Limited liability partnerships are bodies corporate with a legal personality separate from that of their members. But an LLP which carries on a trade or business with a view to profit is treated as a partnership for income and corporation tax purposes. In that case, the LLP's members would be subject to tax on their share of the LLP's profits rather than the LLP being taxed itself. An LLP which does not carry on a trade or business with a view to profit, on the other hand, is chargeable to corporation tax and is not treated as transparent.
Which tax administration provisions apply to LLPs?
So far, so good but which tax administration provisions should HMRC use to raise an enquiry when an LLP has claimed allowances that HMRC wishes to deny? The provisions which apply to bodies corporate, or those which apply to partnerships? This depends on whether the deeming provision extends to tax administration. Even if it does and HMRC has treated the LLP as a partnership for compliance and enforcement purposes, what happens if HMRC subsequently discovers the LLP is not undertaking activity with a view to profit, but is merely seeking to generate tax relief of the LLP’s members? Is a closure notice served in those circumstances validly made?
These were the questions that the Upper Tribunal had to consider in the Inverclyde case. The First-tier Tribunal had held that the closure notices were invalid because the treatment of LLPs as partnerships did not extend to the compliance and enforcement provisions. This effectively meant the taxpayers got off on a technicality because HMRC had served the notices under the administrative provisions that apply to partnerships rather than those applicable to bodies corporate.
Much to HMRC’s relief, the Upper Tribunal reversed this decision holding that HMRC was correct to treat the LLPs in question as partnerships for the purposes of compliance and enforcement. The subsequent finding that the LLPs did not undertake activity with a view to profit (because they were instead seeking merely to generate tax relief for the respective LLP members) did not invalidate the notices served.
A legislative fix has been proposed in Finance Bill 2020 which in HMRC’s view ‘puts beyond doubt that the legislation works as designed and intended’. The proposed legislation specifically addresses the case where an LLP has delivered an LLP partnership return on the basis of operating ‘with a view to profit’ but is subsequently found to be operating ‘without a view to profit’. This legislation would ensure that HMRC can amend the LLP’s return (and the returns of the LLP members) to give effect to the conclusions reached in the closure notice.
Time for a wholesale review?
In most cases, LLPs are acting with a view to profit: Inverclyde and the legislative change is, effectively, tackling a small number of LLPs behaving badly. But there is a more general point here. In his recent post 'Partnership taxation: still a work in progress?', Mike Lane drew attention to the complexity of the taxation of partnerships and Inverclyde highlights the 'awkwardness' around the tax administration of LLPs. It is also further illustration of the confusion that the use of deeming provisions can cause – for more on this see my blog 'How far does the fiction of a deeming provision extend?'.
Rather than further legislative tinkering round the edges, it would be better to have a wholesale review of the taxation of partnerships and LLPs to provide a comprehensive code that does not rely on deeming or guidance to achieve the correct outcome.
Turning to the situation where there is uncertainty regarding the “transparency” status of a limited liability partnership, there is undoubtedly a degree of awkwardness inherent in either party’s analysis.