Tax system needs to take a more strategic approach to partnerships, says OTS

The OTS says that tax policy and administrative processes have generally been designed with sole traders and corporations in mind, and not partnerships. This is despite the fact that partnerships make up 10% of UK businesses with combined sales of £150 billion, and a significant presence in the UK financial services sector. There are also problems in international situations as tax treaties do not always consider partnerships "as much as they should".

In compiling its report into how partnership tax could be simplified, the OTS spoke to members of partnerships, advisers, representative bodies and HMRC staff. It concluded that "partnership tax works, but like a comfortable old shoe it is a little worn at the edges and may have a couple of holes coming through".

Tax expert John Christian of Pinsent Masons, the law firm behind Out-law.com, said that the report confirms that a radical update of how partnerships are taxed is needed covering improved legislation, more detailed and up to date guidance and a more joined up approach in HMRC on partnership issues. "There is a lot of ground to cover but the report makes an excellent start in prioritising the key issues," he said.

Partnership tax law is spread across the tax legislation, but although the idea of a consolidated partnerships tax act was welcomed in theory by those the OTS consulted, it was not felt to be desirable in practice, "as it would lead to duplication and an even longer tax code". This measure was therefore not recommended by the OTS.

The OTS said that the current 'one size fits all' approach of treating small partnerships in the same way as large ones needs to be reviewed as it leads to extra burdens and complexities for small partnerships, when compared to sole traders with similar sized businesses. The OTS would like to explore further reducing the burden to small partnerships of filling in a partnership tax return, considering in particular the opportunities HMRC’s digitisation programme presents for administrative simplifications.

HMRC needs to better coordinate its partnership work and the ways it supports partnerships, the report said. It pointed out that there is no single contact point where partnerships and their advisers can go for specialist advice. This is in contrast to how HMRC handles trusts, pension schemes and charities, all of which are less prevalent than partnerships.

The report described HMRC's stance towards partnerships as "one of the most sensitive issues we have encountered in our project". People told the OTS that HMRC's approach was to treat partnerships and LLPs in particular as if they were "exclusively avoidance vehicles". The OTS said that the debate over the anti avoidance provisions proposed for the Finance Bill 2014 concerning mixed membership partnerships and the proposals to tax members of LLPs whose terms are more akin to employment than self employment as employees, may have contributed to this feeling. However the OTS said that HMRC needed to adopt a more balanced view and make it clearer that partnerships were legitimate commercial structures.

“It is clear from the report that HMRC is highly sensitive about LLP structures and avoidance so it is unlikely that there will be any watering down of the Finance Bill anti-avoidance provisions on LLPs," said Christian.

The report suggests some 'short term fixes', which mainly focus on areas where HMRC can improve its guidance or change tax return forms. 'Medium term fixes' include tidying up HMRC’s Statement of Practice D12 for capital gains of partnerships "to reflect modern-day business practice", ensuring double tax treaties deal adequately with partnerships and changing the way penalties work for partnerships and who has to sign VAT returns.

The OTS has also identified a list of longer term areas to investigate. These include reducing the administrative burdens faced by small partnerships, possibly by removing the obligation to file a partnership return in addition to the individual returns of the partners. The OTS would also like to investigate allowing partners to claim personal expenses as it considers this would be a substantial simplification for many firms.

Another long term issue identified by the OTS is the complexity caused by the 'opening year' and 'closing year' rules where individuals join and leave partnerships and whether a simpler method of giving 'overlap relief' would be "sensible, fairer and appropriate". They would also like to investigate whether it would be possible to abolish stamp duty in relation to partnerships and whether there should there be a formal rule in SDLT that no tax will apply in partnership reorganisations unless cash changes hands.

The OTS gives independent advice to the government on simplifying the UK tax system. The government commissioned the OTS to carry out a review to "identify the main complexities around partnership taxation, and recommend priority areas for a more detailed review leading to specific recommendations." The OTS can only make recommendations and it is up to the government to decide which recommendations to take forward. The Chancellor of the Exchequer is expected to give a formal response to this report in his Budget on 19 March.