In this edition of Fieldfisher's Partnerships Update we highlight:
- HMRC's latest guidance on the new tax rules for salaried members.
- The Office of Tax Simplification's interim report on partnerships.
- A recent Court of Appeal case which explores the court's discretionary power to dissolve a partnership.
We hope you find this of interest.
1. HMRC issues new guidance on new salaried members rules
In recent Partnership Updates we have reported on HMRC's new rules for partnerships. A key element of the new rules is HMRC's proposal to introduce a three step test to determine whether an LLP member is an 'equity member' or a 'salaried member' – the latter being treated as an employee for tax and NICs purposes.
A member will be a 'salaried member' if all the following conditions are met:
- Condition A: The member performs services for the LLP in his or her capacity as a member, and is expected to be wholly or substantially wholly rewarded through a 'disguised salary' that is fixed or, if varied, varied without reference to the profits or losses of the LLP.
- Condition B: The member does not have 'significant influence' over the affairs of the partnership.
- Condition C: The member’s contribution to the LLP is less than 25% of the 'disguised salary'.
These new rules, and accompanying anti avoidance rules, are expected to come into force on 6 April 2014.
In February HMRC issued new technical guidance on the new salaried members rules. The new guidance can be found here. By and large this guidance is made up of examples – over sixty of them – which are designed to help people understand how the new rules will be applied. There are too many to go into in this Partnership Update, but the new guidance is well worth a read.
The guidance does also flag two changes to the proposed legislation:
- Regarding Condition A, the references to wholly or substantially wholly will be clarified in the legislation, setting the threshold at 80%, so the new test will be whether the member performs services for the LLP and it is reasonable to expect that at least 80% of the amounts payable by the LLP for the member's services will be 'disguised salary'.
- Regarding Condition C, concerns were raised about whether firms who wanted to refinance their membership contributions would be able to do so in time (bearing in mind the new legislation will come in to force on 6 April this year). HMRC has confirmed that, to avoid the position where individuals are treated as employees for a short period whilst they obtain finance in order to invest capital, the legislation is being amended. Condition C will not be satisfied if:
- at 6 April 2014, there is an unconditional requirement for that member to provide the capital; and
- the capital is contributed within 3 months from 6 April 2014.
If the member does not contribute the capital within 3 months, then their position has to be reviewed.
There is much that is useful and welcome in the revised guidance. For example, it is clearer from the revised guidance that the 80% test in Condition A can be looked at in appropriate circumstances over more than one accounting period. It is also made clear that provided a profit share is expressed as a percentage of the profits of the firm, this profit share does not become disguised salary merely because those profits are very stable and predictable. This point appears to open opportunities, where an LLP is part of the group, to use structures which stabilise the profits of the LLP as a way of persuading fixed-income partners to take the risk to give up a profit share expressed as a fixed income in favour of a variable profit share.
The revised guidance should operate as a reminder that LLPs should be reviewing their arrangements now as a matter of urgency so they are clear what position they will be in at the start of the new tax year.
2. Tax simplification
There is a hint of irony that, while HMRC is re-shaping the tax rules for partnerships under the tax avoidance banner, the Treasury's Office of Tax Simplification has been commissioned to consider simplifying the taxation of partnerships. Its interim report was published recently and can be found here.
While the OTS is due to re-visit these issues later this year, the emerging themes are:
- The tax system needs to take a more strategic approach to partnerships. Tax policy and administrative processes have generally been designed with sole traders and corporations in mind. Partnerships are not considered to be a focus.
- HMRC needs to coordinate its partnership work and support in a different way. HMRC does not have a partnerships customer directorate, nor does it have a senior civil servant with sole responsibility for partnerships across the range of all taxes.
- Partnership tax rules are spread out across legislation and HMRC guidance. However the OTS's view was that there seems to be little desire for a consolidated taxes act for partnerships.
- The “one size fits all” approach of partnership tax leads to extra burdens and complexities for small partnerships, when compared to sole traders with similar sized businesses. The report recommends some short term fixes, including:
- BIS to re-publish their model partnership agreement;
- publishing a manual of consolidated guidance for partnerships;
- let interest on income be entered in gross on short return;
- changing the corporation tax self assessment return to include a section for income from a partnership;
- HMRC to clarify when partnerships are eligible for entrepreneurs’ relief (particularly regarding possible relief on subsidiary companies held by an LLP);
- the process for issuing unique taxpayer references to foreign partners needs to be streamlined;
- creation of a form of general remittance basis investment relief for groups of non-domiciled individuals investing in UK investment partnerships;
- HMRC to create free software for the smallest partnerships;
- HMRC guidance should be clearer on stamp duty land tax (SDLT) liabilities following changes in profit sharing ratio;
- there needs to be a review and update of the guidance on inheritance tax for partnerships;
- HMRC to clarify their requirements as regards limited partnerships and joint ventures for the purposes of VAT registration, where the present published guidance seems unclear; and
- HMRC to give clear guidance on VAT grouping for LLPs.
3. Case review: Dissolution of a partnership
The landmark, and somewhat controversial, case of Hurst v Bryk (2002) 1AC 185 established the principle that the contractual doctrine of repudiation does not apply to the dissolution of a partnership -essentially on the grounds that such an application of this doctrine would be incompatible with the court's statutory power under section 35(d) of the Partnership Act 1980 to dissolve a partnership when 'a partner … wilfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself ………… that it is not reasonably practicable for the other partner or partners to carry on the business in partnership with him'.
The recent case of Bishop v Golstein (2014) EWCA Civ 10 considered the question of whether one partner's conduct could nevertheless be viewed as the cause of the early termination of a partnership, and as a result entitle the other partner to bring a claim for damages.
The case concerned a falling out between two solicitors, a Mr Bishop and a Mr Golstein. The 'innocent partner', Mr Golstein, had various serious complaints about Mr Bishop's conduct. These included:
- Mr Bishop telling the partnership accountants not to send draft accounts to Mr Golstein.
- Mr Bishop purporting to terminate the lease of the partnership premises without consulting Mr Golstein.
- Mr Bishop refusing to discuss partnership matters with Mr Golstein.
- Mr Bishop excluding Mr Golstein from management decisions.
- Mr Bishop failing to require or encourage partnership staff to respect Mr Golstein's authority as a partner.
Mr Golstein had originally brought his claim for damages on the basis that Mr Bishop had repudiated the partnership agreement. The High Court confirmed (following Hurst v Bryk) that the contractual doctrine of repudiation does not apply to the dissolution of a partnership. Instead, the High Court found that the parties had reached a mutual agreement to dissolve the partnership early, but that Mr Bishop's agreement to this early termination had been caused by the wrongful actions of Mr Bishop and that Mr Bishop was entitled to compensation accordingly.
The Court of Appeal considered various arguments from Mr Bishop, including that there could have been no contractual repudiation by Mr Bishop because, first, Mr Golstein 'affirmed' the partnership (by continuing to work and receive drawings) and, second, there was no 'last straw', no final incident which triggered the repudiation. The Court of Appeal dismissed these arguments, largely because they stemmed from an incorrect assumption that the contractual principles of repudiation (including affirmation and the last straw doctrine) were relevant in a context where the dissolution of the partnership was to be governed by the court's a discretionary powers under section 35(d) of the Partnership Act 1980, rather than under the contractual principle of repudiation.
In deciding the appeal in favour of Mr Golstein, Briggs LJ said: 'If one partner, in breach of his duty to his fellow partner, seeks to squeeze him out or otherwise to conduct himself in a manner which makes it intolerable or impracticable for the other partner to continue to carry on the business with him in partnership, and this causes the innocent partner to dissolve or agree to the dissolution of the firm earlier than would otherwise have occurred, then it is plainly necessary for the law to recognise some means whereby the innocent partner can be compensated for consequential loss'.
The case is interesting in demonstrating the ability of the court to find a means of remedying a loss suffered by a partner in the circumstances, and for its commentary around the application of Hurst v Bryk. It will be required reading wherever a partnership dissolves in acrimony. It should be noted, however, that the decision applies only to general partnerships – LLPs are an entirely different ball game.
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