Many partnerships and limited liability partnerships (LLPs) have both individual and corporate partners. There are various reasons for such ‘mixed partnerships’ being in place, some of the most common reasons being:

• The partnership business was originally carried on within a company, and the company subsequently contributed the business to a partnership and then remained in place as a partner.
• A company was introduced into an existing partnership as a means of allowing external investment to be introduced into the business.
• A corporate partner was put in place to facilitate a deferred remuneration or partner incentive scheme.

A corporate partner was introduced with a view to allowing profits that could not be withdrawn from the partnership by individual partners (eg, because they were required for working capital) to be allocated to the company, such that they would be available for continued use within the business after the deduction of tax at corporation tax rates.

Until 2014, it was considered possible to obtain significant tax savings by allocating partnership profits to a corporate member of a mixed partnership. This enabled those profits to be subject to corporation tax rather than income tax. As described below, the tax rules in this area are now a lot more restrictive and the same tax savings may no longer be available. Consequently, there are some mixed partnerships still in existence that were formed before 2014, but may not have been formed under the current rules.

Whatever the reason for a mixed partnership, there are a number of tax implications that might need to be considered. The purpose of this article is to highlight some of the most significant of these.

Taxable profit calculations

The basic position is that partnerships and LLPs are ‘transparent’ for both income tax and corporation tax purposes; individual partners are subject to income tax on their profit shares and corporate partners are subject to corporation tax on their profit shares.

In a mixed partnership, it must be borne in mind that the profits of the partnership will need to be calculated under income tax rules in order to determine the profits that are subject to income tax in the hands of individual partners, and under corporation tax rules in order to determine the profits that are subject to corporation tax in the hands of the corporate partners.

In many cases, these profits figures will be the same, but differences might arise as a result of issues such as loan relationships, pre-2002 intangible assets and (in some cases, for example where there is a long period of account) capital allowances.

On the subject of capital allowances, it is worth pointing out that the annual investment allowance is only available to individuals, partnerships of which all the partners are individuals, and companies; it is not available to mixed partnerships.

Regardless of whether income tax or corporation tax is in play, the taxable profits of a partnership will, once calculated, need to be allocated between the partners of the partnership. This gives rise to a couple of specific points in the context of mixed partnerships.

First, the legislation states that profits should be allocated “in accordance with the profit-sharing arrangements in place during the period”. These profit-sharing arrangements will have been designed to share accounting profits and it might not always be clear how these are to be applied to taxable profits (ie, how to account for tax adjustments such as add-backs of disallowable expenditure). Within a mixed partnership, it might be considered attractive for add-backs to be reflected in the taxable profits of a corporate partner, so they suffer corporation tax rather than income tax. Some element of judgement may be required, but the key point will be to ensure that, whatever approach is taken, it can be justified as being in line with the relevant profit-sharing arrangements.

Second, since 2014 there have been provisions that mean the basic profit allocations will be overridden in certain situations. These provisions, and the driver behind their introduction, were referred to above and they will often be the most significant issue to be considered in the context of a mixed partnership.

Allocation of profits

Before describing in detail the rules that have been in place since 2014, it is worth looking briefly at some cases concerning the pre-2014 position that have come before the courts in recent years.

In both Odey Asset Management LLP v HMRC [2021] UKFTT 31 (TC) and HFFX LLP v HMRC [2021] UKFTT 36 (TC), profits had been allocated to corporate members as part of deferred remuneration arrangements, with further arrangements having then been put in place to allow these amounts to find their way into individual members’ hands in subsequent years.

In each of these cases HMRC argued, first, that profits allocated to the corporate members should be assessable on the individual members on the basis that, realistically, the individual members had immediate rights to these profits. HMRC lost on this point. HMRC was successful on its second argument – that amounts received by the individuals under the further arrangements should be taxable under the miscellaneous income provisions. But the main point for the purposes of this article is that prior to 2014, there was little that HMRC could do to challenge the initial allocation of profits to corporate members.

The key provisions of the 2014 rules are in s850C, Income Tax (Trading and Other Income) Act 2005. These apply where:

• a partnership has taxable profits;
• an individual partner is allocated either a share of the profit or neither a profit nor a loss;
• a non-individual partner (ie, a corporate partner) is allocated a share of the profit; and
• either Condition X or Condition Y is met.

Condition X is met where it is reasonable to suppose that an amount representing an individual’s deferred profit is included in the corporate partner’s profit share, and as a result the individual’s profit share, and the total tax payable by the relevant partners, are both lower than they would otherwise have been. Deferred profit is an amount that is attributable either to the individual, or to a number of partners including that individual, and which are deferred, whether pending the meeting of conditions or otherwise.

Condition Y is met where three compound tests are all met:

• the corporate partner’s profit share exceeds the ‘appropriate notional profit’;
• an individual partner has the ‘power to enjoy’ the corporate partner’s profit share; and
• it is reasonable to suppose that the whole or part of the corporate partner’s profit share is attributable to the individual’s ‘power to enjoy’, and that the individual’s profit share, and the total tax payable by the relevant partners, are both lower than they would otherwise have been.

An ‘appropriate notional profit’ is made up of an ‘appropriate notional return on capital’ (ie, a commercial return on the company’s contribution to the firm) and an ‘appropriate notional consideration for services’ (ie, an arm’s-length return for services provided by the company). What these each mean in practice will depend on the particular economic circumstances. The ‘power to enjoy’ is defined very widely and encompasses not only circumstances where the individual partner owns the corporate partner, but many other circumstances as well.

Where the provisions apply, the individual’s taxable profit share is increased by the amount of the corporate partner’s profit share that is attributable either to the individual’s deferred profit or to the individual’s power to enjoy the non-individual’s ‘excess’ profit.

The recent case of Walewski v HMRC [2020] UKFTT 58 (TC) involved a detailed examination of Condition Y and sheds some light on the way in which this is to be assessed.

The brief background to this case is that Mr Walewski and Walewski Limited were both members of two LLPs. Mr Walewski personally provided services to the LLPs’ clients, and he argued that he did so through Walewski Limited rather than as a member of the LLPs in his own right.

It was accepted that the company’s profit shares exceeded the ‘appropriate notional profit’ and that Mr Walewski had the power to enjoy these. Mr Walewski argued, however, that the company’s profit share was not attributable to the fact that he had the power to enjoy it, but rather to the work that he had performed through the company. Ultimately the tribunal decided that Mr Walewski had a single ‘fungible’ role and that the only reason he was said to have performed any of his services through the company (rather than as a member personally) was his power to enjoy these profits. Accordingly, Condition Y was held to have been met in this case.

The decision was upheld on appeal to the Upper Tribunal.

Other points

Two other common issues can be relevant to mixed partnerships.

1. As well as the rules already discussed relating to the allocation of profits, there are also rules in s116A, Income Tax Act 2007, that relate to the allocation of losses. These are relevant where an individual makes a partnership trading loss as a result of arrangements that are designed to secure that trading losses are allocated to the individual rather than to a non-individual. Where this is the case, the individual gets no tax relief at all for that loss.
2. A corporate partner of a partnership will often be a ‘close company’. As such, it will need to bear in mind the ‘loans to participator’ rules within Chapter 3, Pt 10, Corporation Tax Act 2010 (CTA 2010). It is worth noting specifically that these rules were extended in 2013 to ensure they apply where a close company makes a loan to a partnership of which one of the partners is an individual who is a participator in the company. These extended rules may well be relevant where a company makes a loan to a partnership of which it is a partner. They should not apply to a corporate partner’s capital account, but the anti-avoidance rule in s464A, CTA 2010, may need to be considered if there are circumstances that are not caught under the general rule, but result in a corporate partner’s funds ending up in the hands of individual partners.

Final comments

Practitioners will come across mixed partnerships that have been established for a number of reasons. This will give rise to specific tax issues that will need to be considered on an ongoing basis.

A whole host of further tax issues can arise when mixed partnerships are created (particularly through the introduction of a corporate partner), or when it is intended to remove or wind up the corporate partner. These are outside the scope of this article, but they too will need to be considered when advising businesses that are either attracted to or (perhaps more likely) disillusioned with a mixed partnership structure.

About the author

Andrew Constable, Partner, Moore Kingston Smith and member of the Tax Faculty’s Business Tax Committee