HMRC to crackdown on private equity and professional service firms

The UK tax authority has launched a crackdown against businesses operating as limited liability partnership. This could result in hundreds of millions of pounds being owed by private equity firms and professional service firms.

HM Revenue & Customs has already begun to investigate firms, and may potentially be looking for tax experts or other individuals involved.

These people said that firms claim that HMRC unexpectedly changed their approach to the “salaried members” tax rules which affect businesses operating as LLPs. People involved in the matter said that unless HMRC softened their approach, affected firms were expected to file a lawsuit.

Among others, US private investment groups such as Blackstone and Carlyle Group may be affected. It may also affect other professional service industries, such as some accounting firms and law firms. The names of firms that are the targets of these investigations are kept confidential.

Blackstone and Carlyle refused to comment.

Mike Hodges of Saffery, a firm that provides accounting services, said the change in HMRC was “seemingly out-of-the blue”. He said that the potential liability for additional costs would be “significant”.

The numbers could be large, as you are talking about LLP members who will likely be earning high salaries and have a lot of income. This means that employers would be paying a substantial amount in National Insurance.

The crackdown on LLPs comes at a time when industries such as private equity are already facing the prospect of increased tax rates if a Labour Government wins general elections on July 4.

Labour has promised to raise the tax rate that private equity executives will pay on carrying interest – the share of gains received by dealmakers when assets are sold – and reform the tax system for wealthy nondoms.

HMRC is investigating whether certain LLPs misclassified members as employees and paid less taxes as a result. In 2014, rules were introduced that defined criteria for determining whether an individual was self-employed, or employed. If the latter, then firms must pay National Insurance Contributions, which are currently set at 13.8% of employee income. Before 2014, LLPs were considered self-employed.

One of these rules states that a member must contribute less than 25% of his or her profit share as capital to the partnership. Then, the member is considered an employee.

This has meant that partnerships have always tried to make sure capital contributions from partners are above the threshold of 25 percent to avoid being classified as salaried members.

Some firms “abused” the system, according to one lawyer.

HMRC updated its internal guidance on February, stating that if you deliberately fail the condition and make excessive capital contributions, it could be a tax avoidance rule.

Jitendra Patel, tax principal of BDO, a firm that provides accounting services, said: “They are effectively saying that if you contribute money to avoid the rules for salaried members, then this is tax avoidance.” It’s like being caught in a trap even if you put your money at risk to comply with the rules.

HMRC’s decision has prompted a backlash among affected sectors and their respective trade associations.

People familiar with the situation said that the British Private Equity and Venture Capital Association and Law Society recently met with tax officials to discuss concerns raised by some of their members.

Michael Moore, CEO of the BVCA, said: “It’s vital that any changes that have an impact are made in a way that is forward-looking, both in terms process and substance, and that promotes the competitiveness of our Financial Services Sector, instead of putting it at risk.”

The Law Society “strongly disagreed with” the change, and requested that it be withdrawn.

The statement continued: “Any change, if any, should only be implemented after a thorough public consultation and without retrospective effect.”

Guy Sterling, partner of Moore Kingston Smith said: “It’s important that people continue to capitalise as needed so that their businesses don’t go under.”

HMRC stated: “We updated the guidance in February to clarify circumstances where specific avoidance rules will apply to help customers get tax right.”

HMRC said that it “regularly reviews” its guidance, and is “committed to hearing stakeholders’ concerns”.