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Private equity houses and professional services firms may be on the hook for hundreds of millions of pounds after the UK’s tax authority launched a crackdown on businesses that operate as limited liability partnerships.
HM Revenue & Customs is already probing firms and could potentially seek backdated contributions, tax experts and other people involved told the Financial Times.
Firms argue that HMRC has unexpectedly changed its approach to “salaried member” tax rules that affect businesses operating as LLPs, those people added. Unless HMRC softened its approach, firms affected by the changes were expected to mount a legal challenge, people involved said.
Businesses that may be affected by the change in treatment include US private equity groups including Blackstone and Carlyle Group, among others. Other professional service sectors including some law firms and accountancy businesses may also potentially fall within its scope. Firms that are targets of the probes are confidential.
Blackstone and Carlyle declined to comment.
HMRC’s change had come “seemingly out of a clear blue sky” according to Mike Hodges, partner at Saffery, an accountancy firm. He added that the amount of potential additional liability would be “significant”.
“There could be big numbers as by definition you’re talking about members of the LLP, who are likely to be among the highest earners and earning high amounts — so a significant employers’ National Insurance contribution.”
The LLP crackdown comes as industries including private equity are already grappling with the prospect of higher tax rates if a Labour government wins the general election on July 4.
Labour has pledged to increase the rate of tax that private equity executives pay on carried interest — the share of the gains dealmakers receive when assets are sold — and to reform the tax regime for wealthy non-doms.
HMRC is currently probing whether some LLPs have misclassified some members as self-employed and paid less tax as a consequence. Rules introduced in 2014 laid down criteria to judge whether individuals were either self-employed or employees — in which case, firms would need to pay National Insurance contributions, currently set at 13.8 per cent of employee income. Prior to 2014, LLP members were generally accepted as self-employed.
One of the conditions of those rules includes whether a member’s capital contribution to the partnership is less than 25 per cent of their profit share. If so, they are deemed an employee.
That has meant partnerships have tried to ensure partners’ capital contributions always exceed the 25 per cent threshold so as to avoid salaried member status.
One lawyer conceded that there had been “abuse” of the system by some firms.
HMRC changed its internal guidance in February and has stated that purposefully failing the condition by making excessive capital contributions could fall foul of tax-avoidance rules.
Jitendra Patel, tax principal at BDO, an accountancy firm said: “They’re effectively saying if you contribute capital to get out of the salaried member rules then that’s tax avoidance. It’s almost like a bit of a trap, in which you’re caught even if you risk your own money to try and comply with the rules.”
HMRC’s move has drawn a backlash from affected sectors and their trade bodies.
The British Private Equity and Venture Capital Association and the Law Society both recently held talks with tax officials on behalf of some of their members who had raised concerns, people familiar with the matter said.
“It is vital that any changes which have an impact on this are forward-looking and made in ways — both in terms of process and substance — that promote the competitiveness of our financial services sector, rather than put it at risk,” Michael Moore, chief executive of the BVCA, told the FT.
The Law Society said it “strongly disagreed” with the change and asked for it to be withdrawn.
It added: “Any changes should be made, if at all, following a proper public consultation exercise and should certainly not have retrospective effect.”
Guy Sterling, partner at Moore Kingston Smith, added: “It is important that individuals can continue to capitalise their business as required so that these businesses do not go to the wall.”
HMRC said: “We updated our guidance in February to clarify the circumstances where particular avoidance rules would apply, to help customers get their tax right.”
HMRC added that it “regularly” reviewed its guidance and was “committed to listening to stakeholders’ concerns”.
Additional reporting by Michael O’Dwyer, Simon Foy and Suzi Ring in London.
