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Private equity houses and consultancy firms may have to pay hundreds of millions of pounds after the UK tax authority launched a crackdown on companies operating as limited companies.
The UK tax authority HM Revenue & Customs is already investigating companies and could potentially demand retroactive contributions, tax experts and other stakeholders told the Financial Times.
The firms argue that HMRC has unexpectedly changed its approach to the tax rules for “salaried members” that affect companies operating as LLPs, these people added. If HMRC does not soften its approach, the firms affected by the changes are expected to take legal action, the people said.
Companies that could be affected by the change in treatment include US private equity groups such as Blackstone and Carlyle Group. Other professional services sectors, including some law and accounting firms, could also potentially fall within the scope. The companies that are the subject of the investigations are confidential.
Blackstone and Carlyle declined to comment.
Mike Hodges, a partner at accountancy firm Saffery, said HMRC’s change “seems to come out of the blue”, adding that the level of potential additional liability would be “significant”.
“The numbers could be large because, by definition, these are members of the LLP who are likely to be among the highest earners and earn large amounts – so a significant employer’s social security contribution.”
The crackdown on LLPs comes at a time when industries such as private equity are already facing the prospect of higher tax rates should a Labour government win the general election on July 4.
Labour has promised to increase the tax rate that private equity managers must pay on carried interest – the share of profits dealmakers receive when assets are sold – and to reform the tax system for wealthy non-residents.
HMRC is currently investigating whether some LLPs have been wrongly classifying some members as self-employed and therefore paying less tax. Rules introduced in 2014 set criteria to assess whether individuals were self-employed or employees – in which case companies would have to pay national insurance contributions, currently set at 13.8 per cent of employee income. Before 2014, LLP members were generally recognised as self-employed.
One of the conditions of these rules is that a partner’s capital contribution to the partnership is less than 25 percent of his share of the profits. In this case, he is considered an employee.
This means that the partnerships have tried to ensure that the capital contributions of the partners always remain above the 25 percent threshold in order to avoid the status of an employed partner.
A lawyer admitted that there had been an “abuse” of the system by some companies.
HMRC changed its internal guidelines in February, stating that deliberately failing to meet the condition by making excessive capital contributions could constitute a breach of tax avoidance rules.
Jitendra Patel, a tax consultant at BDO, an accounting firm, said: “You’re basically saying that if you contribute capital to avoid the permanent member rules, it’s tax evasion. It’s almost like a trap that you’re caught in, even if you’re risking your own money to try to comply with the rules.”
HMRC’s move sparked a backlash from affected industries and their trade associations.
Both the British Private Equity and Venture Capital Association and the Law Society recently held discussions with tax officials on behalf of some of their members who had raised concerns, people familiar with the matter said.
“It is vital that any changes affecting this are forward-looking and are made in a way – both in terms of process and content – that promotes the competitiveness of our financial services sector rather than undermines it,” Michael Moore, chief executive of the BVCA, told the FT.
The Law Society said it “completely disagreed” with the change and called for it to be withdrawn.
It continued: “Changes should, if made at all, only be made after appropriate public consultation and should in no case have retrospective effect.”
Guy Sterling, partner at Moore Kingston Smith, added: “It is important that individuals can continue to capitalise their businesses as required to prevent those businesses from going bust.”
HMRC said: “We updated our guidance in February to clarify the circumstances in which certain avoidance rules apply to help customers get their taxes right.”
HMRC added that it reviews its guidance “regularly” and “listens to stakeholders’ concerns”.
Additional reporting by Michael O’Dwyer, Simon Foy and Suzi Ring in London.