The effects of the tax changes for Partnerships and Partners is about to be felt

These are testing financial times for the many professions such as accountancy, legal practices and other businesses run through Partnerships. In January 2022, HMRC announced changes to the basis on which the profits of standard Partnerships and limited liability Partnerships (LLPs) would be assessed, starting with 2023/24 as a ‘transitional’ year and 2024/25 as the first tax year to which the new rules will apply. The HMRC guidance on the changes can be found here.

The changes are designed to alleviate the most unfair impacts of the previous assessment regime, but have still had the effect of accelerating tax liabilities for many individual Partners, thereby putting significant financial strain on them and their firms.

The tax treatment of individual Partners was further complicated in August 2024, when HMRC revised its approach to differentiating between equity and salaried Members in LLPs.

The effect of these developments is about to be felt by many Partnerships and their Partners as the second and balancing self-assessment tax instalment for 2023/24 and the first payment on account for 2024/25 are due on 31 January 2025.

What does the tax basis period change involve?

Under the new arrangements, HMRC is moving from assessing a Partnership’s profits on the existing ‘current year’ basis to a ‘tax year’ basis, meaning that business profits will be calculated for the tax year rather than for the period for which the Partnership prepares its accounts (i.e. their accounting year) and which may fall during the tax year rather than at the end of it. This aligns the treatment of trading income with non-trading income.

The move to this new tax year basis will involve a transitional (catch-up) year in 2023/24 for any Partnerships and Sole Traders that do not use 5 April or 31 March as their accounting date. In some cases, the effect will be to increase the share of profits for individual Partners to be assessed in that tax year.

There will also be a practical impact. Partnerships that for whatever reason continue to make up their accounts to a date other than the end of the tax year will have a much shorter period in which to finalise their figures. By way of example, firms with accounts prepared to 30 April currently have 22 months before the self-assessment filing deadline for the individual Partners, whereas in future, they will only have 9 months.

Partners will need to ensure they have reserves in place to cover their tax liabilities as the time between the tax being confirmed and being due to be paid will be far tighter. This may have funding implications for them and by extension, also for the Partnership itself.

The five year deferral concession

HMRC will allow Partners to opt to have the additional income assessed for the transitional year over up to five future years, effectively spreading the liability over a longer period and mitigating the immediate cash flow issues for them and their firms. This option can be exercised differently by individual Partners; it does not have to be a firm-wide decision.

This concession is welcome, but it will have implications for Partnerships which cease to trade and for Partners who wish to retire or may, sadly, die during the deferral period. The full outstanding tax liability still deferred will be triggered in the relevant tax year. This will complicate not only succession planning, but any potential merger during the deferral period.

What does this mean for a salaried LLP member?

The  Institute of Chartered Accountants in England & Wales has explored the implications of HMRC’s revised rules on salaried Members of LLPs.

The changes centre on tightening the anti-avoidance provisions that define the element of the amount payable by the LLP in respect of the individual’s services that HMRC can designate as ‘disguised salary’ because it is not variable by reference to the overall profits and losses of the LLP.  The provisions examine the relationship between the disguised salary and the Partner’s contribution to the LLP’s capital.

To the extent HMRC can successfully challenge an LLP’s definition of its equity members, the individuals deemed to be salaried members will face immediate and potentially backdated PAYE and National Insurance liabilities as Schedule E employees, for which the firm will be liable to account, along with the appropriate employer’s National Insurance.

Dealing with the HMRC changes

For those firms and individuals facing a challenge to meet their January 2025 tax bills, it’s not too late to put in place the extra funding needed, but any cash raising needs to take account of the impact on future cash flow if advantage is being taken of the five year deferral option.

Firms also need to look closely at the status of their salaried Partners to manage the risk of HMRC action to re-define their employment status, as well as considering issues such as partner retirements due over the next five years and any plans to close their practices or merge with others.

These aspects may be difficult for the management of firms to deal with objectively without outside help from other professionals more experienced in these matters. The cost of that input should not be seen as a barrier, rather it represents a significant potential net benefit.

If you are seeking professional advice for your firm, Opus is here to independently assist. You can speak to one of our Partners, who can discuss options with you. We have offices nationwide and by contacting us on 020 3995 6380, you will be able to get immediate assistance from our Partner-led team.