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HMRC internal manual

Business Income Manual

Business Income Manual: Computing the amount to assess: Mixed Membership Partnerships: Excess profit allocation: Condition Y: Is the profit share influenced by the power to enjoy?

ITTOIA/S850C(3)(c)

Where the “power to enjoy” requirement is met, then for Condition Y to apply it must also be reasonable to suppose that the non-individual’s profits are higher than they would otherwise have been because of the individual’s power to enjoy them.

  • Reasonable to suppose means that you take a realistic view of the facts and use a balanced common sense approach.
  • Reasonable to suppose does not mean that it has to be certain.
  • Reasonable to suppose means you should ignore an improbable or extreme outcome.

 

If one or more individual members own the corporate member, and the corporate member is allocated any residual profit, after the individuals have been allocated a share, then it is reasonable to suppose that the corporate member would not have received this profit but for the power to enjoy.

The individual may have an interest in the non-individual partner but this may be so small that it is clear that on a realistic view of the facts the profit share has not been affected.

*Example 1 *

This example looks at where an individual member has a small investment in a corporate member such as a quoted company.

*MMM LLP has as members, A, B and C, together with X Plc, which is a listed on a major exchange. A has a small investment in X Plc as part of a share portfolio. B has a small investment as she used to work for X Plc and received the shares under an incentive scheme. There are no other arrangements by which they can benefit from the profit share of X Plc *

It would not be reasonable to suppose that the profit share of X Plc has been increased because A and B have shares. Their holdings are such that they could not have influenced the allocation of profits to X Plc.

The crucial factor for the mixed membership partnership legislation to apply is that there has been a diversion of profits from an individual to a non-individual member. Profits of a non-individual member can only be reallocated to an individual member to the extent that it is reasonable to suppose that those profits are attributable to the individual member’s power to enjoy them. This is to be determined on a just and reasonable basis.

*Example 2 *

This example looks at where an individual assigns part of their interest in the LLP to their company.

*O is a member of ON LLP. He sells part of his interest in the LLP to his company ONO Ltd, which becomes a member of ON LLP. *

*Following the sale, O’s share of the profit is reduced, and what he terms an “equity profit” is allocated to ONO Ltd. *

ON LLP is a mixed membership partnership. ON Ltd provides no services or capital to ON LLP so the appropriate notional profit is NIL.

It is reasonable to assume that ONO Ltd is receiving this profit because of O’s power to enjoy and profits should be reallocated accordingly.

If O withdrew from the partnership to prevent the mixed membership rules from applying then he would continue to be taxed as a partner as a result of S850D, with the excess allocation to the company then being treated as his profit share.

*Example 3 *

This example looks at a situation where there are a number of corporate members.

*X LLP has individual members D, E and F together with three companies D Ltd, E Ltd and F Ltd. D is the 100% shareholder of D Ltd. E is the 100% shareholder of E Ltd. The shareholders of F Ltd are F and his spouse. *

*Prior to the admission of the three corporate members D, E and F shared profits 60:20:20 and following the admission of the corporate members their individual profit share entitlements are each reduced by the amount allocated to their respective companies. D Ltd, E Ltd and F Ltd are not entitled to any profit share if D, E and F respectively cease to be LLP members. *

The profit shares of D Ltd, E Ltd and F Ltd are attributable to D, E and F respectively. It is reasonable to ascribe direct causal connection between the profit share allocated to D Ltd (for example) and D’s status as a member of X LLP and shareholder in D Ltd. It is also clear that D’s profit share (for example) is lower than it would have been had he not been shareholder in D Ltd with ability to access the profit share allocated to D Ltd.

*Example 4 *

This is a general example looking at what happens under the new legislation when individuals use a corporate member to defer paying tax.

*The membership of ABC LLP consists of three individuals, A, B and C, who decide that they want to retain funds in the LLP for working capital. In order to avoid the retained profits being taxed at higher income tax rates, they introduce a corporate member, ABC Ltd, which is fully owned by A, B and C. *

*ABC Ltd does not provide any services and only a nominal amount of capital. *

*A, B and C work out what they wish to draw personally and allocate the balance of the profit to ABC Ltd. The profit share allocated is invested or retained in the partnership by the company member as additional partnership capital or advances. *

The individual members meet the enjoyment conditions in relation to the sums allocated to their company.

The three individual members are taxed on an additional profit, split on a just and reasonable basis, equal to the profit share allocated to ABC Ltd, less a sum that represents an appropriate notional return on the nominal amount of capital introduced by ABC Ltd.

It is also likely that this is an arrangement that has a main purpose of securing corporation tax treatment of the profit. It is also possible that Condition X (profit deferral) applies see BIM82740.

*Example 5 *

This is a further general example where an individual diverts profits through a company owned by a close relative.

*D is a member of DEF LLP. With the agreement of the other members, D introduces as a member, D Ltd, a company that is owned by his wife. D continues as a member, only now he does some work for the LLP through D Ltd. D Ltd provides only a nominal amount of capital. *

*The only change is that the profit share, previously allocated to D, is now allocated partly to D himself, but mainly to D Ltd. *

D Ltd is owned by the wife of D, so a connected person is in a position to enjoy the profits of D.

D is taxed on an additional profit equal to the profit share allocated to D Ltd. Whilst D Ltd is providing services to DEF LLP, the reality is that the work is such services as are being provided by D, another member. These services are ignored in determining the appropriate notional consideration for services. D Ltd provides no other services, so the appropriate notional consideration for services is nil.

Example 6

This example looks at the question of whether the profit share is influenced by the power to enjoy.

G is a member of GHIJ LLP. Since it was formed in 2007 there have been two corporate members. H Ltd is owned by, and provides the services of, H, the sister of G. H has never been a member. GG Ltd is owned by trustees on behalf of the grandchildren of G.

G has the power to enjoy for both H Ltd and GG Ltd. The question is whether the profit shares are influenced by the power to enjoy.

In the case of H Ltd, the facts show that H is working for the LLP and all profits allocated to H Ltd properly reflect that work. The profit share is not affected by the power to enjoy and the legislation does not apply to H Ltd’s share of the profit.

In the case of GG Ltd, the profit share is influenced by the fact that G wants the money to pass to his grandchildren. The excess profit allocation rules apply to the profit share, and G will be taxed on the profit share, subject to any notional profit.