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HMRC internal manual

Business Income Manual

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Business Income Manual: Computing the amount to assess: Mixed Membership Partnerships: Excess profit allocation: Takeover of the LLP

Although usually treated for UK tax purposes as a partnership, an UK LLP is a body corporate.

This section looks at where the LLP is subject to a takeover by another body corporate.

The way that the excess profit allocation rules apply to takeovers will vary from case to case, depending on the facts of that case.

It is worth remembering that the principle behind the excess profit allocation rules is that they apply where an individual, or individuals, divert all or part of their profit share to a non-individual member or members, usually a company or companies, in order to reduce tax on their profit share or as part of profit deferral arrangements.

At the same time, the excess profit allocation rules do not apply to mixed membership partnerships in which the individual and non-individual partners are genuinely acting at arm’s length and not intending to defer a profit share or secure a tax advantage.

 

Example 1:

This example looks at whether a sum is deferred profit?

XYZ PLC acquires an interest in ABC LLP from the existing members who continue to be involved in the LLP as members following the transfer. Prior to becoming a member of the LLP, XYZ PLC was unconnected to ABC LLP or its members.

The sale price agreed is the open market value of that interest in ABC LLP as at that date. To protect the value of the business being bought, the terms of sale are that part of the consideration is deferred for two years. If the individuals leave in that time they will forfeit all or part of the consideration.

XYZ PLC, an unconnected party, acquired an interest for the OMV at the time. On a realistic view of the facts the sum deferred is a not a remuneration or benefit from the LLP. It is not linked to the profits made in the period in which XYZ PLC is a member of the LLP.

This can be contrasted with:

*XYZ PLC agrees that, if they remain members for three years, the individual members will receive an additional sum based upon the profits of ABC LLP over that period. *

This is a share of the profits that has been deferred and it is no different to any other case where a share of the profit is deferred. Condition X is satisfied.

 

Example 2:

The new owners may want to ensure that the existing members remain with the business. This will particularly be true where it is a “people business”.

This example looks at a takeover where the previous members retain an equity stake after the takeover.

RSTU LLP is a consultancy business.  The ABC Corporation sees RSTU as a way of entering the UK market, however it sees it as important to retain the services of R, S, T and U, the existing members, and wants them to retain an interest in the LLP.

ABC buys a majority stake (80%) in RSTU LLP with each of the existing members retaining a 5% share.

It is recognised that R is looking to partially retire. It is agreed that in three years’ time ABC will buy 20% of R’s stake at the then OMV. It will buy a further 20% a year later and the balance when R decides to retire. The LLP Agreement provides that the individual partners must sell all their interests on retirement.

It is assumed that Condition Y is not satisfied as R does not have the power to enjoy the profit share allocated to the ABC Corporation.

The question is whether Condition X is satisfied? Is it reasonable to suppose that the purchase by the corporate member of R’s interest in the LLP represents “remuneration or other benefits or returns” that have been deferred?

Reasonable to suppose means that you take a realistic view of the facts and use a balanced common sense approach.

Possible pointers include:

  • The ABC Corporation is a large independent concern; it is not a money box retaining profits for the purpose of buying out interests.
  • What are the profit sharing arrangements? Is there anything that looks as if it is money being held back from the individual members?
  • Would the ABC Corporation have sufficient funds to buy the interest held by R regardless of the profitability of the LLP?
  • How did R acquire the interest - was it acquired by purchase at arm’s length or as an initial investor?

The question then is does it look as if the sum paid includes any profit held back, or does it look like the terms on which an independent party would buy that interest?