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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: Private equity investment

In some cases an outside investor, such as a private equity fund will become a partner, directly or indirectly and inject capital into the firm.

If they chose to do so through a corporate vehicle then it may make the firm a mixed membership partnership.

In some cases the excess profit allocation rules will not apply as the individual members do not meet the power to enjoy requirement (see BIM82770).

 

Example 1

Example looking at where capital is injected by external investors using a corporate vehicle.

*LMN LLP has received an injection of capital from a group of external investors, none of whom are members of LMN LLP. The investors have chosen to invest through a limited company. *

This is a mixed membership partnership but the legislation does not apply as the individual members do not benefit from the sums allocated to the company.

If one of the individual partners in the firm had a small stake in the private equity fund then the question is whether it is reasonable to suppose that part of the profit is allocated to the corporate partner as a result of that stake.  

The way to approach the issue is to ask whether the power to enjoy condition is met, in which case the mixed membership partnership legislation will apply, unless it is not reasonable to suppose that any part of the corporate member’s profit share can be attributed to the power to enjoy.

 

Example 2

This example looks at where the corporate member is jointly owned by the private equity fund and the individual members.

The question is whether it is reasonable to suppose that the corporate member’s profits have been increased as a result (Condition Y at S850C (3)).

*MNO LLP has received an injection of capital from a private equity fund via a corporate member, MNO Ltd, which is jointly owned by the fund and the individual members of MNO LLP. *

This is a mixed membership partnership and the individual members are in a position to enjoy profits paid via the corporate member. However that does not necessarily mean that the excess profit allocation rules apply. Is there any evidence that the profit share allocated has not been influenced by the power to enjoy?

If we add in additional facts:

*MNO Ltd has ordinary share capital and preference shares. All the preference shares are held by the private equity fund. The profit share allocated to MNO Ltd is calculated so that it is enough to pay the dividend on the preference shares only. *

Condition Y is not satisfied as it is not reasonable to suppose that the profit share allocated to MNO Ltd is attributable to the fact that the individual members could benefit.

Alternatively:

*MNO Ltd is jointly owned by the fund and the individual members of MNO LLP. MNO Ltd only has one class of shares, of which the fund holds 60%. *

Why would the members choose to put money into their firm in this format? Is there, for example a tax advantage for them in so doing?

 

*Example 3 *

This is a more complex example:

*A LLP has 50 individual members and a corporate member B Ltd with 100 issued ordinary shares. 30 of the shares of B Ltd are listed on AIM and owned by investors otherwise unconnected to the LLP or its individual members. The remainder of the shares are owned by 40 of the individual members together with 20 former LLP members (who no longer provide services of any form to the LLP). *

*So as to attract the initial investment on IPO and to retain the external investor appetite, B Ltd has 100% control of A LLP including control of any changes to the contractual profit share entitlements of the individual members which are determined entirely at its discretion and in accordance with market rate levels of remuneration. *

*Most of the Directors of B Ltd are also members of A LLP; they are subject to Directors fiduciary duties to ensure that every decision taken is in the best interests of the shareholders; that is as shareholders and not in their role as members. *

The answer to this example will turn upon the facts. It is, however, helpful to remember that the purpose of the excess profits allocation legislation is to prevent partners from obtaining tax advantages by using the mixed membership structure to alienate their personal income.

A useful question to ask is would B Ltd would receive the same profit share if/when the member-shareholders were no longer members of the LLP and/or if/when they remain members but are no longer shareholders?