This briefing covers two recent developments which reflect the theme of increased transparency and compliance activity.
First, the government has published draft legislation to clarify aspects of partnership taxation for direct tax purposes. We have set out below some of the key themes and main changes, along with our comments.
The changes mainly create new compliance burdens (i.e. additional information to be provided in partnership tax returns in certain circumstances). Any additional information will need to be included in tax returns for tax years 2018/2019 onwards. However, it may be advisable to take action now (e.g. by amending relevant provisions in partnership agreements) to ensure that relevant provisions (e.g. provision of information by partners) cater for the proposed changes.
Limited partnerships, limited liability partnerships and general partnerships are all affected (whether the partnership is established under UK law or not).
Second, a development relating to the UK’s implementation of Article 31 of the EU Fourth Money Laundering Directive (MLD4), which requires member states to establish central registers of beneficial ownership information for express trusts. We consider how these new provisions apply to trusts used in fund structures.
1) Clarification of partnership taxation rules
The policy intentions behind these reforms include seeking to address areas of uncertainty and complexity identified as problematic by stakeholders; limiting the opportunity for partnerships to manipulate the allocation of taxable profits to obtain a tax advantage; and facilitating digitisation of partner taxation compliance using information in the partnership return. The practical effect is a greater compliance burden, third party scrutiny and disclosure requirements. Some partnerships will also need to review their profit sharing arrangements.
Partners in nominee or bare trust arrangements
Where a partner of a partnership is a trustee for a beneficiary who: (i) is absolutely entitled to the partner’s share of profits; and (ii) is chargeable to tax on those profits, the beneficiary is to be treated as the partner for the purposes of calculating profits and also the partnership tax return. This applies for tax years from 2018/2019 and, for calculating the beneficiary’s share of profits where it is a corporation taxpayer, for accounting periods beginning on or after 1 April 2018.
Our suggested action to anticipate this is to include in the partnership documents a mechanism requiring partners to disclose the identity and tax status of the beneficiaries of any partners who are bare trustees or nominees. It is not yet clear if structures such as Jersey property unit trusts (JPUTs) are caught, and we understand that HMRC is considering this as part of the ongoing consultation on the draft legislation.
Reporting for layered partnerships
Where a partnership (the Reporting Partnership) has a partner that is itself a partnership (the Participating Partnership), the Reporting Partnership will have to report on four different bases in its partnership tax return: by assuming that the Participating Partnership is (i) a UK resident individual; (ii) a non-UK resident individual; (iii) a UK resident company; and (iv) a non-UK resident company. This will apply for returns made for tax years from 2018/2019 and is intended to ensure that the partners in the Participating Partnership are provided with the information they may require to complete their own UK tax filings.
However, not all four computations will be necessary where all of the partners in the Participating Partnership(s) (either directly or indirectly via any number of intermediate partnerships) are named in the Reporting Partnership’s tax return, including the tax status of at least one of the indirect partners, and it is apparent from this information on the return which basis/bases of calculation is/are appropriate.
Affected partnerships have a choice: either to face the additional compliance burden of the Reporting Partnership having to report on all four bases; or to obtain the identity and tax status of each of their indirect partners (i.e. via any Participating Partnership(s) and any number of intermediate partnerships). Given that the partnership return itself is not a publicly available document, the preference may well be for the latter, in which case some additional drafting will most likely be needed in both the partnership documents of the Participating Partnership(s) and the Reporting Partnership, to include a mechanism for Participating Partnerships, on subscription and then on an annual basis, to provide the necessary information to the relevant Reporting Partnership for the purposes of its partnership tax return.
It may be that some fund structures do not face this compliance burden – the rules only apply where another partnership is itself a partner (i.e. the Participating Partnership referred to above) in the Reporting Partnership. Therefore, in cases where the direct partners in the Reporting Partnership are all non-partnership vehicles, for instance, corporates (excluding for these purposes those partnerships which are treated as corporates, such as LLPs) or individuals, the additional compliance burden does not apply.
Allocation of partnership profit for tax purposes
A new measure is intended to restrict the ability of partners to change the methodology for allocating the profits and losses of a period between partners for tax purposes after the period in question. Separately, there is clarification that partnership profits must be allocated for tax purposes between partners in the same ratio as the commercial profits. This will be the starting point, however, as existing tax legislation could require further adjustment to the profit allocated to partners for tax purposes. The intention is not to restrict any partnership’s ability to allocate profits between partners on a commercial basis. These changes apply for periods beginning on or after Royal Assent of the Finance Bill 2018 (expected Spring 2018).
If there is a simple percentage profit allocation set out in the partnership agreement, there should be no concern. Partnerships with more complex profit sharing arrangements will need to consider how they may be affected by the new rules.
Allocation of partnership profits determined by the partnership return
The allocation of partnership profits or losses shown on a partnership tax return is to be conclusive and final for tax purposes, subject to a new right of a partner to refer a dispute on the allocation to a Tribunal within 12 months of submission. Where the Tribunal determines the return is not correct regarding a person’s share of the partnership’s profits and losses, HMRC must amend the return accordingly – these amendments, including any associated costs of any Award, could impact any of the partners. This applies for returns made for tax years from 2018/2019.
Again, our suggested action point is to include drafting in partnership documents to enable partners to review draft partnership tax returns before they are submitted to HMRC. This is likely to be most relevant for joint venture partnerships. When drafting provisions that are intended to enable partners to comment on or approve partnership tax returns, it will be necessary to consider incorporating a strict timetable for the provision of draft returns to partners for comment and for them to provide any comments, so as to avoid delays which could lead to the late submission of partnership tax returns.
Miscellaneous other measures
A small number of other changes have been proposed, which go beyond the scope of this alert. In essence, those changes affect the income tax basis periods of indirect partners and relax the reporting obligations of investment partnerships in relation to overseas partners.
2) Trusts beneficial ownership register for fund structures
Another recent development relates to the UK’s implementation of Article 31 of the MLD4, which requires member states to establish central registers of beneficial ownership information for express trusts. New obligations are contained in the The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the Regulations), which came into force on 26 June 2017, to be read alongside HMRC’s 9 October 2017 guidance (in the form of FAQs).
The Regulations impose a new obligation on trustees of both UK resident express trusts and non-UK resident express trusts which are liable to UK tax, to: (i) maintain an accurate and up-to-date record of all the beneficial owners of the trust (and any other potential beneficiary that is an individual and is named in a letter of wishes or similar document); and (ii) in any tax year in which the trustees are liable to pay income tax, capital gains tax (CGT), inheritance tax, SDLT, SDRT or land and buildings transaction tax (Scotland), provide HMRC with specified information on the trust, the trust property and the beneficial owners. As drafted, this information will only be available to law enforcement agencies (and EEA money laundering authorities) and not made public. However, there is a proposal by the European Commission to amend MLD4 and make this register publicly-available at some stage in the future.
JPUTs that hold UK assets directly are within scope (as are any other offshore or UK unauthorised unit trusts). However, the trustee of a JPUT will only need to register if and when it becomes liable to pay UK tax, as set out above.
Assuming that the JPUT is structured as a “Baker” trust that is centrally managed and controlled outside the UK and does not hold UK residential property, neither the JPUT nor the trustee should be subject to UK direct taxes. However, given that the definition of tax includes stamp taxes, there is still a risk of a registration requirement arising and this will need to be taken into account when considering transactions that have SDLT or SDRT implications (i.e. the acquisition of UK land or securities).
If registration is required, then the trustee has to complete and submit the trust registration documentation by no later than 5 October after the end of that tax year (extended to 5 December 2017 in respect of a 2016/2017 liability incurred).
Regardless of whether a trustee is required to register with HMRC, it is under an obligation to maintain an accurate and up-to-date record of all the beneficial owners of the trust (and any other individual potential beneficiary), as this information can still be requested from any law enforcement authority. Criminal sanctions apply for non-compliance; HMRC can also impose a financial penalty and publish a statement about the failure.
We would also mention a few other points of interest for fund structures:
- All UK resident express trusts (that are not authorised unit trusts) are subject to the Regulations.
- Non-UK express trusts which are feeder funds will not be in scope. Neither will a non-UK resident express trust which holds UK assets (even UK residential property) through a non-UK company. In both cases the trust does not receive UK source income or hold any UK assets on which it is liable to UK tax.
- Charitable trusts are not excluded from the requirements. However, the trustees of UK charitable trusts would typically not be required to report to HMRC, provided their activities all fall within the relevant exemptions from applicable UK taxes.
- Non-UK charitable trusts could be caught as they may be subject to UK tax (unless they are in the EU, or the EEA member states of Norway, Iceland or Liechtenstein).
Please do get in touch if you want to discuss any of the issues raised in more detail.