In summary, the government’s proposals are:
Nominees and bare trustee arrangements
Many investors hold their interests in funds through nominee arrangements, as do executives using the “assignment route” to receive carried interest (an arrangement involving using a company to hold the partnership interest which then assigns the right to receive profits to an executive). As such, it is only fair that the person or persons ultimately entitled to the partnership profits pay tax on those profits, rather than the nominee. The consultation suggested that the government was keen to revisit the question of how to tax these situations, and there was some concern that this might result in tax for the nominee. The government has confirmed in its response that it agrees with the common sense approach and intends to legislate to ensure that the beneficiary of the nominee or bare trust arrangement is treated as a partner and named on the partnership tax return (and is therefore liable to tax on its share of profits).
Depending on how the new law is drafted, one consequence of this is that beneficiaries of these arrangements, e.g., executives holding carried interest under the ‘assignment route,’ could find that they become ‘connected’ for tax purposes, by virtue of being treated as ‘partners’ in this way. This has the potential to create knock-on tax consequences for many, as this concept is used across UK tax legislation. Importantly it is used to determine whether companies are ‘closely held’ which then drives various anti-avoidance tax provisions.
Reporting on “ultimate recipients” of profit through a chain of partnerships
The government had also suggested using a “look through” approach to treat the ultimate recipients of a partnership’s profits as partners in that partnership. This would require a partnership to possibly look through a number of partnerships in the ownership chain to include such owners on the partnership tax return and, as highlighted in several responses, would place a huge administrative burden on that first partnership.
The government has therefore proposed that a profit generating partnership with a partner which is itself a separate partnership must report the details of just that partner with computations of taxable profit on all four possible bases (UK-resident individuals, non-UK resident individual, UK-resident company, non-UK resident company). However, where details of all the ultimate recipients of a partnership’s profit have been provided to HMRC, the computations provided will only have to be appropriate to those persons.
This proposal is clearly better than the original suggestion, and whilst it will create an additional compliance burden (in terms of the different basis of computations to be used), this is mainly likely to affect fund partnerships with, for example, several funds of funds as its investors, where tracking through each level of ownership up to the ultimate recipients would be a huge administrative task. For less widely held partnerships, such as carried interest and co-investment partnerships of which the fund manager’s executives are partners, the partners’ identities should be very easily obtainable enabling only the computations needed to be carried out.
OECD’s common reporting standards (CRS)
Many investment funds will be “reporting financial institutions” under the OECD CRS, and obliged to provide details of their partners and ultimate beneficiaries under these rules. To avoid duplication, the government is proposing that funds that have provided these details under CRS will not have to report the full details of the partners again in their partnership tax returns. This assumes that only investment profits are being received – if trading or property income is being allocated then full details of all partners and their profit allocations will still need to be submitted on the partnership tax return.
Other proposals included in the consultation which the government has commented further on are:
- There is no intention to pursue the possibility of HMRC requiring a payment on account in situations where reporting requirements are not complied with. Although the government firmly believes all partnerships should know who its partners are and report accordingly, the current system of penalties for late or incomplete partnership returns will continue to apply.
- A proposal to clarify that the profit sharing arrangements in a partnership or LLP agreement are the determining factor in identifying partners’ profit shares but that this could be overridden by a notification to HMRC was highlighted as placing undue influence on the partnership, especially during a dispute. The government have accepted this and the first point of reference for HMRC in determining the profit allocations for partners will be the partnership tax return – with no requirement for the partnership to notify HMRC of any changes in profit sharing.
- For partners who join or leave partnerships part of the way through an accounting period, which is relevant both for transfers of investor’s interests as well as executives leaving or joining carried interest and co-investment schemes, the government intends to treat such leaver or joiner as taxable on their share of profits or losses for the period in which they were partners, with the allocation provisions within the partnership agreement in force at the time being applied. They also intend to legislate so that changes to profit sharing arrangements made after the end of an accounting period will not apply retrospectively to such accounting period.
The government has announced that the aforementioned changes will be legislated later this year, to take effect for accounting periods starting on or after 5 April 2018.