HMRC Warning: Hybrid Partnership Tax Scheme Flawed

HMRC is warning private landlords forming hybrid partnerships to avoid tax could face more enormous tax bills because the scheme is flawed.

The tax authority says the hybrid partnership scheme restructures a property business so lands can ignore mortgage interest relief restrictions, reduce tax on rental profits and cancel some capital gains tax (CGT) on selling homes and inheritance tax (IHT) due on the estate on death.

“HMRC’s view is that this scheme does not work. People who use these arrangements may have to pay more than the tax they tried to avoid and pay interest, penalties and high fees for using such schemes,” says the warning.

HMRC did not identify the scheme promoters, but they allegedly include lawyers, accountants and other property-orientated organisations. It's being reported that other landlord associations have suspended dealings with partner tax advisors due to the HMRC guidance.

How a hybrid partnership works

A detailed analysis published by HMRC explains how the scheme works.

• A landlord forms a company and a limited liability partnership (LLP)
• The landlord and company join the LLP as partners
• The landlord transfers  their rental portfolio to the LLP
• The landlord claims relief on the LLP’s mortgage interest payments
• The landlord and company allocate the LLP profits to ensure the landlord remains a basic rate taxpayer, with any remaining profits going to the company

Tax advisers promoting the scheme tell landlords structuring their property business like this leads to smaller tax bills because:

• The LLP has minimal set-up costs.
• Transferring properties to the LLP removes any accrued CGT and resets the CGT tax clock to zero. If homes
• The landlord stays a basic rate taxpayer.
• The company can claim mortgage interest relief as rules restricting the claim apply to landlords, not companies.
• The company pays tax on profits at a lower rate than higher (40 per cent) or additional rate (45 per cent) for landlords.
• Business Profit Relief (BPR) applies to an LLP property business, minimising IHT.

HMRC argues the hybrid LLP structure is unlikely to work for four reasons:

• The way profits are reallocated to a corporate LLP partner breaches legislation (Income Tax (Trading and Other Income) Act 2005, Section 850C and 850D)
• How income streams are diverted  does not comply with anti-avoidance legislation in the Income Tax Act 2007, Chapter 5AA, Section 809AAZA
• CGT rules do not change the base cost of assets when they are moved to an LLP (Taxation of Chargeable Gains Act 1992 Section 59A)
• A property rental business is likely excluded from BPR as the legislation bars ‘making or holding investments’ (Inheritance Tax Act 1984 Section 105(3))

The HMRC warning comes with an offer of help for landlords worried about their tax status after joining the alleged anti-avoidance scheme.

“If you think you’re already involved in this arrangement and want to get out, HMRC can help. HMRC offers a range of support to get you back on track or avoid being caught out in the first place,” says the online document.

“If you’re using this or similar schemes or arrangements, HMRC strongly advises you to withdraw from it and settle your tax affairs. You can do this by emailing HMRC at spotlight63@hmrc.gov.uk, and we will tell you what further information we require.”

HMRC also suggests concerned landlords should take independent professional advice.

The tax authority adds that avoidance scheme promoters face penalties for failing to disclose their operation within five days of making the scheme available. Fines start at £600 daily for non-disclosure and can rise to £1 million.

HMRC did not name the promoters of any hybrid LLP schemes.

Hybrid partnership FAQ

What is a landlord hybrid partnership?

A hybrid landlord partnership involves setting up a limited liability partnership between a landlord and a company controlled by the landlord. The aim is to save tax by exploiting different financial rules for each entity.

Does a hybrid partnership save tax for landlords?

HMRC says a hybrid partnership is tax avoidance and does not work. Tax experts and lawyers argue for and against. Until a scheme is tested in the courts, it’s difficult to say who is right.

Why is HMRC acting against hybrid partnerships now?

HMRC has not revealed why a warning was published, but generally, a warning comes before HMRC intends to investigate what is considered widespread tax avoidance.

I’m in a hybrid partnership. What do I do?

If you are a landlord immersed in a hybrid partnership, you should take independent professional advice from a tax expert or lawyer unconnected to the scheme promoters. The promoters will be keen to protect their reputation and financial interests, so they may not be the best source of advice.

My hybrid partnership follows HMRC guidance - am I OK?

HMRC manuals and guidance have no force in law and are published in good faith. The contents have often been challenged in the courts, often resulting in a loss for HMRC. As such, they are HMRC’s interpretation of the law open to court clarification.