Consultation on LLPs
Increased tax transparency - an ever shrinking world
Taxation of ‘trail commission’ to investors
R&D Tax Relief Are you claiming?
25% tax charge on benefits conferred through trusts and LLPs
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Our tax newsletter for the asset management, investment banking and broking industry
Consultation on LLPs On 20 May HMRC released their open consultation on the tax rules applicable to partnerships, a move first alluded to in the Budget 2013 and a step that will undoubtedly get the attention of many in the industry given that, for many, partnerships have become the preferred entity of choice in the UK.
The proposal focuses on two aspects which HMRC believe result in unfair tax advantages for businesses operating through LLP structures.
(a) has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
1. Removal of the Presumption of Self Employment The first aspect is the removal of the presumption of self employment to tackle disguising of employment relationships within an LLP and the introduction of tests to evidence self employment. An advantage may be obtained by members of LLPs over employees as employment related National Insurance Contributions (NICs) are not paid and there is a cashflow advantage as income tax is not deducted at source. The consultation proposes that if an individual meets either of the two conditions below they will be considered to be an employee:
(b) is not entitled to a share of the profits; and
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1. A “salaried member” of an LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership.
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2. A “salaried member” of an LLP includes an individual member of the LLP who does not meet the first condition but who:
(c) is not entitled to a share of any surplus assets on a winding-up. The first condition is assessed by reference to normal employment status tests such as whether there is right of control over what, where, when and how the individual undertakes their work, the basis and method of payment, provision of holidays, sick pay, pension arrangements, etc. The second condition is a more subjective test and this is recognised by HMRC in their discussion of this test when they say that risk or entitlement will be ignored if, having regard to circumstances and economic rewards, it is insignificant. For example, a member receiving a guaranteed salary of £200,000 irrespective of profits or losses of the business and not being required to repay drawings taken if profits are insufficient will be considered to be an employee.
FOCUS ON TAXATION May 2013
Consequently, if one of the above conditions is met, the individual will be considered to be an employee and not self employed and Class 1 NICs will be due. Furthermore additional complications could arise where an employment relationship is deemed as this would also place such individuals within the remit of the notoriously complex disguised remuneration provisions and the employment related securities legislation. 2. Manipulation of profit or loss allocations The second aspect aims to counter the manipulation of profit and loss allocations to achieve a tax advantage. There is currently a difference between corporate and income tax rates in the UK.This is coupled with the fact that members of LLPs are not taxed on amounts drawn from the business but on profits or losses allocated to them which may differ significantly to effort or capital contributed. Despite recent steps to address perceived avoidance in the area by extending the close company rules, HMRC clearly feel additional changes are required.
HMRC considers those businesses who have structured themselves as LLPs with corporate members to have obtained an advantage over those LLPs without corporate members...
The consultation identifies three distinct situations that they plan to address: 1) LLPs with mixed members where profits are allocated to the member that pays the lowest rate of tax; 2) LLPs with mixed members where losses are allocated to the member that pays the highest rate of tax; and 3) LLPs where profit entitlements are reduced in return for payment made by members who will be taxed more favourably. The proposal specifically mentions profit deferral arrangements whereby profits are allocated to a corporate member which has no material impact on the profitability of the business. HMRC recognises that there are regulatory requirements to operate deferral or clawback but states that these are exceptionally applied although this might change in the future. Whilst referencing AIFMD clearly HMRC have not provided any guidance on their thoughts. Precisely how an LLP business operating above or on the cusp of the AIFMD de minimus limit is expected to plan at present is unclear and disappointing given the imminent arrival of the regime in July. Retention of working capital to finance growth is also specifically mentioned in the consultation and many regulated firms allocate profits to a corporate member to fund increasing regulatory capital requirements. HMRC considers those businesses who have structured themselves as LLPs with corporate members to have obtained an advantage over those LLPs without corporate members or companies as they are able to obtain cheaper working capital and not pay employment taxes. This is disappointing as it is equally possible for partnerships to add a corporate member and doesn’t acknowledge there will be a further tax charge when profits are extracted under law. A business should be entitled to structure itself however it sees fit and there is
nothing preventing a business structuring itself as an LLP with a corporate member if commercially that works for them, indeed where part of larger corporate groups, not allowing for this appears unfeasible. To counteract the perceived advantages, where an LLP has both members liable to income tax and members not liable to income tax, and it is reasonable to assume the main purpose, or one of the main purposes, of the LLP profit sharing arrangements is to secure a tax advantage, HMRC will reallocate profits depending on the economic connection between the members. For example, where the individual was a 50% shareholder of the corporate member and the corporate member was allocated £100,000 of profit, the individual would be assessed to income tax on an additional £50,000, reflecting their interest in the corporate member. The economic connection may not be as simple as shareholding but can also include arrangements documented in side letters or deferral arrangement when amounts vest. Where an LLP has both members liable to income tax and members not liable to income tax and it is reasonable to assume the main purpose, or one of the main purposes, is to allocate a loss to a member with a view to them obtaining a reduction in their tax liability, then no relief will be given for that loss. Finally, where a payment is made to the LLP or to a member in return for a share in profits in order to obtain a tax advantage, then the payment received will be considered to be income in the hands of the member transferring their rights or connected persons. Targeted anti-avoidance rules will be introduced in Finance Bill 2014 when the proposals are due to be enacted to ensure that careful crafting of LLP Agreements does not conflict with the substance of the arrangements. Interestingly HMRC makes reference to the application of GAAR which they state may apply in some circumstances but admit that the flexibility to allocate profits and losses is currently permitted by legislation. The closing date for comment on the consultation is 9 August 2013 with rules to be introduced in the Finance Bill 2014 and to take effect from 6 April 2014. There will be no grandfathering of arrangements entered into before 6 April 2014. Given the gravity of the proposed changes we will be responding to HMRC’s proposals and will update you on further developments. In the meantime, it is important to remember that this is only a consultation and the proposed rules are by no means certain. Firms should take stock of their current arrangements, identify where the presumption of self employment may be weak, consider the profit allocation methodology applied and whether there are tax advantages obtained that may require reconsideration if HMRC’s proposals pass into law in 2014. Marie Barber
FOCUS ON TAXATION May 2013
Increased tax transparency - an ever shrinking world Following the criticism of high profile companies such as Apple, Google, Amazon and Starbucks and deals being struck between jurisdictions to exchange information, barely a day goes by without a new story talking about tax transparency making the headlines. In a personal tax context, one only needs to read the 2013 offshore evasion strategy published by HMRC on 20 March 2013 to understand just how tough a stance the Government is taking on offshore evasion. In April 2009, the G20 leaders declared that the era of banking secrecy was over. OECD Member States perceive increased tax transparency for individuals as going hand in hand with the ability to combat tax evasion. An example of the importance the OECD places on increased tax transparency and combating tax evasion is the mandate it has given to the Global Forum on Transparency and Exchange of Information for Tax Purposes to conduct peer reviews of the 120 Member States of the Global Forum against the internationally agreed standard for transparency and exchange of information. The international standard is based on OECD and UN Model Tax Conventions and is focused around three elements, namely: 1) the availability of information; 2) the access to information; and 3) the exchange of information with safeguards to protect confidentiality. G20 finance ministers highlighted at their April 2013 summit that they considered the international standard to be the automatic exchange of information, although it is understood that not all countries have adequate infrastructure in place to automatically exchange information. Accordingly, all jurisdictions are encouraged to sign or express interest in signing the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, building on existing frameworks like the EU savings directive. The drive by OECD Member States in targeting overseas tax evasion is evidenced by the introduction of the US’s FATCA regime which squarely seeks to impose US compliance requirements beyond their own borders. With many leading tax administrations likely to follow suit this is surely a sign of things to come. At the UK level, HMRC entered into an agreement with the Principality of Liechtenstein in 2009 following a number of well publicised data thefts. This resulted in the introduction of a Taxpayer Assistance and Compliance Programme, a Tax Information Exchange Agreement and a tax disclosure facility in the UK, the Liechtenstein Disclosure Facility. In October 2011, the UK and Swiss Governments signed a similar agreement to cooperate on tax matters; however, this sought to protect anonymity. Following in this theme, the UK government made Budget announcements earlier this year to introduce similar bilateral agreements with Guernsey, Jersey and the Isle of Man. On 25 April 2013, the Cayman Islands communicated to the UK Government that it was committed to joining the G5 pilot recently announced by the UK,
France, Germany, Italy and Spain, on multilateral automatic exchange of tax information. On 2 May 2013, it was also announced that Anguilla, Bermuda, the British Virgin Islands, Montserrat and the Turks & Caicos Islands had signed up to the same G5 pilot, such that each territory would automatically exchange information bilaterally with the UK and multilaterally with France, Germany, Italy and Spain. In recent weeks, it was reported that David Cameron wrote to 10 territories and Crown dependencies, encouraging them to increase the level of tax transparency in the global fight against tax evasion. In short, increasing pressure is being placed on jurisdictions with perceived shortfalls regarding tax transparency to combat overseas tax evasion. The personal risks associated with individuals holding untaxed assets can be particularly significant. HMRC is mounting many serious tax investigations under Code of Practice 9 and, in the most extreme cases, conducting criminal investigations. The Finance Act 2010 introduced new offshore penalties of between 30% and 200% of the additional tax, dependent on the relevant jurisdiction. Bearing in mind the risks associated with holding untaxed assets, individuals in such a position are strongly advised to speak to a tax adviser in order to identify personal tax issues, determine which facility would be the most appropriate and seek assistance with the disclosure process in order to build a compliant platform for the future. These tax information exchange agreements are also particularly relevant in the context of alternative investment funds. For AIFMD purposes, one prerequisite under the Third Country Passport regime (due to come into effect at the earliest in Q3 2015), is that tax information exchange agreements exist between the EEA Member States in which the fund is intended to be distributed and both 1) the jurisdiction in which the fund is established, and 2) the jurisdiction in which the manager is established. This AIFMD driven requirement is forcing non EEA jurisdictions with significant financial centres to sign up to increased tax transparency, or run the risk of being sidelined in the distribution of alternative fund products into EEA Member States. Global fiscal policy is moving towards ever more tax transparency. Taxpayers with unresolved tax issues are advised to take action to bring such matters into check at the earliest possible opportunity. The message from Governments around the globe is that uncovering non compliance is simply no longer a question of if, but when. Antoine Housden
The drive by OECD Member States in targeting overseas tax evasion is evidenced by the introduction of the US’s FATCA regime which squarely seeks to impose US compliance requirements beyond their own borders
FOCUS ON TAXATION May 2013
Taxation of ‘trail commission’ to investors On 25 March 2013 HMRC published Revenue & Customs Brief 04/13 providing guidance with regard to their view on the tax treatment of payments of ‘trail commission’ on investment products in the UK.
The move was intended to clarify existing legislation rather than introduce a new regime, but for many, the move raised more questions than it answered, creating some unintended consequences in the meantime. The announcement stated that certain trail commissions passed on to investors as rebates in collective investment schemes and other investment products could be considered to be annual payments subject to income tax. As such HMRC would expect that under existing legislation where located in the UK those entities paying the rebates would deduct basic rate tax at source and investors would include such payments in self-assessment returns for 2013/14 onwards. HMRC has invited comments on its draft guidance by 30 June 2013.
HMRC argues that trail commissions meet each of these characteristics of annual payments and are therefore a withholding tax requirement exists.
Arrangements whereby all or part of any trail commission is paid by a UK fund manager to an investor, either directly or via other intermediaries who use it to meet the liabilities of, or provide a benefit to the investor, could impose a withholding tax requirement on the UK fund manager. This typically happens as a result of an agreement between the investor and the fund platform, although it could be as a result of an agreement between the investor and their adviser or the fund manager. Such payments usually originate from the annual management charge paid by the collective investment scheme to the fund manager. HMRC states that there has been a misconception by some in the industry that such payments are not taxable in the hands of the investor and no withholding tax requirement existed, however this is not HMRC’s interpretation. They have confirmed that they will not seek to collect withholding tax on past payments from those arising before 6 April 2013, however, thereafter they consider that where payments fall within the definition of an annual payment a fund manager should be withholding basic rate tax. ase law has established four essential characteristics C for a payment to be an annual payment: • The amounts must be paid under a legal obligation; • The payments must be capable of recurrence; • The payments must be income, as opposed to capital, in the hands of the investor; and • The payments must represent ‘pure income profit’ of the recipient. HMRC argues that trail commissions meet each of these characteristics of annual payments and therefore a withholding tax requirement exists. Industry bodies, such as AIMA and the IMA, have engaged in discussions with HMRC on whether the payments
made under such arrangements constitute a ‘pure income profit’ i.e. they come to the recipient without them having to do anything in return. HMRC has stated that they recognise that payers will need to make new arrangements to allow them to deduct basic rate Income Tax from such payments and accept that this may not be possible for payments made at the start of the tax year commencing 6 April 2013. To allow for this short implementation period HMRC will accept an approximation of the tax deducted at source up to the end of the calendar year 2013 providing that this is as accurate as reasonably possible and that the payer makes arrangements to update systems by the end of 2013. A significant point of concern raised within the industry was that the proposed legislation could inadvertently affect non-UK resident investors in an offshore fund to whom a fee rebate is paid by a UK manager. This arises as the territorial scope of the annual payments legislation imposes a withholding tax requirement where the payments are deemed to be UK source income. In a written ministerial statement made on 21 May 2013 the Economic Secretary to the Treasury recognised this error. In their statement the Government agreed that by imposing a requirement to withhold tax for offshore investors could have negative implications on the international competitiveness on the UK funds industry and that the legislation would therefore have to be amended. Given that this release has run parallel to the Government’s recent launch of the UK’s investment management strategy we would hope for greater consultation and forethought in the future. To rectify the issue, the Government published two draft statutory instruments on 29 May to remove the duty to withhold tax from rebates where these payments are made to investors who are not UK resident for tax purposes. Responses are requested on the draft instruments by 25 June. Although the drafts have no prescribed date to come into force, they do appear to have effect for the tax year 2013/14 onwards suggesting they apply from 6 April 2013. This will be a welcome move if it removes an interim period of doubt, as is hoped, which would otherwise arise from 6 April 2013 when the instruments are enacted. In any case, UK based fund managers should review their contractual agreements and seek advice on how they may need to implement a withholding regime for UK investors or restructure their affairs in light of the proposed legislation. Priya Mukherjee
FOCUS ON TAXATION May 2013
R&D Tax Relief - Are you claiming? Economic growth is key to the recovery in the UK. The coalition Government is clearly placing their faith in UK businesses to drive that growth, a cornerstone of which is the investment and development of world leading design and technologies to give the UK a competitive advantage in the global economy. Key to this policy is the generous R&D Tax Credit scheme; however it is surprising that relatively few businesses in the investment management sector have sought to make claims despite many hiring scientists, mathematicians and technology experts. The tax relief operates by encouraging companies to invest in R&D activities by providing additional relief on qualifying R&D costs. Relief is available to all businesses both large and small, but it is the relief afforded to small and medium sized enterprises (SMEs) that offers the largest savings. Currently a tax deduction of up to 225% may be claimed, however many companies that may be entitled to the relief are not claiming this deduction. The main reason for this seems to be that R&D instantly conjures up, for many, images of men in white coats performing extensive scientific research. However this is not the case and many projects could qualify as R&D. As you may expect, the pharmaceuticals and biotech industries are the top two claiming industries, however it may be a surprise to some that banking and financial services are in the top five claiming industries. For some this could be a major relief, especially hedge fund managers, many of whom develop their own bespoke trading systems and technologies. Although there are no definitive rules for what qualifies for the relief the key criteria for any project is that it must seek to achieve “an advance in science or technology” through the resolution of “scientific or technological uncertainty.” For any development project that a business embarks upon where there is an element of uncertainty there is a possibility the work may be eligible for R&D. Technological uncertainty is an interesting concept and is where most managers may qualify. Where managers are trying to combine different technologies to resolve an uncertainty it may well qualify as R&D. Additionally the design and development of new trading algorithms may also qualify. In practice tax specialists, be they advisors or at HMRC, are typically only ever going to understand a fraction of the real detail in an R&D
project so much relies on whether the individuals undertaking the work believe their activities qualify. For SMEs the 225% relief is given as enhanced deduction within the tax computation. By way of example if a company has spent £100,000 on a R&D project they will be entitled to a £225,000 deduction in their tax computation. Loss making businesses can either look to carry the additional loss created by the relief forwards, back a year and in some cases sideways through group loss relief claim. Alternatively they can seek to surrender the loss and receive a direct cash payment, currently 10% of the enhanced expenditure i.e. the £225,000 above would result in a cash payment of £25,000 from HMRC, a particularly useful addition to the cash flow of a start up business in the early years, albeit lower than the value of the loss if used to offset profits. Although the relief is only available to companies and not LLPs, the inclusion of a company, to incur the costs, in an LLP structure should be a relatively straightforward process, however, the recent LLP consultation may require that services be provided under a specific contract between the LLP and Ltd in order to utilise the relief effectively. Nonetheless, the support the current Government has given to the scheme in recent years by increasing the relief suggests that it is here to stay in the long term. This provides the kind of certainty that justifies taxpayers arranging their affairs in such a way that they are able to claim all appropriate relief. Preparing a successful claim can be an involved and time consuming exercise. It requires that eligible projects and qualifying activities are appropriately presented to HMRC in the context of the industry and legislation. As such, technical advice from experienced professionals is recommended to both secure and maximise the relief. Businesses that undertake R&D activities should investigate how a claim may be constructed and the potential benefits for their business. James Henry
25% tax charge on benefits conferred through trusts and LLPs On 28 March the draft Finance Bill 2013 was released in the UK setting out the full detail of the proposed legislative changes announced in the Budget 2013 in relation to benefits. Of particular interest are the proposed changes to Part 10 of CTA 2010 relating to the taxation of close companies. The existing legislation focused on the loans and advances being made to participators of close companies, but the proposed amendments, which are applicable from 20 March 2013, now include
two new scenarios. These are where a close company makes a loan or advances money to: Continued over
For any development project that a business embarks upon where there is an element of uncertainty there is a possibility the work may be eligible for R&D.
FOCUS ON TAXATION May 2013
1) the trustees of a settlement, one or more of the trustees or actual or potential beneficiaries of which is a participator in the company or an associate of such a participator, or 2) a limited liability partnership or other partnership, one or more of the partners in which is an individual who is a. a participator in the company, or b. an associate of an individual who is such a participator In such scenarios if the close company is deemed to be party to a tax avoidance arrangement which confers a benefit through a trust or LLP, either directly or indirectly, to a participator of the close company or associate of such a participator then a charge equal to 25% of the benefit conferred will arise. This charge will rest with the close company. The legislation is in draft format and will formally be enacted following Royal Assent sometime over the summer. Given the wide use of LLP structures in the investment management industry, most of whom have a corporate member, where a profit allocation has been received then this matter may require further investigation. Additionally, with many businesses using trust structures to hold investments and possibly defer remuneration for regulatory purposes, managers may have found an unwelcome tax charge has now been imposed. Key to determining whether the legislation applies is resolving what HMRC regards as a close company. This is a notoriously complex area of the UK tax code, but generally speaking it is a UK resident company that is controlled by five or fewer participators. Participators are generally shareholders, or persons that have some kind of stake in an entity be it economically or through management control. Where a company is a subsidiary of another company or companies then those companies are themselves tested with the same close
company tests as the legislation attempts to pierce the corporate veil to look through to the ultimate beneficiaries. Importantly, it is at this stage the requirement for the entity to be UK resident is disregarded. Typically to arrive at a conclusion an analysis may require multiple layers of investigation before a conclusion has been met. Where a close company has been identified operating in a manner such that one of the two scenarios would apply and assuming that HMRC would regard it as taking part in a tax avoidance arrangement, the next step is to identify where any benefit has been conferred and whether those parties in receipt of it are participators or associates to participators. Where the close company analysis has been undertaken it will typically be relatively clear who are participators, however, identifying their associates widens the scope of the legislation further still. This requirement will catch many scenarios as being a partner in a partnership with a participator will deem an individual to be an associate of that participator, which is just one amongst many possible links. Given the prevalence of 31 March year end accounting dates, the timing could not have been worse, with the detail being released on the Thursday before the Easter weekend. It would be cynical to suggest that the timing was deliberate, but in any event the effective date of 20 March places the impact in to 2012/2013 fiscal period which for some may create issues. Keen eyed auditors will need to get comfortable that a 25% tax liability is not lurking off balance sheet. If this legislation creates an issue that a business needs to address they should seek advice in advance of any benefits being conferred. It should be noted that this is separate to the LLP consultation released on 20 May which is in draft form only. The close company legislation is in force and now is the time to act.
Contacts If you have any questions regarding articles in this issue, or for further information, please contact the relevant person: TAX ADVISORY Stephen Rabel t: +44 20 7862 0814 e: [email protected]
Claire Mascarenhas t: +44 20 7862 0834 e: [email protected]
Marie Barber t: +44 20 7862 0811 e: [email protected]
Winnie Tsui t: +852 2281 0117 e: [email protected]
Michael Beart t: +44 20 7862 0888 e: [email protected]
Antoine Housden t: +41 22 715 2846 e: [email protected]
Editor e: [email protected]
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The opinions expressed herein are those of the authors and other contributors and do not necessarily reflect the views of the Firm. This is not intended as specific legal advice for any purpose. Kinetic Partners, established in March 2005, is an award winning global professional services firm focussed exclusively on the financial services industry. Kinetic Partners LLP is registered in England and Wales, company number OC311318. Kinetic Financial Services (Ireland) Limited is registered in the Republic of Ireland, company number 400790. Kinetic Partners US LLP is registered in Delaware. Kinetic Partners Cayman LLP is registered in England and Wales, company number OC314982. Kinetic Partners Audit LLP is registered in England and Wales, company number OC312728. Kinetic Partners (Switzerland) SA is a société anonyme registered with the Registre du commerce, Genève, Suisse. Kinetic Partners Risk and Valuation Services Ltd is registered in England and Wales, company number 7028150. Kinetic Partners (Malta) Limited, registered in Valletta, Company Number C45147. Kinetic Partners Risk & Valuation Services (Malta) Limited, registered in Valletta, Company Number C48854. Kinetic Partners (Cayman) Limited, registered in Grand Cayman, Company Number 214564. Kinetic Partners (US) Limited, registered in Delaware. Kinetic Partners Audit Malta Limited, registered in Malta No. C-52626. Kinetic Partners (Hong Kong) Limited is registered in Hong Kong, company number 1565797. Kinetic Partners (Luxembourg) Sarl is registered in Luxembourg, company number B 112.519. Kinetic Partners (Channel Islands) Limited is registered in Jersey, company number 110351.