Business Income Manual: Computing the amount to assess: Mixed Membership Partnerships: Excess profit allocation: Businesses transferred to the partnership: Examples
This section sets out how the excess profit allocation rules, as set out at BIM82855, apply to examples where a company transfers its business to an LLP.
*Example 1 *
This example looks at the basic situation where a business is transferred from a company to an LLP.
*John and Jane are shareholders in a company, S Ltd, which runs a securities trading business. John has 90% and Jane has 10%. Both are highly qualified and work in the business. The company transfers its business to a partnership, S LLP, and it, John and Jane become partners in the business. The partnership agreement provides that 50% of the profits of the firm are paid to the company indefinitely, and the individual partners share the rest of the profit equally (i.e. 25% each). *
S Ltd will be entitled to be taxed on an appropriate notional return on capital (in this case, the value of the assets contributed to the firm).
The question is then whether any profits in excess of this allocated to S Ltd are attributable to John and Janet’s power to enjoy those profits. Given the nature of the business, and the fact that Jane and John are still as actively involved in it as they always were, HMRC would consider that all of the excess profit should be reallocated from S Ltd to John and Janet. This is a ‘people’ business and the profits rely on John and Janet’s continuing involvement in the business. Janet and John control the profit allocation and it is not reasonable to suppose that they would allow profits to be allocated to S Ltd if they did not have the power to enjoy those profits. .
*Example 2 *
This is another example of a transfer of a business from a company to an LLP.
*PeopleCo Ltd is a professional firm that had been trading for many years. A few years ago P, the 100% owner of PeopleCo Ltd decided that he wanted to reorganise the business to motivate his key staff and give them an ownership interest. He also had in mind succession to the business when in due course he retires. Recognising that PeopleCo Ltd was a people business, he set up an LLP, whose members are P, PeopleCo Ltd and the key staff who he hopes will take over the business. PeopleCo Ltd transfers the business to the LLP. *
*PeopleCo Ltd receives the profit share agreed when the business was transferred to the LLP. *
*P remains a member of PeopleCo LLP and receives a personal profit share. *
PeopleCo Ltd will be entitled to be taxed on an appropriate notional return on capital (again, the value of the assets contributed to the firm). The question is then whether any further profits allocated to PeopleCo Ltd in fact reflect the work done by P. As he is continuing to work in the business in the same way as he has done previously, it would be expected that the profits for periods after the transfer should be allocated to him and not to the company.
A helpful way to look at this is to ask whether the profit sharing arrangement between PeopleCo Ltd and the LLP is the same as it would have been had P actually retired, and whether P’s own profit share is commensurate with the work done.
This looks at an example of a transfer of a business from a company to an LLP where the founder is retiring.
*Oldco Ltd had been trading for many years. A few years ago P, the owner of Oldco Ltd decided that he wanted to retire. He set up an LLP, whose members are P, Oldco Ltd and a number of individuals who he hoped would take over the business. The business is then transferred to the LLP and Oldco Ltd is credited with the value of the business as capital introduced. *
*Oldco Ltd receives a profit share. *
*P is working a reduced number of hours in the business and receives a small personal profit share that is commensurate with the work he does. *
The first question is whether the profit share received by Oldco Ltd exceeds the appropriate notional profit. If the profit share is less than the appropriate notional profit then there is no reallocation.
Assuming that there is such an excess allocation the next question is whether this is by reason of the economic connection. It is likely that it is, but if the particular facts show that any economic connection between the individual and non-individual members does not result in profit being shifted from the individual partners to the non-individual, the mixed membership partnership legislation will not apply.
*Example 4 *
This example looks at where a company transfers its business to an LLP some of whose members are minority shareholders in the company.
*Oldco Ltd is a manufacturing firm that had been trading for many years. A few years ago P, the majority owner of Oldco Ltd decided that he wanted to retire. He set up QRS LLP, whose members are Oldco Ltd and a number of unconnected individuals whom he hoped would take over the business, three of whom, Q R and S, were minority shareholders in Oldco, holding 35% of the ordinary shares between them, P holding the remaining 65%. *
*Oldco Ltd receives the profit share agreed when the business was transferred to the LLP. *
*P retires at the time of the transfer of the business and subsequently provides no services to the LLP. *
Q, R and S will potentially receive part of Oldco’s profit shares in the form of dividends. The question is whether the share allocated to Oldco exceeds the notional profit because they are shareholders. The shares in Oldco all carry equal voting rights and rights to a dividend, and P, a non member of the LLP, controls Oldco, holding 65% of the shares. In this case there is nothing to suggest that the connection Q, R and S have with Oldco has influenced the profit-sharing arrangements – in particular, most of the profits flow to an unconnected individual who is no longer a member. The position could be different if P, Q, R and S held different classes of shares with different rights.