Mixed-member partnerships combine at least one individual partner with a non-individual partner, commonly a limited company. Such structures are not inherently problematic, and genuine commercial arrangements can operate without adjustment. The difficulty arises where partnership profits are allocated to the corporate member in circumstances where an individual partner can ultimately enjoy those profits or where the allocation effectively defers profits that would otherwise have been taxed on the individual.
The legislation can then reallocate part of the company’s profit share back to one or more individual partners for Income Tax purposes.
When mixed-member partnerships fall within the excess profit rules
The rules first require a taxable partnership profit and an allocation of part of that profit to a non-individual member. A company is the most common example, although a non-individual partner can include other entities.
The mixed-member partnership excess profit rules broadly identify two routes by which an adjustment can arise. One concerns deferred profits; the other concerns a corporate profit allocation exceeding an appropriate commercial return where an individual partner has the power to enjoy some or all of that corporate allocation.
The rules do not automatically apply merely because an LLP contains individual members and their associated company. The commercial basis of the profit allocation has to be examined.
Mixed-member partnerships and the appropriate notional profit
Where the power-to-enjoy condition is relevant, the corporate member’s appropriate notional profit broadly consists of two components: a reasonable return on capital contributed to the partnership and arm’s-length consideration for services genuinely supplied by that corporate member.
The appropriate notional profit calculation specifically divides the amount into a notional return on capital and notional consideration for services. A large profit allocation cannot therefore be justified merely by pointing to a small amount of share capital or administrative support.
Consider an LLP in which two individuals perform substantially all professional work while a company owned by them contributes capital and limited administrative services. If a disproportionate share of profit is allocated to the company, the amount exceeding an appropriate commercial return may require closer examination.
The tax analysis is not based simply on the profit-sharing percentages written into the LLP agreement. It considers why those percentages exist and the economic relationship between the members.
Power to enjoy is deliberately broad
An individual does not necessarily need to withdraw the company’s profits personally for the rules to become relevant.
Power to enjoy can arise through connection between the parties, arrangements designed to secure Corporation Tax treatment rather than Income Tax treatment, or wider circumstances giving the individual economic access to or benefit from the company’s allocated profits.
For owner-managed structures, the fact that an individual partner also owns the corporate member is therefore highly relevant, although the remaining statutory conditions still have to be considered.
Retaining profits inside the company does not, by itself, establish that the allocation is commercially justified.
The adjustment occurs in the partnership tax computation
Where the rules apply, the relevant excess amount is reallocated from the non-individual partner to the individual partner for tax purposes. The partnership’s overall taxable profit does not increase; instead, the allocation among members changes.
This matters because the adjusted shares, rather than the contractual shares before applying the legislation, should be reflected in the partnership tax reporting.
The company may consequently be taxed on a smaller share than shown by the commercial accounts while the individual is taxed on an additional amount. Separate rules then address certain payments subsequently made by the company out of profits that have already been reallocated, reducing the risk of the same economic amount being taxed twice.
Commercial evidence should exist before profits are allocated
Mixed structures should document the capital contributed by each member, services supplied, commercial risk borne and basis on which profits are allocated. A percentage chosen at the year end purely to move taxable profit into a company is much harder to defend than a commercial methodology embedded in the partnership arrangements.
Where an LLP operates alongside an owner-managed company, the company consequences should be reflected in its Corporation Tax computation while the individuals’ profit allocations must be reconciled with their personal tax position. Structures involving substantial corporate allocations should obtain specialist tax advice before profits are finalised rather than attempting to justify the allocation after the partnership return is due.
Disclaimer: This article is provided for general guidance only and does not constitute personal tax, legal or financial advice. The correct tax treatment depends on the specific facts, applicable legislation and HMRC practice at the relevant time. You should contact us for advice tailored to your circumstances before taking or refraining from any action.
