HMRC's new LLP tax guidance sends a mixed message on anti-avoidance

Law firms and other LLPs have been busy preparing for the incoming changes to the taxation of partnerships since they were announced in the last Autumn Statement, but in recently updating its guidance on the legislation affecting the taxation of LLPs, HMRC has been sending mixed messages regarding what will be considered anti-avoidance.

One of the salaried member tests (condition C) is whether an LLP member's capital contribution in the firm is less than 25 per cent of his disguised salary. If that is the case, the member is a salaried member if he also passes the other two tests.

The anti-avoidance clause in the draft legislation will take effect from 6 April 2014. It is broadly written and, in essence, allows HMRC to ignore arrangements with one of the primary purposes of ensuring that one of the salaried member tests is failed. At first sight, this could mean that organising for members to subscribe extra capital to a level above the Condition C threshold might not be taken into account in the capital contribution test.

However, in the draft guidance, HMRC indicates that a genuine subscription of capital is a game changer. Parliament is setting a capital test hurdle and, if you clear it, the anti-avoidance clause should not apply. The guidance goes on to acknowledge that members will often borrow their capital from a bank, which HMRC initially indicates is acceptable.

HMRC notes that many firms are currently restructuring their finances in the lead-up to the new legislation becoming effective in April and has recognised that the banks might be struggling to process all the fresh loan applications they have received before the legislation becomes effective.

Thus, HMRC is organising for the draft legislation to be amended so that the capital a member who has an irrevocable commitment to subscribe by 6 April 2014 will count as a capital contribution for the Condition C test on that date if the capital is to be paid by 5 July 2014.

Unfortunately, HMRC's comments on what it regards as artificial arrangements, which may be challenged under the anti-avoidance clause, go beyond what one might expect.

Loans to members for capital contributions

HMRC regards the making of a loan from the firm to a member to enable that member to make a capital contribution to the firm as an artificial arrangement. One might like to argue that this should not necessarily be the case, but it is understandable that HMRC would see such an arrangement as potentially very artificial.

But HMRC then takes the example further.

It indicates that its view of artificial arrangements includes situations where a firm organises for a bank to make a loan to a member out of a partnership facility and, as part of the arrangement with the bank, the firm agrees to reduce other indebtedness to the bank. HMRC's view appears to be that, as the firm's and the bank's overall position has not changed, the capital subscription is not genuine.

Where a firm has an overdraft, a fresh injection of capital from members must, on the day of receipt, reduce the firm's overdraft. To make sense with HMRC's other comments on genuine capital subscriptions, its anti-avoidance concerns presumably only apply where the firm agrees to reduce its overdraft facility as part of the arrangement of partners' loans for capital.

Firms need to take great care with these impending changes to the tax treatment of salaried members, particularly in agreeing the terms with their bank on any fresh partner capital loans. There is some way to go to establish clear new rules, but in the meantime it is advisable to seek professional advice to stay the right side of the anti-avoidance test.

A follow-on article in the next issue of Managing Partner will explore the practical implications for law firms in greater detail.

Louis Baker is head of professional practices at UK accountancy firm Crowe Clark Whitehill (www.crowehorwath.net/uk)