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When the General Anti Avoidance Rule came into force this year, there were a few charming ingénues who thought it might herald an end to the era of continuous legislative tinkering by HMRC. They will be sorely disappointed, as a new targeted anti avoidance rule aimed at artificial profit allocation within partnerships emerged in the autumn statement. This raises the interesting question of what the point of the GAAR is if it is not going to be used, but that is a subject for another day.
The new targeted anti avoidance rule (“TAAR”) aims to prevent what has become near standard practice in highly profitable partnerships, the allocation of profits earmarked for reinvestment to a corporate partner. Indeed, avid readers of the Roythornes Agri E-brief will remember that we discussed such a business structure in our Michaelmas E-brief last year.
The logic behind this kind of profit allocation is fairly straightforward. A company will pay only corporation tax whilst an individual will pay income tax, more than likely at the higher rate. Allocation of profits to a company thus preserves more money for the business in the short term. Of course, such a structure is not tax avoidance in the true sense since, on any distribution of profits from the company to individuals, there will likely be a further tax charge, so the advantage is usually one of timing only. Nevertheless, the arrangement has attracted the ire of HMRC, hence the new rule.
The draft legislation allows HMRC to reallocate profits back from a company to an individual where:
This reallocation would make the profits subject to income tax on the individual, thus negating the tax saving by allocation to the corporate partner.
So what is excessive? In the draft legislation, an excessive profit allocation is one that exceeds the aggregate of a market rate of interest on capital and a fair arm’s length price for services rendered by the company to the partnership as a whole.
In the most straightforward of cases, therefore, where a partnership contains a corporate member that is controlled by the partners and does nothing other than act as a warehouse for profits, the rule will certainly apply.
All is not lost, of course.
First, in many cases where a partnership has a corporate member, that member will exist for sensible non-tax reasons such as to act as a service company providing a vehicle for employing workers with the benefit of limited liability. In these cases, a fair arm’s length price for the services rendered by the company will allow a sensible level of profits still to be allocated to the corporate partner without them being considered ‘excessive’.
Second, the draft legislation does not just affect farming. It will also have a serious impact on large accountancy and other professional services firms which employ a mixed partnership model. The larger professional firms are almost certainly already lobbying hard for the dilution of the new measures. So we must wait to see whether they make it into the next Finance Act unscathed.
Roythornes has a wealth of experience in advising farms and estates about their legal structures. If you have any questions at all about the issues raised in this article, get in touch with your usual contact, or call Robert Webb, 01775 842621