Firms challenge new tax legislation that will threaten existence of wealth managers structured as LLPs.
Investment managers and wealth managers are challenging new government tax rules on LLPs as they feel they are being punished because a small number of firms are using the structure to avoid tax.
Many boutiques and larger investment management firms are formed as limited liability partnerships (LLPs) and there are now more than 800 within investment management, up from 325 before the financial crisis.
An LLP is a corporate body that is regarded as transparent for tax purposes and therefore pays no corporation tax or capital gains tax. Instead, each partner is assessed on their share of the LLP’s income as a self-employed person rather than an employee. It also reduces personal responsibility for business debts.
Could LLP tax rules sound death knell for small firms?
However, the government is concerned companies are being set up in this way for tax avoidance purposes, as corporate partners are taxed at a lower rate than individuals.
The proposals were first announced in May 2013 and further clarification was given in the Autumn Statement 2013.
Chancellor George Osborne confirmed the government plans to look into LLPs and whether they are being used to disguise employment relationships. It is estimated a clampdown would bring in £1bn in revenue, and much of the legislation is due to take effect from 6 April 2014.
Magnus Spence (pictured), chairman of thinktank New City Initiative, said the new rules could sound a death knell for investment managers.
He said: “The main thrust of the proposals as originally envisaged in May 2013 seemed perfectly reasonable.
Where partnership structures have been used to present staff as partners with the intention of avoiding Employers’ National Insurance Contributions when in reality they are employees, it is understandable the government should seek to use legislation to close down this practice,” he said.
“But, the draft legislation issued in December 2013 has a number of consequences which could prove highly damaging to the future of smaller wealth managers, investment managers, and hedge fund managers which have used the partnerships as the structure of choice since they were established in 2001.”
Spence said LLPs are attractive because they allow broad ownership by the people in a business and offer a flexible way for partners to participate in the returns and risks of the company.
This creates greater incentives for performance and helps ensure risk is properly managed. “It is noteworthy that, during the financial crisis, there was not a single partnership that was required to be bailed out by the government,” he added.
One of his primary concerns is that firms who reward investment managers based on the performance of their funds could find those profits subject to National Insurance contributions.
Spence said: “The natural consequence of this would be that investment management partnerships would be discouraged from attracting new investment management teams and rewarding them based on their own performance contribution.
“This in turn would be likely to lead to smaller, less efficient investment management firms which are more susceptible to market downturns, and are less likely to invest in strong infrastructures to support their businesses.”
A second concern is that of forcing partners to increase the amount of capital invested in the partnership, while ignoring any investments made by partners directly into the funds they manage. Spence argued this move goes against regulation such as UCITS V and AIFM, which want managers to co-invest in their funds with clients to align the interest of fund managers and their investors.
His final worry is that certain partners will need to demonstrate they have significant influence over the LLPs affairs if they wish to avoid paying employers NI contributions on their profit allocations.
Spence said: “This seems to strike at the heart of one of the key attractions of partnerships... that they are exactly that… a partnership of interests rather than a dictatorship, however benign, where a minority of directors can ride roughshod over the views of other colleagues.
Traditionally, partnerships have meant each partner had one vote and no one partner had the ability to overrule the views of other partners.
The new tax rules are likely to take decision-making within partnerships closer towards the corporate world.”
Spence warned this additional legislation could be the final straw for firms, and they may choose to move their businesses offshore to avoid yet more onerous rules.
“The costs associated with these new regulations always fall on small businesses, and there is no doubt smaller investment boutiques have struggled to cope with the changes. For some, the pain is just too great and they have decided to up sticks and move to more friendly business environments such as Switzerland, Singapore, or Dubai.
“The new tax rules are likely to threaten the very existence of partnerships in the investment management industry at a time when their benefits in terms of aligning investors and their investment managers are more important than ever. HM Treasury needs to be very careful it does not throw the baby out with the bathwater.”
The government proposes to:
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Look at whether an LLP is disguising employment relationships.
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Look at whether firms are allocating business profits to corporate partners in order to pay less tax.
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Require LLP members to pay higher NI contributions after removing the ‘presumption’ that they are self-employed rather than employees.
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Require partners to increase the capital invested in the LLP.
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Much of the legislation is due to take effect from 6 April 2014.
Investment managers ‘need stronger case’ to challenge LLP tax changes
John Redwood MP has told investment managers they are unlikely to successfully challenge the upcoming tax changes to LLPs unless they build a stronger argument.
Speaking at the Institute of Chartered Accountants in England and Wales last week in a debate held by New City Initiative, Redwood said the industry’s arguments were “too vague and too general” and unlikely to persuade MPs to change the rules.
In last year’s Autumn Statement, Chancellor George Osborne said the government plans to look at the use of LLPs and whether they were disguising employment relationships. It will also consider whether firms are allocating business profits to corporate partners in order to pay less tax, as corporate partners are taxed at lower rates than individuals.
Redwood said: “If you are going to make this case – and I have not yet heard a case from you that will convince politicians – you need to persuade them that keeping your current tax arrangements as opposed to the proposed ones will mean they collect more tax rather than less.
“There are two things that could start to make that case: firstly, some businesses might give up on London altogether and, secondly, there could be wholesale conversion from LLPs into company structures. I would want to see that these arguments are true before suggesting them to the Treasury.”
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