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HMRC internal manual

Business Income Manual

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HM Revenue & Customs
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Partnerships - loss relief restrictions: LLP members

S107-S109 Income Tax Act 2007; SI 2005 No 2017

All members of limited liability partnerships (LLPs) established under the Limited Liability Partnerships Act 2000 (see BIM82110) are subject to restrictions on the extent to which they can set their share of trading losses made by the LLP against their other income or capital gains.

From 10 February 2004 there are more stringent restrictions for non-active LLP members in early years of trading, see BIM82640. The guidance below applies to all other LLP members and to non-active LLP members in later years of trading.

Limit of relief

A comparison has to be made between:

  • the total amount of sideways loss relief (see BIM82601) in respect of losses from the same trade already allowed together with the relief sought for the year less the total amount of recovered relief (see BIM82610), and
  • the individual’s contribution to the partnership at the end of the basis period for the loss-making tax year.

The total sideways relief must never exceed the contribution to the partnership.

For losses sustained by a non-active LLP member on or after 2 March 2007 (whether in an early year of trading or in a later year) the £25,000 annual limit for sideways loss relief also applies, see BIM82611.

A loss arising from relevant tax avoidance arrangements entered into on or after 21 October 2009 is subject to the general restriction of relief for tax-generated losses; see BIM85761 and BIM85762.

Purpose test

Capital contributions paid by a non-active LLP member on or after 2 March 2007 (whether in an early year of trading or in a later year) do not count if the main purpose, or one of the main purposes, for contributing them to the partnership is for the partner to reduce their tax liability through sideways loss relief, see BIM82640.

The purpose test does not apply to any loss derived solely from qualifying film expenditure. See BIM82610.

The purpose test does not apply to capital contributions made by active LLP members.- or turn it round and say that the purpose test only applies to non active LLP members

LLP member’s capital contribution

An LLP member’s contribution to the LLP at any given time for the purpose of loss relief restrictions is:

  • the amount that the member has contributed to the LLP as capital,

less

  • any withdrawn capital,

less

  • any contribution where the financial cost of making the contribution may not be borne by the partner personally,

plus

  • the amount of the member’s liability on a winding-up.

Withdrawn capital

‘Withdrawn capital’ in calculating a LLP member’s capital contribution at any given time is:

  1. any amount previously drawn out or received back, directly or indirectly, by that time, other than amounts chargeable to Income Tax as a result of being drawn out or received back;
  2. any amount the individual draws out or receives back in the five year period starting with the time at which the amount of the individual’s contribution is being calculated, other than amounts chargeable to Income Tax as a result of being drawn out or received back;
  3. any amount the individual is or may be entitled to draw out or receive back at any time when the individual is a member of the LLP;
  4. any amount the individual is or may be entitled to require another person to reimburse to them.

The five year rule in (2) above is to prevent a member increasing their capital contributions temporarily to inflate the amount of trading losses that they can set against their other income or gains. If the member withdraws any capital from the LLP within five years of the time that their contribution was calculated for loss relief purposes, the extent to which they can claim loss relief is reduced.

There is no specific provision for a tax charge to claw back all or part of the relief already given if a member withdraws any capital from the LLP within five years of the time that their contribution was calculated for loss relief purposes. The ‘discovery’ rules of S29 Taxes Management Act 1970 (assessment where loss of tax discovered) should be used to go back and restrict the original amount of relief given.

Financial cost of contributions not borne by partner

Amounts are excluded from being capital contributions in two further situations:

  • where the partner takes out a loan to finance a contribution, and the loan is on limited or non-recourse terms (for the meaning of `non-recourse terms’ see BIM82655), or the cost of repaying the loan is or may be borne, assumed or released by someone else, or the partner’s loan repayment costs over any period of five years are less than they would be on arm’s length commercial terms,
  • where arrangements are made so that the financial cost to the partner of making the contribution can be reimbursed by someone else.

Further guidance on amounts excluded in these situations is at BIM82655 onwards.

LLP member’s liability on a winding-up

A member’s liability on a winding-up is the amount which:

  1. the individual is liable to contribute to the assets of the LLP in the event of it being wound up, and
  2. the individual remains liable to contribute for a period of at least five years beginning with the time at which the amount of the individual’s contribution is being calculated (or until it is wound up, if that happens before the end of that period).

All LLP members act as agents of the LLP and are not personally liable for its debts. If the LLP becomes insolvent the members’ liability is limited to their investment in the LLP and they cannot be required to contribute to any shortfall out of their private assets. Their position is similar to that of company shareholders.

However, although LLP members are not personally liable under the LLP Act for the debts of the LLP, and are not required by law to contribute to any shortfall out of their private assets, they may have accepted such liability under the terms of an agreement.

Basing the restriction on the amount of the member’s liability on a winding-up, if that is greater than the amount subscribed by the member, was exploited by schemes which accredited to members unrealistically high liabilities in a winding-up, that in practice were never likely to materialise. The restrictions for losses sustained by non-active members of LLPs and by non-active general partners do not therefore adopt this approach, see BIM82640.

Contributions to meet negligence claims

Where a member of a LLP makes a capital contribution to a partnership in order to meet a liability for negligence for which they are personally responsible, that amount is to be taken into account in determining the amount of their capital contribution to the LLP. That member is entitled, provided the conditions for the relief are otherwise met, to relief up to a maximum of the amount of their additional contribution under either the normal sideways loss relief provisions, or under the post-cessation expenditure rules if they have left the LLP or the LLP has ceased business.

Undrawn profits

The undrawn profits of a member of a LLP cannot normally be added to their subscribed capital. This is because, subject to any agreement between them, a member’s undrawn profit is normally regarded as a debt of the LLP. This means that the member ranks, for that sum, alongside the other creditors in the event of liquidation. If however the terms of the agreement between the members specifically provide that the undrawn profit stands as part of a member’s capital contribution and that agreement is unconditional then that amount is added to the contribution of capital above.

Members’ guarantees

Guarantees given by members in respect of money borrowed by the LLP do not count as the contribution of capital.

Members’ loans to the LLP

Loans made by members to the LLP do not count as the contribution of capital.