If various leaks in the press this week are to be believed and the Treasury does not appear to have denied them, it appears likely the government is looking hard in the upcoming autumn Budget at imposing NICs on partnerships, whether lawyers, accountants or other professional services.

It appears this tax would be imposed on both limited liability partnerships (LLPs) and traditional partnerships. There can be no rationale for differentiating between traditional partnership and LLPs.  Otherwise, one immediate response might be that people sacrifice the limited liability afforded by LLPs in favour of a traditional partnership with lower tax exposure, which cannot be progressive. 

We must assume that the additional tax burden that partners will face is on 15% of income, presumably less the tax and national insurance contribution (NIC) relief on that at up to 47%, so just under 8% additional tax on a partner’s income.

Currently employer’s NIC is not imposed on partners profits shares because partners are not employees. On the flip side partners do not get the statutory benefits associated with employment. There are already established formal anti-avoidance guidelines (the salaried members rules) to prevent people exploiting the rules so that only genuine partners are treated as self-employed.

From the press reports it is not clear how this will be administered. Employer’s NIC is calculated and paid by employers by reference to salary payments paid via the payroll and subject to PAYE deductions. 

Partners receive a profit share – that is a share of the net profit of the business, usually not known until the end of the accounting period, or some while afterwards. 

So, will it therefore be imposed directly upon the partner, via self-assessment? If so, how will that work? An actual employer would get tax relief for the employer’s NIC payments, so how will this relief be given to partners/LLPs?  Perhaps a new ‘Partnership NICs’ at around 8% but this would only lead to more complexity.

One outcome from this new tax if it is introduced will be for professional firms to think about operating through companies. In this new world this will undoubtedly be more tax efficient (if only slightly) in all scenarios. 

Currently partners pay tax on all partnership profits, even if those profits are reinvested in the business. Essentially in a traditional partnership model, where profits are reinvested in the business this is done with post-tax profits. However, in a corporate structure profits could be retained rather than distributed, thus creating scope for tax deferral.  Would this potentially lead to lower tax revenues? Or the anticipated revenue from the new Partnerships NICs being lower than forecast? Both seem plausible to me.

LLPs were introduced in 2001 for very good reasons, namely recognising the need for limited liability yet the commercial need to preserve partnership-style internal flexibility, particularly in professional services and to improve the UK’s commercial competitiveness by offering a modern entity comparable to structures available in other jurisdictions. For example, LLCs in the US.

The introduction of Partnership NICs would surely create a pull towards corporate structures, which is not always aligned with the commercial needs of the business – particularly for people businesses (eg, professional firms selling peoples time and expertise) which would ordinarily use a partnership / LLP structure for the flexibility and ease of bringing people into the partnership and exiting partners. 

It seems likely to me that this measure will actually encourage the short-term tax motivated decision for partnerships/LLPs to incorporate en masse, which might be to the detriment of the long-term needs of the business (and therefore the professional services sector in the UK)?

And we could see further unintended consequences. Many large firms are international. Will we see some partners move away from London to escape the tax especially those for whom it is easy to practice outside the UK? This could be the final straw for some partners who can easily practice from outside the UK.

Alternatively, some of the increased tax burden partnerships and their partners could face under these rules might simply be passed on to firm employees, eg, with staff receiving lower pay rises than they otherwise would. More fundamentally we might see people try to move from being partners to self-employed consultants.  Perhaps a small law firm might try to split into multiple consultants to try and avoid the charge with the result that there will be a need for yet more new anti-avoidance rules on top of existing rules.  

About the author

James Kipping ATT CTA is a private client tax partner at MHA