, and
  • There is no commercial reason for the company to be allocated a share of the business profits, other than tax saving, and new source of funding for their business?
  • It is “reasonable to suppose” that the individual would have had a higher profit share if he/she had not been connected with the company.

Are there any defences?

The tests set out above are more objective than the initial proposals. However, they still represent a significant change in the way in which mixed partnerships are taxed. The conditions set out above do allow for some measure of protection, particularly for commercial arrangements. However, the profit sharing arrangements needs to be reviewed in detail, to ensure that they are commercially defensible.

HMRC have indicated that they will accept only a small mark up on cost recharges from a corporate partner, and will limit the tax impact of funding costs recharges so that the corporate partner makes only a reasonable return from its investment/ loans.

What action do we need to take now?

The new rules apply from 6 April 2014, so there should be no impact on any accounting period ending in the 2013/14 tax year. Having said that, it has always been open to HMRC to challenge any profit allocation they consider to be unjustified.

Review the profit sharing arrangements and amend any partnership agreement to make clear the commercial rationale for the profits allocated to any corporate partner.

For example, one of our clients uses his company profits to fund the family partnership start-up costs, so it is reasonable (in my opinion) to allocate losses to the funding partner, the corporate. Another client sold 50% of their partnership to their own limited company a couple of years ago. All properly declared on their personal tax returns, and not challenged by HMRC, so a 50% profit share would seem to be reasonable for the corporate.

Nevertheless, we are advising all clients of the threat, and suggesting they review their agreements and revise them to make explicit the commercialism of their own particular arrangements.

We cannot guarantee they won’t be challenged, but they’ll be better able to defend themselves if they are.

If you would like to explore your own position in more depth, please speak to your tax adviser, or contact us if you would like a second opinion.

And to answer the question….

With so many non-fiscal reasons to adopt a mixed partnership structure, the may become rarer, but I don’t think they are a thing of the past. In essence, closing down a mixed partnership, just because of the new rules, suggests to me that it existed for tax mitigation purposes only and therefore could have been attacked under any number of anti-avoidance measures.