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‘( ) The Chancellor of the Exchequer shall, within six months of the passing of this Act, publish and lay before the House of Commons a report setting out the impact, over the next three years, of the changes made to the Corporation Tax Act 2009 and the Income Tax (Trading and Other Income) Act 2005 by Schedule 13.
( ) The report must in particular set out—
(a) how much additional tax revenue the measures introduced by this section are expected to generate to the UK Exchequer, for each year in which they are in operation; and
(b) the impact of those measures on revenues lost to the Exchequer as a consequence of tax avoidance schemes for each year in which they are in operation.’.
Clause 68 and schedule 13 introduce changes to the taxation of partnerships, in particular limited liability partnerships. The reforms are designed to prevent tax avoidance through the use of certain partnership structures. There are four main changes. First, there was previously a presumption of self-employment for partners in an LLP. The new rules remove that presumption and introduce a series of tests designed to stop the disguising of normal employment arrangements through LLP structures.
Secondly, profit sharing within partnerships can be flexible, which in the past has been used to generate tax advantages, particularly in relation to mixed-membership partnerships, which is when there are both corporate and individual members. Various structures have been used to allocate profits to a low-tax entity, such as a company, while losses were allocated to individual partners, who could make more tax-efficient use of the losses. The new measures aim to prevent these types of arrangements.
Thirdly, one of the arguments used to justify the need for mixed-member partnerships was the need to warehouse profits that cannot be paid to partners in cash as a result of regulatory requirements. In particular, under the alternative investment fund managers directive, AIFMD firms are obliged to withhold elements of remuneration payable to certain staff, including partners or members of an LLP, and to make the right to receive this conditional or subject to clawback. When the rules apply to members of an LLP, the tax treatment is that all the profit is taxed in the year in which the profits are made, irrespective of whether such profits are paid out. Under the new rules, AIFMD firms will allow that profit, which is required to be deferred, to be allocated not to the relevant individual, but instead to the firm itself, which will pay tax on this at the higher rate. When the individual is able to access the profits, he or she will be taxed, but will receive a tax credit in respect of the tax paid by the firm and any overpayment of tax may be repaid.
Fourthly, on asset disposals, one partner could previously transfer an asset or income stream to another partner in return for a payment and the transferee might have had a tax attribute that would mean it was not taxed on that income stream. Under the new rules, when a person disposes of an asset or income stream through a partnership and the main purpose, or one of the main purposes, is to secure a tax advantage, the new rules would impose an income tax charge on the person making the disposal or transfer of the asset.
By way of background, LLPs set up under UK legislation are bodies corporate that combine the organisational flexibility of traditional partnerships with the benefit of limited liability for their members. The policy intention when LLPs were introduced was that they would be treated for tax purposes as though they were traditional partnerships, rather than being subject to corporation tax, as would be normal for a body corporate. That means that individual members are taxed on their share of the profits of the LLP in the same way that individual partners in a traditional partnership are taxed.
The schedule introducing these changes is very long, and the rules are detailed and complex. There are two very helpful HMRC technical notes, which between them have a total of 57 examples, each of which contain scenarios that are caught or not by the new rules—I rather felt like I was back at bar school as I was working my way through each scenario and working out whether the new rules caught those arrangements or not.
We support the need for action in this area. There has clearly been abuse of the current rules and it is right that action is taken to crack down on tax avoidance in this area. The action is supported by stakeholders, too. The Chartered Institute of Taxation commented at the time:
“There has undoubtedly been some abuse of the current rules with, for example, cleaners and seasonal agricultural workers being made partners to avoid national insurance. The Government were right to review the taxation of LLP members in the interests of fairness in the tax system.”
The House of Lords Economic Affairs Committee also commented:
“The Government is clearly right to look again at the taxation of Limited Liability Partnership members as the legislation introduced in 2000 has failed to bring their tax treatment in line with that of general partnerships, and provided opportunities to avoid tax liabilities.”
The original consultation on partnerships was launched in May 2013, after Budget 2013, in which it was announced that
“the government will consult on measures to remove the presumption of self-employment for limited liability partnership partners, to tackle the disguising of employment relationships through LLP structures”.
That consultation closed in early August and the HMRC published a summary of responses on 10 December 2013, alongside draft Finance Bill provisions. There is, as I am sure the Minister will be aware, a widespread view that the legislative proposals before us today, which appeared in the draft Finance Bill, are very different from those in the May consultation document. Indeed, the CBI said:
“The consultation process which took place between May and August 2013 sought responses to a much narrower set of proposals than those published on 10 December. Had business known these parameters, many more may have responded and those that did respond may have responded differently”.
In addition, the Office of Tax Simplification has also been reviewing the whole area of partnership taxation. It was commissioned to look into the taxation of partnerships in 2013. The interim report of the OTS review was published on 22 January 2014, which was also after the draft Finance Bill was published in December 2013. That seems a somewhat strange way to go about this review and reform process.
The key issue in relation to clause 68 and schedule 13 therefore relates to the process—the problems with the consultation and the substantially different approach adopted in the draft Finance Bill and the Bill before us today. The Minister will know that the House of Lords Economic Affairs Committee recommended delaying the implementation of the legislation until April 2015 to allow for further consultation with interested stakeholders, including business, taxation and legal specialists, so that the legislation can be targeted properly. Will the Minister explain what consideration he gave to that suggestion and why that approach has been rejected in favour of bringing in the rules much earlier?
The Association of Taxation Technicians has said it believes that the attempt to provide an objective measure of when a member of an LLP is a real partner has, in its view, resulted in what it considers to be a fairly mechanical approach. It fears that this approach takes no account of the modern management structure of partnerships or differences in factors such as size, structure, complexity, the nature of the trade, history and career patterns of businesses that are structured as LLPs. As a result, the ATT suggests that there should be a deferral—along the lines suggested by the House of Lords Committee—or, failing that, the inclusion of a clearance provision in the legislation that would enable LLPs to agree with HMRC the tax status of their members and thereby overcome the uncertainties that it believes are introduced by these provisions. However, that is not the approach that has been adopted by the Minister in the clause and schedule before us. It would be helpful to hear from him about the ATT’s fears and whether he considered the idea of a clearance provision that would ensure that the measures do not unwittingly introduce unnecessary uncertainty into the tax system.
As I said earlier, the Office of Tax Simplification conducted a review of partnership taxation, with the results being published on 22 January 2014. Introducing the complex legislation before us will affect many businesses, potentially leading to structural change. On the face of it, that might seem a strange process and unnecessary complication while the results of the OTS review are still being considered. What is the Minister’s response to such claims? Is he concerned that the changes might be seen as a piecemeal approach to reform? How will he ensure that the path he has chosen to take with the legislation before us will provide much-needed stability and certainty to the UK tax system?
Another important issue is whether businesses will have enough time to adapt to the changes, the passing of which will require some LLPs to undergo radical restructuring. The Institute of Chartered Accountants in England and Wales thinks that insufficient time has been allowed for businesses to make the necessary arrangements, given the legislative and regulatory timetable that the Government have pursued. LLP members subject to the new legislation will be taxed as employees from 6 April 2014. The ICAEW thinks that the real-time information requirements for reporting payroll data will merely add to the high administrative burden for LLPs and HMRC. What assessment has the Minister made of whether businesses have enough time to adapt to the changes? What is his assessment of the extent of the administrative burden they will have to bear as a result?
The ICAEW has stated that the proposed new rules for salaried members in LLPs and the non-corporate member rules for all partnerships will involve a significant additional compliance cost for LLPs. Have the Government evaluated the effect on bottom-line costs for the affected businesses? Similarly to our attitude to the changes to the rules on intermediaries and disguised self-employment, although the Opposition welcome measures to counteract tax avoidance, what steps will the Government be taking to ensure that the employment law aspects of the changes are also reviewed?
The increasing divide between employment law and tax law has the potential to lead to more uncertainty, complexity and unfairness as individuals are taxed as employees but without equivalent employment rights. The proposals to tax LLP salaried partners as employees might create a further group of individuals who will be in that position. What discussions has the Minister had with colleagues in other Departments, including the Department for Business, Innovation and Skills and the Ministry of Justice, about the impact of the changes and how they will interact with employment law?
On a broader level, it is apparent that many of the problems being addressed by the proposals stem once again from the different tax costs of employment and self-employment, as well as the different rates of tax paid by small companies and unincorporated businesses. Like me, the Minister will have heard such differences described often as structural problems in our tax system. Many stakeholders believe that until they are resolved we will continue to see piecemeal legislation being introduced. There is a danger that that might make a complex situation and a complicated tax code even worse. Will the Minister set out for the benefit of the Committee the steps that the Government will be taking to perform a thorough review of the whole issue?
The Chartered Institute of Taxation also makes an important point about employment status. It says:
“The result of the Government’s approach in this area, and in respect of agency workers, is that we now have several definitions of when a worker is employed or self-employed.”
It then gives the example of employment law tests, which
“are well known and, in general, the result of applying these tests for, for example, employment rights purposes are followed for tax purposes too.”
It also gives the example of intermediaries legislation. It says that
“these tests apply for tax purposes only, and give rise to no employment rights, and include IR35 and individuals working through personal service companies, individuals working through umbrella companies—managed service companies—as well as the provisions included in clauses 16-21 of the Finance Bill 2014 in respect of employment intermediaries.”
We debated that in an earlier sitting. The chartered institute also points to employment status in relation to ordinary partnerships. It says that
“these tests have been built up over many years and are largely known and accepted by HMRC and taxpayers.”
Now, of course, we have the employment status provisions in relation to LLPs. The institute says that
“the test will apply for tax purposes only and the individuals affected will gain no employment rights.
It fears that the result of all that is a real and growing confusion in the law about how employment status is established. Does the Minister agree? If so, or if he fears that that may prove to be the case, does he propose to look at that?
For those LLPs that are uncertain whether the new rules apply to them, HMRC’s non-statutory business clearance process will not be available until after the Finance Bill receives Royal Assent. Does the Minister think it is right that, given that uncertainty, in the interim those LLPs will need to take a view on whether the new rules apply?
The House of Lords Committee raised concerns that the proposed changes to tax arrangements for LLPs will apply only to UK-registered LLPs and not to those conducting business here but formed elsewhere. Will the Minister explain whether the Government will be taking steps to reconsider the position of non-UK LLPs? I should also be grateful if he would give a breakdown of how the Government arrived at the potential overall £3.26 billion tax yield for these measures.
The intention of our amendment is to probe the Minister. We want to ensure that the expected £3.26 billion tax revenue is realised and we seek reassurance from the Minister that the new proposals will be effective in clamping down on this area of tax avoidance and, given the detail of the legislative tests introduced by schedule 13 in particular, will not inadvertently create more tax avoidance opportunities. I would be grateful for clarification on those points.
I rise to make a couple of points raised with me by LLPs in my constituency and friends on the House of Lords Economic Affairs Committee. I do not want to duplicate the hon. Lady’s points, but I want to raise: the legislative tests to determine the status of LLP members; the application of the new rules from the start of the fiscal year, April 2014; and the position of non-UK LLPs.
The three legislative tests in the Bill for determining whether a member of an LLP is an employee of the partnership rather than a true partner seem a little different from those consulted on before the draft Bill was published. The House of Lords Committee felt that those tests will fail to achieve parity with the outcomes produced by the general partnership rules as the Government intend. Will my hon. Friend the Minister remain open to suggested amendments with the aim of making improvements and clarifications to that?
Can we consider allowing businesses to apply the changes from the beginning of their own accounting year, rather than the start of the tax year, to reduce compliance costs? Can we look again at ensuring that domestic LLPs are not at a disadvantage relative to non-UK LLPs?
When are the Government planning to carry out a formal post-implementation review of the changes? Will the review include a rigorous assessment of whether the expected yield has materialised? Like the hon. Member for Birmingham, Ladywood, I suggest that the proposals should perhaps be delayed to April 2015 so that we can get both the legislative approach and the drafting right, which would give LLPs time to adapt. To minimise compliance costs, will the Government consider applying the new rules from the start of the LLP’s accounting year, rather than from the start of the fiscal year?
In summary, this is great legislation, and it is right that we ensure that such loopholes are closed. My questions are purely probing in order to ensure that we do that as effectively as possible.
Clause 68 and schedule 13 make changes to prevent tax losses arising from disguising employment relationships through LLPs and from certain arrangements involving the allocation of profits and losses among partnership members. Amendment 15 seeks the publication of a report on the measure’s tax impact, and I will address that shortly.
The measure has two strands. The first concerns individual members of LLPs who are essentially employees. Such people are referred to in legislation as salaried members. Under existing rules, individuals who are members of an LLP are taxed as if they are partners in a partnership even if they are engaged on terms closer to those of an employee. LLPs can therefore be used to disguise employment and to avoid employment taxes, which results in unfairness and a loss to the Exchequer of income tax and national insurance contributions.
The second strand concerns the allocation of profits and losses between partnership members. Under partnership law it is not necessary for profits and losses to be shared among partners in proportion to a partner’s contribution to the partnership, which means that where partnerships consists of individuals and a company or, say, a trustee, there is scope to manipulate the allocation of profits and losses so that profits are taxed at a lower tax rate than they should be and losses are relieved at the highest income tax rate. A variation on that theme is where partners reduce their profit entitlement in return for a payment made by another member who is taxed more favourably on those profits. The measure is about reducing distortions between partnership types, thereby ensuring that disguised employment in LLPs and inappropriate partnership allocations to a company or similar vehicle do not create tax advantages.
Clause 68 and schedule 13 address the disguising of employment relationships in relation to salaried members of LLPs—that is part 1 of the schedule. Part 2 addresses tax-motivated allocations of profits and losses in mixed-membership partnerships, including LLPs. Part 4 addresses tax-motivated disposals of assets through partnerships, including LLPs. Part 3 introduces a new income tax collection mechanism for partnerships and LLPs operating as an alternative investment fund manager. I will now explain each of those aspects in a little more detail.
Part 1 of the schedule will ensure that a salaried member of an LLP is treated as an employee of the LLP for income and corporation tax purposes. Associated changes to the national insurance contributions rules have been made in the National Insurance Contributions Act 2014 and subsequent regulations. When the tax legislation relating to LLPs was introduced in 2001, it deemed all members to be self-employed. The new rules remove that automatic presumption, and individual members will be tested against certain criteria to determine whether they should be taxed as self-employed.
Broadly, the new rules seek to differentiate between an individual member of an LLP who has the characteristics of a partner and one who is tantamount to an employee. In order to do that, the legislation introduces three conditions. First, at least 80% of the individual’s reward for their services for the LLP is fixed or not generally subject to the overall profits and losses of the LLP; secondly, the individual does not have significant influence over the affairs of the LLP; and thirdly, the individual does not have significant capital invested in the LLP. If all three conditions are met, the individual will be a salaried member and will be treated as an employee of the LLP for tax purposes. These rules apply only to UK LLPs. Entities outside the UK that are broadly equivalent to a UK LLP do not benefit from the automatic presumption of self-employment and there is no evidence of their being used to disguise employment. The Government will, of course, continue to monitor this area and will act quickly if needed.
The change in part 2 of the schedule will affect partnerships, including LLPs, where the partners or members include both individuals and non-individuals, typically a company member of the partnership. Broadly, the new rules will prevent tax loss by reallocating excess profits allocated to a non-individual partner—say, a company partner—to an individual partner. That will remove the tax advantage achieved by that individual under an arrangement where the excess profits are taxed at a lower rate than if the individual, instead of the company, had received the profits. The rules will also deny certain income tax loss reliefs and capital gains relief for a loss allocated to an individual partner instead of a non-individual under avoidance arrangements.
Part 3 of the schedule addresses a particular issue for partnerships that manage alternative investment funds. The legislation will introduce a mechanism for members of such partnerships to allocate profits to the partnership where members cannot immediately access the profits because of requirements under an EU directive to defer remuneration of key staff of AIFM firms. The legislation will impose a charge to tax on such profits at the additional tax rate of 45% to be paid by the partnership. If the member subsequently receives the profits, the individual can claim a tax credit against the tax paid by the partnership up front. That mechanism will ensure that AIFM partnerships can comply with the new EU-wide regulatory rules without needing to turn to tax-motivated arrangements involving mixed membership partnerships.
Part 4 of the schedule would affect those who use partnerships to dispose of income streams or assets without triggering a charge to tax on income. The legislation will apply where a person disposes of all or part of an asset or income stream under arrangements intended to secure a tax advantage. The legislation will impose a charge to tax on income on the person making the disposal.
The majority of partnerships will not be affected by these changes as they are not LLPs employing salaried members or mixed membership partnerships involving tax-motivated arrangements. The partnerships affected are likely to be limited in number and are primarily large professional or AIFM partnerships.
The information sought in Opposition amendment 15 was published in the tax information and impact notes covering all four parts of the legislation in December last year. An updated note concerning the salaried member legislation in Part 1 was also published on 7 March 2014. The figures show that the measure is expected to raise about £3.3 billion over the next five years. The figures were subject to the scrutiny of the Office for Budget Responsibility and I can confirm that the figures were certified by the OBR following the rigorous procedures that the Government have put in place. Therefore the report proposed in the amendment is not necessary.
Let me deal with questions asked by the hon. Member for Birmingham, Ladywood and my hon. Friend the Member for Solihull. First, both asked about the salaried member legislation published last year, which is, it is argued, significantly different from the consultation proposals. I do not accept that view. The draft Finance Bill 2014 legislation published in December is based on specific statutory tests, as proposed in HMRC’s original consultation document.
As is usual, the original consultation proposals were updated, but that merely reflected the consultation responses received last year. A number of consultation respondents have supported the Government’s position. For example, both KPMG and the Alternative Investment Management Association provided positive endorsement while giving evidence to the House of Lords Economic Affairs Finance Bill Sub-Committee. The legislation has been further revised, taking into account suggestions received during the latest consultation, which was between December 2013 and February 2014. The final legislation was first published on 7 March, just before the publication of the Lords’ report on 11 March, and republished as part of the Finance Bill on 27 March.
Regarding how the new tests differ from the consultation proposals, the legislation sets out three requirements, all of which must be met before a member of a limited liability partnership can be classified as a salaried member, as I set out earlier. The requirements catch individuals who would, if engaged on similar terms by a company, be employees. I do not intend to repeat those conditions. Taken together, the requirements encapsulate what it means to be operating in a typical partnership. Those tests were developed to reflect the responses received during the consultation and they updated the initial proposals set out in the consultation document.
The question raised by my hon. Friend the Member for Solihull as to whether the Government are open to amendments ties in with the question whether the policy should be put back. Most LLPs have prepared for the change on the basis of the published proposals before the implementation date of 6 April 2014. Introducing further changes now will mean that the legislation could not have been introduced according to the previously announced timeline, which would not be in line with the Government’s principles of open and fair consultation. Of course, the Government keep all such matters under review for the future, but we will not be amending the legislation.
As for a post-implementation review, all tax policies are kept under review. There are no plans for a public review. We will ensure that the yield from the measure is monitored.
Regarding the argument that implementation should be delayed, I would make a similar point. We believe that we have given sufficient notice of the change, and it has been clear what the start date would be for some time. I have already touched on whether domestic LLPs are disadvantaged. The compliance costs for business are set out in the impact note. The vast majority of LLPs will not be affected. There will be some one-off costs as partnerships come to terms with the new rules, but they will not be significant. HMRC clearance processes will not be available until after Royal Assent, but that is the normal process.
I hope that the clause will stand part of the Bill.