Ploughing new ground

These are difficult times for farming, and the need for an accurate, updated partnership agreement has never been more important, says Julie Butler

In an attempt to counter perceived abuse of partnerships for tax avoidance purposes, HMRC launched a consultation on two aspects of these structures and limited liability partnerships (LLPs) on 21 May 2013. A key focus of the consultation paper is 'mixed partnerships' and how they are taxed. Mixed partnerships, including LLPs, are those comprising individuals and companies as partners.

In these arrangements, the companies are usually owned by some or all of the individual members. Such structures have become increasingly fashionable in farming with many being undertaken in haste without proper research.

HMRC believes there has been an increase in 'corporate partner planning' for tax purposes. In its view, such planning is trying to get the best of both worlds, combining the flexibility of partnerships with the benefit of lower corporate tax rates.

Everyone in farming was trying to achieve the best but often creating a sham with no partnership agreement, no shareholders agreement and no legal structure to deal with this eventuality.

The consultation document proposals seek to reverse the advantage where profit allocations in a mixed partnership are made to attempt to secure a tax advantage, by making the allocation for tax purposes to the individual partners subject to income tax on a 'just and reasonable basis'.

With regard to corporate partners, there are questions being raised about:

• the recent consultation

• whether the immediate tax savings have been calculated versus the possible tax loss in the future, for example inheritance tax (IHT) or capital gains tax (CGT)

• HMRC's attitude to 'sham' corporates moving forward; and

• consideration being given to the '¨IHT position of land being farmed by a limited company, for example '¨50 per cent business property relief (BPR) restriction as mentioned.

LLP self-employed status is also under review. The government plans to remove the presumption of self-employment for LLP partners, to tackle the disguising of employment relationships through LLPs, and counter the artificial allocation of profits to partners (in both LLPs and other partnerships) to achieve a tax advantage.

Misuse of the partnership rules has been a feature of many avoidance schemes closed down in recent years. Responses to the recently launched consultation document must be made '¨by 9 August 2013.

Agreement renewal

There are many events to trigger '¨the renewal of the partnership agreement, for example, the death or departure of a partner, or the admission of a corporate partner and changes '¨to the profit-sharing ratios. However, these events often happen without updating the partnership agreement.

One surprising problem is when a corporate service company is admitted as a corporate partner and the shareholders agreement is not drafted at the same time as the company is formed, and the partnership agreement is not updated.

However, there are far more less-sophisticated situations to address, such as aging farm partners watching the farm grow in value while potential disputes between family members increase.

Yet, despite both the increase in value and family emotions, the updating of the partnership agreement is often forgotten.

Full BPR

A key component of a partnership agreement is the protection such an agreement can give to 100 per cent BPR as protection for assets used in a business. BPR will be restricted to 50 per cent not 100 per cent relief on:

• land, buildings, machinery or plant which, immediately before the gift, was used wholly or mainly in a business carried on by a company of which the donor then had control, or by a partnership of which they were then a member; and

• land, buildings, machinery or plant that is settled property in which the donor has a qualifying interest in possession and which is used wholly or mainly for the purposes carried on by them (Inheritance Tax Act 1984, section 105).

Limited partners

With effect from 6 April 2013, all limited partners have been required to pay a class 2 National Insurance contribution (NICs), and since the same date, sleeping and inactive limited partners (SLIPs) '¨will be required to pay both class 2 and class 4 NICs after reviewing the interpretation of the law.

HMRC now takes the view that SLIPs are liable to pay class 2 NICs because they are "gainfully employed" as self-employed earners for the purposes of section 2(1)(b) of the Social Security Contributions and Benefits Act 1992. Class 2 NICs will be payable weekly from 6 April 2013, unless a limited partner is either under 16; over pension age; is granted the small earnings exception; is a married woman or widow with reduced liability; or claims deferment on account of other employments.

SLIPs will therefore need to check their class 2 NICs position. Those who are not already paying class 2 NICs as a result of being self-employed must advise HMRC of their self-employed status and arrange to pay NICs or seek exception/deferment, etc, according to their individual circumstances. Many SLIPs will qualify under one of these exceptions, but there is a need to ensure that the appropriate action has been taken.

HMRC now takes the view that SLIPs are liable to pay class 4 NICs because, for there to be a partnership '¨for the purposes of the Partnership Act 1890, the persons making up the partnership (whether general, sleeping '¨or limited partners) will all be "carrying on a business in common with a view '¨of profit".

In addition, section 15 of the Social Security Contributions and Benefits Act 1992 imposes no requirement that partners have to be active in the business.

Class 4 NICs are assessed annually, but because HMRC announced its revised view towards the end of the 2012/13 tax year, SLIPs should account for class 4 NICs liability, if any, for the 2013/14 tax year of assessment and for subsequent tax years. Losses from earlier years, which have not yet been set against profits chargeable to class 4 NIC, can be brought forward and set against class 4 NICs profits from the same trade.

There are many new partnership start-ups, possibly from a sole trade and consideration must be given to:

• asset pooling - application of Jenkins v Brown to partnership

• contributing assets - ring-fencing assets in the partnership;

• transfers of interests in partnerships and stamp duty land tax.

'¨If an elderly sole-trader farmer expands to a partnership to help with the running of the farm and diversified activities, has the potential loss of 50 per cent BPR been considered?

Changing capital shares

Often, farming families will change the capital accounts ownership of the farm and therefore the ownership of the capital of the partnership assets, not realising that this does actually trigger a CGT liability. The change in capital shares is a disposal for CGT purposes, and needs to be recorded and disclosed. There are many opportunities to mitigate liabilities that arise from such disposals, for example claiming capital losses on a milk quota.

Budget 2013

The 2013 Budget did look closely at changes to partnership income and profit shares, and it is generally considered that where profit shares are being revised just to manipulate tax savings, this will be stopped by HMRC.

However, many farming families will change the profit shares on a month-by-month or year-by-year basis, depending on what is happening in the partnership and who is contributing the most. This is particularly common with elderly partners, whose ability to contribute decreases over time.

It is generally considered that provided the partnership agreement allows for this flexibility, and is based on fact, that the profits and losses can be revised to reflect these changes, which are driven by age, time of year, and nature of farming, etc.

Many farms operate through the trading vehicle of a partnership. It is essential to review this structure, making sure it is the most efficient, that the legal agreements are all in place with regard to both partnership agreements and wills that support these, and that consideration is given to an LLP, corporate partner or '¨a service company.

This is all against the backdrop of uncertainty over the CAP Reform and many farmers are anxious not to change the nature of their business because of the potential impact on future single farm payment entitlements.

Julie Butler is a partner in Butler & Co. She is the author of Tax Planning for Farm and Land Diversification, Equine Tax Planning and Stanley: Taxation of Farmers and Landowners