The Revenue has announced a number of measures - and, for the arrangements covered by this article has already implemented the measure - to crack down on what it perceives as the use of partnerships for tax avoidance purposes.
In all cases, they counteract what have been reasonably standard and long-term planning measures.
This is the first of a two-part look at the new measures.
Transfer pricing arrangements
With effect from 25 October 2013, two specific arrangements have been blocked:
- Many large partnerships have set up a service company to employ their staff and provide facilities. The services provided by the service company to the partnership are charged at cost. The transfer pricing legislation deems that the services are provided at market value by the service company to the partnership, typically at a 5% mark-up to cost. This means the company is deemed to receive taxable income (taxed at 23% currently), but the partners obtain a deduction for this adjustment, saving tax at up to 45%. As this is a tax only adjustment, no change is made to the actual payments between the parties, so the partners only pay original cost while obtaining a greater tax deduction. Whilst the transfer pricing adjustment applies automatically to large businesses, it is possible for small and medium sized entities to elect into it, thus also benefitting from the tax advantage.
- The second arrangement is often found in private equity transactions that are excessively leveraged with debt when compared to their equity. Due to the high level of debt, the legislation restricts the interest deductible on these loans in the hands of the company under the transfer pricing legislation, thus increasing the company's taxable profits. However, the individual making the loan can claim a compensating adjustment for the amount described and can often receive the interest payments on these loans free from the income tax charges of up to 45%. In effect, this is an additional equity.
For the service company arrangements, the new legislation provides for a one-way adjustment so that the service company pays corporation tax on the transfer pricing adjustment with no corresponding deduction in the partnership.
The legislation does provide a let-out: where the correct economic price is charged, no transfer pricing adjustment will be made. The upshot is that partnerships that wish to avoid the new charge will have to charge and pay the correct economic price.
For private equity type arrangements, the transfer pricing adjustment will be taxable on the individual. This may lead to some instances of double taxation. The income treated as arising in the individual's hands is characterised as a dividend, so it will be taxable at rates up to 37.5%. In addition, where the interest is accrued but unpaid, no charge will arise until the interest is paid.
It should be noted that individuals affected will only have to apply the new rules from 25 October 2013. For companies where the accounting period spans 25 October it will be necessary to time apportion the transfer pricing or interest adjustment.
This new measure is likely to mean that many partnerships and overly leveraged companies will have to review their arrangements in order to avoid falling within the new provisions.
Given the very short lead time in which these changes were introduced this is likely to mean that, in practice, many businesses will not have had time to consider what changes should be made and then to implement them.
This is particularly the case where it is necessary to obtain consents from third parties, which is likely to be the case in many private equity type arrangements.