A typical conversation with clients who are thinking of incorporating an LLP is around the way in which members of LLPs are taxed during the opening two to three years of trade. For many, the opening years can be somewhat confusing if, as with most US inbounds, the entity will not have an accounting period ending between 31 March or 5 April. To add to this, the concept of overlap profits i.e. profits that are taxed in more than one tax year, can also be a bone of contention.
From 6th April 2024, all members of an LLP will only be taxed on profits apportioned on a pro-rata basis to the tax year (i.e. ending on 5 April). As a result, members of a Fund Manager LLP that is incorporated after 6 April 2024, will not need to worry about overlap profits should they choose an accounting date other than between 31 March or 5 April.
However, they and also members of existing LLPS (which do not have an accounting period ending between 31 March or 5 April), will need to go through a process of incorporating their profit shares for the period between the end of the accounting period and 5 April into their tax returns. This is calculated by apportioning the profits in the relevant accounting period by reference to the number of days. The issue here is that if the accounting period has not ended at the time of calculating the apportionment, an estimation will need to be included. This estimation will then need to be revised when the actual results are finalised (and therefore an amended tax return will need to be submitted).
Unless a Fund Manager LLP has an accounting period ending between 31 March and 5 April, all the members will need to deal with the complication of having to estimate profits and amend tax returns for each year. To avoid this some LLPs may want to consider changing their accounting period to 31 March, but this may not be possible in some cases (e.g. where the parent entity is not in the UK and requires a specific accounting period end date).
Members of existing Fund Manager LLPs where the accounting period does not end between 31 March and 5 April, will need to account for the fact their profits will be taxed sooner under the new method compared to the current way in which they are taxed.
As an example:
Members of a Fund Manager LLP that has an accounting year ended 31 December 2022, will have their share of the profits of this period (i.e. the year ended 31 December 2022) taxed in 2022/23. If the rules did not change, their taxable profits in the following tax year (i.e.2023/24) will be their share of the profits for the year ended 31 December 2023. However, under the new rules, the member will be taxed on profits for the period 1 January 2023 to 5 April 2024. So a proportion of profits, under the new rules will be taxed earlier. The additional profits [1] taxed in 2023/24 as a result of the reform, will be automatically spread over five years (it is possible to elect out of spreading, and pay the tax upfront). Whilst spreading is helpful, Fund Managers will still incur a higher a tax charge in the year than may have previously been anticipated. This will need to be factored in when managing cash flow. From 6 April 2024 the members will be taxed on their share of the profits for the tax year.
Fund Managers will therefore need to plan ahead and consider whether or not the acceleration of tax has a knock-on effect with their regulatory requirements. The need to manage cash flow becomes more critical when you take into consideration the requirements of the Investment Firm Prudential Regime (“IFPR”). If the acceleration in tax coincides with the need to contribute more capital to the LLP under IFPR, then managers who rely on profits as a means of contributing back to the LLP could be left in a position of having to source additional cash. Therefore, whilst the reform is intended to simplify the way in which members of an LLP are taxed Fund Manager LLPs still need to keep a close eye on the impact that tax may have on the regulatory aspects of the business, with IFPR being the most current piece to watch out for.
Tax and regulatory requirements should be considered together. A change in one policy may have an unexpected effect on the other. If you would like to find out more about our services please contact skanagarajah@wheelhouse-advisors.com
[1] The spreading of the additional profits only relates to the tax year ended 5 April 2024. Fund Manager LLPs that are considering changing their accounting period should therefore do so in relation to accounting periods ending in 2023/24 in order to access the spreading of profits.