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Private equity houses and professional services firms could stand to pocket hundreds of millions of pounds after the UK tax authorities launched a crackdown on companies operating as limited companies.
HM Revenue & Customs is already investigating companies and could potentially ask for retroactive contributions, tax experts and others involved told the Financial Times.
Businesses claim that HMRC has unexpectedly changed its approach to the ‘paid member’ tax rules that affect companies operating as LLPs, these people added. Unless HMRC softened its approach, companies affected by the changes were expected to mount a legal challenge, those involved said.
Among the companies that could be affected by the change in treatment are US private equity groups, including Blackstone and Carlyle Group, among others. Other professional services sectors, including some law firms and accounting firms, may also be included. Companies targeted by the investigations are confidential.
Blackstone and Carlyle declined to comment.
HMRC’s change came “seemingly out of a clear blue sky” according to Mike Hodges, partner at Saffery, an accountancy firm. He added that the amount of potential additional liability would be “significant.”
“It could be large numbers because by definition you are talking about members of the LLP, who are likely to be among the highest earners and earn high amounts – so a significant employer contribution to national insurance.”
The LLP’s crackdown comes as sectors including private equity are already grappling with the prospect of higher tax rates if a Labor government wins the July 4 general election.
Labor has pledged to increase the tax rate private equity managers pay on carried interest – the share of profits dealmakers receive when assets are sold – and to reform the tax regime for wealthy non-doms.
HMRC is currently investigating whether some LLPs have misclassified some members as self-employed and paid less tax as a result. Rules introduced in 2014 set out criteria for assessing whether individuals were self-employed or employees – in which case companies would have to pay National Insurance contributions, currently set at 13.8 percent of employee income. Before 2014, LLP members were generally accepted as self-employed.
One of the conditions of these rules includes whether a member’s capital contribution to the company is less than 25 percent of his or her profit participation. If this is the case, they are regarded as employees.
This means that partnerships have sought to ensure that partners’ capital contributions always exceed the 25 percent threshold, thus avoiding salaried member status.
One lawyer admitted that the system had been ‘abused’ by some firms.
HMRC changed its internal guidance in February, stating that deliberately failing to meet the condition by making excessive capital contributions could breach tax avoidance rules.
Jitendra Patel, tax director at BDO, an accountancy firm, said: “They are basically saying that if you put in capital to avoid the rules for wage earners, that is tax avoidance. It’s almost like a trap, where you’re trapped even as you risk your own money to try to comply.”
HMRC’s move has sparked a backlash from affected sectors and their trade bodies.
The British Private Equity and Venture Capital Association and the Law Society recently held talks on behalf of some of their members with tax officials who had raised concerns, people familiar with the matter said.
“It is vital that any changes affecting this are forward-looking and implemented in ways – both in process and content – that promote, rather than jeopardize, the competitiveness of our financial services sector,” says Michael Moore. , CEO of the BVCA, told the FT.
The Law Society said it “strongly disagreed” with the change and asked for it to be withdrawn.
It added: “Any changes, if at all, should be made after proper public consultation and certainly should not have retroactive effect.”
Guy Sterling, partner at Moore Kingston Smith, added: “It is important that individuals can continue to capitalize their businesses as needed so that these businesses do not go under.”
HMRC said: “We updated our guidance in February to clarify the circumstances in which certain avoidance rules would apply, to help customers get their tax right.”
HMRC added that it reviewed its guidance “regularly” and was “committed to listening to stakeholders’ concerns”.
Additional reporting by Michael O’Dwyer, Simon Foy and Suzi Ring in London.