Could partnerships be a target for the Chancellor’s Budget?

In summary:

• Reports speculate that Rachel Reeves is to reduce the tax benefits of LLPs used by lawyers, accountants, consultants and other professions
• Currently, partners or members in these structures are treated as self-employed, and neither the partnership nor the partners pay employers’ or employees’ national insurance contributions, instead partners pay Class 4 NIC
• The rumoured change would see partners and members facing a significant hike in the tax on their earnings
• While the changes appear to be designed to address unfairness in the tax treatment of partners compared with employees, they don’t consider the additional costs of being a partner, including financial risk and a lack of employment rights

As press speculation continues in the run-up to the Autumn Budget, one area currently receiving a lot of attention is national insurance contributions (NIC) and partnerships. It’s been reported that Rachel Reeves is considering applying employers’ NIC to partnerships, including limited liability partnerships (LLPs). Professions, such as lawyers and accountants, are among those that often use LLPs, whose partners are treated as self-employed and exempt from employer’s national insurance.

The change to partnerships was proposed in a recent report by CenTax. Although this report was not commissioned nor endorsed by HMRC, The Times reported on 21 October that the Chancellor could impose a new charge on those using partnerships, which would be marginally less than the 15% rate of employers' national insurance. A day later, the paper updated its stance, saying that, to avoid hitting GPs, the change would be limited to LLPs and would not impact general partnerships.

The focus of the report is on equalising the tax treatment across different forms of income from work and the expectation would be that, if the change was introduced, it would only apply to trading partnerships and not investment partnerships. It should be noted however that there have been separate reports that the Chancellor is considering a policy that would see landlords pay NIC on rental income.

While it’s still unclear, with a little over a month to go until Budget day, whether the change will happen, it’s worth noting that it would have a substantial impact. CenTax estimated that imposing employer national insurance on partnerships would raise around £2bn a year for the Treasury. According to the think tank, the average salary of partners and members of solicitor LLPs is £316,000.

Dan Neidle, of Tax Policy Associates, provided a noteworthy example: “A solicitor whose gross income is £316k (the average partner/LLP income) currently takes home about £180k. If his income was subject to employer national insurance, he’d take home £158k. This is a very big difference. His effective tax rate (i.e. overall tax divided by overall income) has gone up from 43% to 50%. His marginal tax (i.e. the % tax they pay on the next pound he earns) has gone up from 47% to 54%. We see more dramatic effects if we go to the largest law firms, where many partners earn well into seven figures.”

Neidle also commented, “CenTax used historical ‘elasticity’ data to estimate that imposing NICs on partnerships would cause a loss of tax revenue equal to about 20% of the ‘static’ estimate. That feels in the right range. The question is whether there would be a wider impact on UK law firms, fund managers etc, beyond just the loss of tax revenue, and perhaps a wider impact on the City and the economy as a whole.”

The focus of the commentary around the LLP changes is on equalising the NIC treatment of partnership income with employment income. It doesn’t consider other factors that come with being a partner or member, such as the financial risk (capital contributions) and lack of employment rights.

Neither does it recognise that, while partners of large professional services firms are often subject to income tax on their profit shares, in reality, some of this share reflects their equity in the business that will often never be realised in the form of a capital gain. 

It is hoped that a significant change like this, bringing with it a wealth of complications, would only be introduced following a consultation. Especially as partnerships are still dealing with the aftermath of basis period reform and the resulting accelerated tax, as well as the FRS102 changes coming in shortly which will also impact profits.

However, the Chancellor has discretion to set the date from which tax measures announced at the Budget apply. There are several examples of changes to transaction taxes, like CGT and SDLT, being effective from Budget day, to ensure disposals cannot be accelerated before the effective date.

NIC changes, like income tax, normally apply from 6 April, with mid-year changes resulting in more complicated calculations, but there have been exceptions. In 2022, the employee Class 1 threshold was changed from 6 July, as the 23 March Budget did not leave enough time to implement a change from 6 April. In 2024, Class 1 and Class 4 rate reductions came in from 6 January, just over a month after the Budget.

If this change were to materialise, there would be a lot to think about – in particular, modelling the tax impact, communicating the changes to partners and considering the longer-term operating structure.

However, until the Chancellor reveals her red briefcase and her announcements, not much can be done in the way of planning or preparation. The severity of the LLP national insurance rumour has certainly alerted many, and it’s safe to say, this is one of the stronger rumours that has materialised in the lead up to the Budget. Whether or not it will transpire come 26 November remains to be seen.

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