A Stealthy Approach

The limited liability partnerships legislation came in with little fanfare. ARTHUR SELLWOOD summarises the pertinent points.
ON 20 JULY 2000, section 1(1), Limited Liability Partnership Act 2000 announced, without much publicity, a new form of legal entity to be known as a limited liability partnership. Section 1(2) stated that such a partnership was a body corporate with a legal personality separate from that of its members and that it would be formed by being incorporated under that Act.
The entry of such partnerships into the Taxing Acts was done in even lower key. Usually, additions or amendments are made to the main Tax Acts through the annual Finance Acts; in the instant case, however, the taxation treatment for limited liability partnerships was prescribed in the Liability Partnership Act 2000. Apart from some minor amendments, section 10 added sections 118ZA to 118ZD to the Taxes Act 1988 and sections 59A and 156A to the Taxation of Chargeable Gains Act 1992. Section 11 added a new section 267A to the Inheritance Tax Act 1984 and sections 12 and 13 contained some provisions relating to stamp duty and Class 4 National Insurance.
During the Act's passage through Parliament, it was indicated that, for those limited liability partnerships which carried on businesses for which the proposed structure was not originally intended, the tax provisions would be reviewed, and, if necessary, would be subjected to new legislation to be included in the following year's Finance Bill. The Revenue feared, in particular, that the structure of a limited liability partnership might be adopted for tax purposes rather than to obtain the benefit of limited liability.
The Limited Liability Partnership Act came into force on 6 April 2001, but it was only on 8 November 2000, in his pre-Budget report, that the Chancellor announced that he intended to bring forward rules to provide that:
 exempt bodies are taxed on any income from property they receive in their capacity as members of a limited liability partnership;
 the same consequences follow for shareholders in a company that disincorporates to form such a partnership as currently follow when a company disincorporates to form an ordinary partnership; and
 loans used to provide money to purchase an interest or share in an investment limited liability partnership will not qualify for tax relief.
The Government also said that it would welcome views on whether limited liability partnerships were likely to be used for businesses other than professional partnerships and, if so, whether further tax legislation was required to provide certainty of tax treatment on the basis of the intention that the creation of such partnerships should not give rise to a significant loss of tax.
Tax Bulletin
Tax Bulletin 50 appeared in December 2000. It contained commentaries on most of the points likely to require consideration for the purpose of calculating the tax liability of the members of this new form of partnership. The Revenue was particularly anxious to stress that the guidance given in its Bulletin 38 about what was meant by a true and fair view for the purposes of calculating the taxable profits of other professional partnerships applied equally to the profits of the new forms of partnership.
New legislation
Neither the Budget statement in March 2001 nor the original Finance Bill contained any proposals for changes in the rules for limited liability partnerships. On 3 May 2001, however, a Revenue press release announced that new clauses relating to limited liability partnerships for the Finance Bill had been tabled. One clause ensured that such partnerships were generally treated for tax purposes not as corporate bodies, but as partnerships. This clause amended section 118ZA, Taxes Act 1988 and section 59A, Taxation of Chargeable Gains Tax Act 1992 and added a new section to the latter Act. Another new clause and a new Schedule were designed to prevent loss of tax through the use of limited liability partnerships for investment and property investment. During the Standing Committee debate, the Paymaster-General said that extra-statutory concessions and statements of practice which affected limited liability partnerships might be amended when the statutory provisions had been settled. The new provisions for limited liability partnerships were included as sections 75 and 76 of, and Schedule 25 to, the Finance Act 2001. Most of these proposals were deemed to have come into force from 6 April 2001.
Formation of a partnership
While the setting up of a limited liability partnership may represent the creation of an entirely new business, it may equally well be the incorporation of an existing partnership business. The treatment for tax purposes has been somewhat contrived so as to require the tax to be levied on its members rather than on the corporate body itself, but other factors enter into its choice as an appropriate business structure. The chief of these is the protection of limited liability which is offered to its members. This advantage is also afforded by incorporation as a company, but that may also produce for its members liability to pay-as-you-earn tax and Class 1 and 1A National Insurance contributions.
In order to incorporate one of the new entities, two or more persons associated for carrying on a lawful business with a view to profit must have subscribed their names to an incorporation document which must meet certain specified requirements and be lodged with the appropriate registrar of companies. Membership is given to those who subscribe their names to the incorporation document or to other persons by and in accordance with an agreement with the existing members. A person may cease to be a member by death or by dissolution of the partnership, by agreement with the other members or by giving reasonable notice to the other members. The mutual rights and duties of members are to be governed by agreement between the members or between the partnership and its members. There are provisions governing such points as the position of members as agents of the partnership, the cessation of rights of ex-members and the method of designating members where this is appropriate. Changes of membership and designated membership have to be registered.
Taxation
The original provisions of the Limited Liability Partnership Act 2000 indicated that limited liability partnerships would, despite their incorporation, be taxed as partnerships. This is made even clearer in the revised section 118ZA, Taxes Act 1988. This section indicates that, where a limited liability partnership carries on a trade, profession or other business with a view to profit, all its activities are treated as carried on in partnership by its members and not by the partnership as such. Anything done by, to, or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to, or in relation to the members as partners. The property of the partnership is treated as held by the members as partnership property. Non-profit making bodies, such as clubs and societies, continue to be taxed as companies as they do not fulfil the specified condition of carrying on their business with a view to profit.
Demergers
Tax Bulletin 50 indicates that where a limited liability partnership takes over only part of an old partnership trade, such an event constitutes a demerger to which Statement of Practice 9/86 applies. Unless it can be shown that, on the demerger, the part of the business carried on by the limited liability partnership is recognisably the business carried on by the old partnership, the cessation provisions will apply. If, however, it can be shown that the new entity does carry on the old partnership business the cessation provisions will not be applied and any overlap relief available to the old partnership will be carried forward.
Disincorporation of a company
It has been confirmed that a company can disincorporate and become a limited liability partnership by taking the necessary steps. The Inland Revenue says, however, that, for shareholders in the disincorporated company, the same consequences will follow as now do so where a company disincorporates and forms an ordinary partnership.
Loss relief
For an individual limited partner within the scope of section 117, Taxes Act 1988, that section limits the loss relief which he may claim as his contribution to the trade at the appropriate time. His contribution to the trade is defined as being the aggregate of:
 the amount which he has contributed as capital so far as he has not withdrawn it or received it back; and
 the amount of any profits to which he is entitled and which remain undrawn.
A limited liability partner's loss relief is similarly restricted but, in his case, to the greater of the amount subscribed by him and his liability in a winding up. The amount of his liability in a winding up is the amount which he is liable to contribute to the assets of the partnership in the event of it being wound up and which he remains liable to contribute for the period of at least five years from the relevant time. The amount which he has subscribed is the amount which he has contributed to the partnership as capital, less any amounts he has withdrawn or received back previously and any amounts which he draws out or receives back within five years of the relevant time, or is or may be entitled to draw out or receive back at any time while he is member of the partnership or which he is or may be entitled to require another person to reimburse to him. The capital contribution excludes an addition for undrawn profits. This is because a member's undrawn profits will normally be regarded as a debt of the partnership, which means that the member involved ranks for that sum along with other creditors in the event of liquidation. Where the terms of the agreement between members specifically provide that the undrawn profits stand as part of a member's capital contribution and the agreement is unconditional, the undrawn profit has to be taken into account for calculating the limit. The change in the definition of a member's capital contribution is due to the introduction of new section 118ZC, Taxes Act 1988.
Another change with regard to losses carried forward is made by new section 118ZD. Where losses relating to a trade carried on by a member of a limited liability partnership are, in any chargeable period, prevented from being given or allowed by section 117 or 118 in their unamended form, the position will be as follows. In each subsequent chargeable period in which the person concerned carries on the trade as a member of the limited liability partnership and any of his total unrelieved loss remains outstanding, sections 380, 381, 393A(1) and 403, Taxes Act 1988 (and sections 117 to 118 as they apply in relation to these sections) shall have effect as if any loss sustained in the period represented or was increased by the total unrelieved loss outstanding.
Interest on loans
Where an individual obtains a loan to purchase a share in a partnership or to contribute money to a partnership by way of capital or premium which is used wholly for the purposes of the trade, profession or vocation carried on by the partnership, relief for interest on the loan is available under section 362, Taxes Act 1988. Such relief was not available to a limited partner under the Limited Partnership Act 1907, but new section 118ZD(2), Taxes Act 1988, amending section 362, states that this restriction does not apply to a limited liability partner unless it is an investment limited liability partnership.
Successions
Tax Bulletin 50 sets out the official view on a number of points arising where a limited liability partnership succeeds to a business carried on by an old partnership. For instance, where, owing to a change in the basis of assessment, there has been liability to a catching up charge, the spreading rules will continue to apply as if the conversion to a limited liability partnership had not taken place.
Where an obligation to pay an annuity is transferred from an old partnership to a limited liability partnership, the members of the latter will be entitled to higher rate tax relief for their share of the continuing payments.
The succession of a limited liability partnership to a business carried on by an old partnership will not of itself give rise to a balancing event for the purposes of capital allowances.
Capital gains
The Limited Liability Partnership Act 2000 introduced some additions and amendments to Taxation of Chargeable Gains Act 1992 including a new section 59A. Section 75, Finance Act 2001 substituted a new version of this section and added a further new section 169A. The latter came into force from 3 May 2001, and the other provisions affecting capital gains operate from 6 April 2001.
New section 59A makes it clear that limited liability partnerships carrying on a trade, profession or other business with a view to profit are treated as partnerships for the purposes of capital gains tax. Partnership assets are treated as belonging to the partners who are directly taxable on their share of any chargeable gains arising on disposal of those assets. If there is a temporary cessation of trade, the tax status of the partnership continues. This is also the case in a winding up provided that the process is not unnecessarily prolonged and that the purpose of the winding up is not the avoidance of tax. But on liquidation a limited liability partnership ceases to be treated as such from the earlier of the appointment of a liquidator or a court-order for winding up. When the normal capital gains rules thus cease to apply, the limited liability partnership is taxed through the liquidator as a company on any chargeable gains on disposal of its assets. The only asset then held by the members is their capital interest in the partnership; the disposal of this is based on the amount of the capital distribution made by the liquidator. Such capital interests are treated as acquired at the date and the then cost of the partner's admission to the partnership.
The commencement and cessation of a partnership's status as a limited liability partnership does not of itself give rise to a charge to capital gains tax on its members. But, under new section 169A, any gain deferred by a claim for gift relief when the limited liability partnership status no longer applies does not fall out of charge. Where a member holds an asset acquired from a disposal to him, any gain which has been held over under section 165 or 260 immediately becomes chargeable.
Investment and property
Schedule 25 to the Finance Act 2001 is concerned with investment and property investment limited liability partnerships. An investment limited liability partnership is defined in very similar terms to those used to define an investment company in section 130, Taxes Act 1988. A property investment partnership of this type is one whose business consists wholly or mainly in the making of investments in land (which includes buildings and structures and other features of land). Whether a partnership has such a status is considered for every period of account.
Exemptions given for other tax purposes to pension funds do not apply to income derived from investments, deposits or other property held as a member of a property investment limited liability partnership under new section 659D, Taxes Act 1988. Such income is to be taxed at the rate applicable to trusts specified in an appropriately amended section 686. Some exemptions are given to pension funds and schemes from capital gains tax under section 271, Taxation of Chargeable Gains Act 1992. When the assets in question are held by the fund or scheme as a member of a property investment limited liability partnership, the exemption is disapplied by section 271(12).
Insurance companies and friendly societies
Special provisions, i.e. new sections 438B and 438C, Taxes Act 1988, are made for insurance companies which are members of a property investment limited liability partnership and as such are in receipt of income or capital gains. If a policyholder's share of income and gains is derived from an insurance company's membership of the specified type of partnership and is referable to pension business, it is charged to corporation tax. For these purposes, the amount derived from the partnership is treated as derived from a separate Schedule A business and is charged at a corporation tax rate equal to the basic rate of income tax. The income is included in the insurance company's calculation of pension business profit. The policyholder's share is the amount remaining after deduction of the shareholders' share, for the calculation of which a formula is supplied by new section 438C(2).
Some amendments are made to existing provisions in respect of double taxation relief and allocation of capital allowances in the insurance company's computation where income received as a member of a property investment limited liability partnership is involved.
The profits from life or endowment business of friendly societies or the other business of a registered or an incorporated friendly society are exempt from corporation tax. This is withheld in respect of the income and gains received by such societies as members of a property investment limited liability partnership.
Arthur Sellwood MA is a former Inspector of Taxes.

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