Is Labour’s rumoured attack on partnerships justified?

The issue

According to reports in this week’s media, Rachel Reeves is planning to hit partnerships with higher tax charges at next month’s Budget.  People are speculating that the Chancellor will take steps to impose Employers’ National Insurance Contributions (‘NIC’) on the earnings of individual partners. This measure is said to be targeted at high earning professionals such as solicitors and private equity fund managers, as well as GPs, who the Government believes are unfairly benefiting from structuring their affairs in this way.  This could apparently generate around £2bn of tax revenue.

The details are unclear, but we believe that this will be brought about by treating each partner’s profits as including 15% NIC (equivalent to the rate paid by employers in respect of ordinary employees).  The net profits i.e. the amount excluding the 15% NIC would then be subject to income tax and Class 4 NIC.  To maintain parity, we expect that there would be a minimum threshold of £5,000 before the 15% charge applies, as with ordinary employees.

Rationale behind the policy

Newspaper reports say that the Chancellor’s interest in this area came about as a result of a policy paper issued by the Centre for the Analysis of Taxation (‘Centax’) which highlighted disparities in the rates of tax levied on partnership profits compared to other businesses.  This is borne out by the table below, which shows the effective tax rates typically payable in different scenarios based on current tax rates. 

Individuals who operate through partnerships currently pay the lowest effective rates at all levels.  This has mainly occurred because of increases in corporation tax and dividend tax rates, which are not payable by the self-employed and those who operate through a partnership.

Example of how this would operate

Luke, Leia and Han are partners in Star Wars Solicitors LLP earning profits of £50,000, £100,000 and £200,000 respectively.

Taking Luke first, the table below shows his tax position before and after the proposed changes (as we envisage they will operate):

* Employers NIC is calculated as (£50,000 – £5,000) x 115/100 x 15%

The proposed charge will cost Luke nearly £5,000 and equate to an almost 50% increase in the effective rate of tax he pays.

Undertaking the same exercise for Leia and Han leaves the following comparison:

WSM’s view

Contrary to the Chancellor’s aims of making those with the “broadest shoulders” pay their fair share, the above analysis shows that these changes would hit those lower down the income scale the hardest (at least in percentage terms).  Centax propose a partnership allowance (similar to the Employers Allowance) that would provide credit on the first £10,500 of any NIC charge to temper the effect of the changes, although this would only aid the very smallest businesses.

In recent years, partnerships have been something of an outlier, with partners being taxed at lower rates than those who choose to operate via a limited company.    However, it should be noted that unlike company owners – who can choose when to extract their profits – partners have no choice over when they are taxed.  Rachel Reeves could be cutting her nose off to spite her face if this change leads to a rush to incorporate to take advantage of tax deferral.