September 18, 2017

Draft Legislation Published on UK Partnership Taxation

Earlier this year, HM Revenue & Customs published various ideas to ‘clarify’ the tax treatment of partners in partnerships, as part of its response to a consultation on changes to the taxation of UK partnerships. Draft legislation implementing many of these suggested changes has now been published and it is clear that there are some significant changes proposed, in terms of both the mechanics surrounding the filing of partnership tax returns and the basis of liability for partners and others interested in partnership profits. The nuances of how these changes interact with existing UK partnership tax rules means that a thorough analysis will be needed in order to understand their full impact and their practical implications. However, the headline points from the draft legislation, for those using partnerships as part of their fund and fund management structures, are discussed in this alert.

Nominees and bare trustee arrangements

The draft legislation sets out new rules so that a beneficiary of a nominee or bare trust arrangement (where the bare trustee or nominee acts as the partner in the partnership on behalf of such beneficiary) will be treated as a partner for reporting and profit calculation purposes. That means that any such beneficial owners will have to be named on the partnership tax return in the same way as actual partners. For investment partnerships, the draft legislation has not changed the tax liability position that most practitioners would have viewed as the correct position under current law (as regards to the beneficial owner and not the nominee being subject to tax on such amounts) but rather clarifies and formalises this position as a matter of these tax rules.

There was some speculation that the new law, if drafted too broadly, could have wide-ranging tax consequences by virtue of beneficiaries being treated as partners for all other tax purposes (for example, being treated as ‘connected’ in certain situations). It is therefore welcome news that the current draft legislation is only targeted at the specific tax rules to which it was intended to apply and as such it should not operate to treat such beneficiaries as ‘partners’ for all UK tax purposes.

Reporting on “ultimate recipients” of profit through a chain of partnerships

It was clear from the consultation that HMRC felt some change of law was needed to improve their ability to collect the correct amount of tax from ‘indirect’ partners in partnerships (by which they mean partners in a partnership which is itself a partner in the underlying partnership, with this concept applying through any numbers of tiers of partnerships). Recognising that a “look through” approach to tax reporting for all partnerships would place a huge administrative burden on the lower tier partnerships, the government has proposed in the draft legislation that a profit generating partnership with a partner which is itself a separate partnership must report the details of just that partner, but with computations of taxable profit being made on all four possible bases for UK tax purposes (UK-resident individual, non-UK resident individual, UK-resident company, non-UK resident company). However, where details of all the partners and indirect partners have been provided to HMRC, the computations provided will only have to be those appropriate to those persons. The details given must include the partner’s name at a minimum, and also some information as to that partner’s corporate form and UK residency status; the term partner here also extends to include beneficial owners under nominee arrangements.

This will create an additional compliance burden (in terms of the different bases of computations to be used). In a funds context, this is likely to affect fund partnerships with, for example, several funds of funds as investors, where tracking through each level of ownership up to the ultimate partners would be practically impossible. For less widely held partnerships, such as carried interest and co-investment partnerships in which the fund manager’s executives are partners, the partners’ identities should generally be easily obtainable, enabling only the relevant categories of computations to be carried out. For trading partnerships, such as fund manager LLPs, there are also new provisions dealing with the treatment of indirect partners and the basis on which they are considered to be carrying on a notional trade in respect of their interest in that partnership.

Investment partnerships and tax reference numbers

Investment partnerships (excluding trades, professions and property businesses) will welcome new provisions which remove the obligation to obtain a UK tax reference number for certain types of partners and indirect partners (including beneficiaries under nominee arrangements). The new position only applies where the partner is not chargeable to UK income tax or corporation tax and where information about the person is required to be reported to HMRC under the UK’s implementation of the CRS regime. Whilst limited in scope, this will assist funds that have struggled to obtain complete details for each partner and in particular a Unique Taxpayer Reference number for each partner. However, the exemption as drafted appears not to apply in situations where an investment fund’s reporting obligations under CRS are solely to a foreign tax authority.

Funds of funds and stacked partnerships

There are specific rules that will be relevant for funds of funds and other tiered partnership structures requiring the profits and losses from each underlying partnership to be reported separately on the top partnership’s tax return.

Allocation of profits or losses between partners

One of the most radical changes in the draft legislation is the introduction of the concept that the partnership tax return will be conclusive in determining for tax purposes the question of whether any person has a share in partnership profits and what that share is. Disputes in this regard can be challenged by referral to the tribunal. The draft legislation also introduces more specific rules determining how a partner’s profit share is to be calculated, setting out how the partners percentage of profits and losses is to be calculated. In combination, these provisions mark a move away from the partnership agreement as determining partners’ taxable profit shares in a partnership.

The government has announced that these changes will come into effect in relation to the tax year 2018-2019, except for the changes to the allocation of firm’s profits or losses between partners and those relaxing the requirement to provide tax reference numbers, which will come into effect with the passing of the Finance Bill for periods of account starting after that date.