The rules on corporate taxation of associated companies are complicated but must be fully understood by solicitors to ensure they do not face bigger tax bills. Andy Poole looks at the problems that can arise




It is becoming increasingly common for professional partnerships to have one or more separate companies controlled by firms that have been incorporated to carry out ancillary or regulated functions.



However, there may be a sting in the tail for companies attached to partnerships, and even for otherwise totally unconnected companies that are controlled by different partners.



The taxation of companies is usually relatively straightforward, with corporation tax chargeable at 20% on profits up to £300,000, 32.5% between £300,000 and £1.5 million, and 30% above £1.5 million. Where companies are associated with one another, the above thresholds are split evenly between the companies. So, for three associated companies, the thresholds for each company are £100,000 and £500,000.



The reasons for this are simple – it ensures that tax cannot be avoided by splitting activities across a number of companies that are controlled by the same individual, or group of people, in order that each company can benefit from a full £300,000 of profits at the lower 20% tax rate.



Associated companies are those companies controlled by the same person or group of people, as well as companies that fall within a conventional group structure. However, for the purposes of determining control, an individual is deemed to control any company that is controlled by an ‘associate’ or ‘associates’ of his. The definition of ‘associate’ includes not only family members and certain trust relationships, but also business partners of the individual. This is where problems can occur.



This article will give an understanding of where problems arise without going into too much detail on the complicated mechanics of the rules.



Associated companies

Consider a five-partner firm that has two trading companies within its control, and consequently believes that each company will be taxed at 20% on the first £150,000 of its profit.



Two of the partners have joined together to purchase a small portfolio of residential investment properties which they acquired through another company, the shareholdings in which are 50% each. Another partner has inherited from his mother the shares in a retailing company which employs a manager who oversees the day-to-day running.



There are now four companies that are controlled by partners of the firm, and consequently four associated companies instead of two. The threshold at which each one starts paying 32.5% corporation tax on its profits is now halved to £75,000. This affects both the ‘core’ partnership companies and the partners’ own personal interests.



Worse, if one of the partners has sheltered his tax liability by investing in a film partnership (or similar partnership designed to generate a large initial tax loss), then he has joined another partnership. As a result, the corporate interests of his other partners, whom he does not even know, will also be associated companies.



On the face of it, this seems somewhat unfair, and in the context of families there is a longstanding concession that narrows down the family relationships that are considered relevant in circumstances where there is no substantial commercial relationship between the companies involved.



Discussions were held between the accountancy professional bodies and the Inland Revenue (as it then was) two years ago about extending this concession to apply to partnerships in similar circumstances, but no changes were forthcoming.



Directors’ responsibilities

Since each company is required to self-assess its corporation tax liability, it is the directors’ responsibility to be able to satisfy themselves of the number of associated companies that the company has. Since the 20% rate of corporation tax is claimed as part of the tax return, if the directors cannot justify that claim, then strictly all of its profits should be charged at the full rate of 30%.



To assess whether the directors are entitled to claim the lower rate of tax, all partners must be open with each other about any companies in which they have investments, and for larger firms this could amount to a significant information-gathering exercise. Revenue & Customs is becoming increasingly astute on this issue, and if a company has understated the number of associated companies that it has, and the directors ought to have known the figure was incorrect, penalties may arise.



More remote associations

There are some areas of light amongst the gloom. Companies that are not controlled directly by partners, such as interests held by their spouses or civil partners, do not contribute to one global total. They still need to be separately considered though, as they could still affect the tax liability of partnership companies, and there may be an impact on their own tax liabilities.



There is also currently some doubt over whether this issue applies to limited liability partnerships (LLPs) since, although for the main tax purposes an LLP is treated as a partnership, it technically does not have partners but members, and there has been some discussion over whether members of an LLP fall within the term ‘partners’ as used for defining associates. Until a case is heard on how the legislation should be interpreted, there will not be a definitive answer on this point.



Conclusion

To summarise, if any partner has any external interest in a company or another partnership or LLP (including tax avoidance vehicles structured as partnerships or LLPs), then this could impact adversely on the tax liabilities of both the partnership’s companies and the external companies.



All partners and firms that control any active companies need to be aware of the issue and ensure that their accountants are fully briefed – the complications of working out which companies are associated with which others can then be left to their advisers.



Andy Poole of Hawsons is the UK chairman of LegalPlus, an association of solicitor-specialist accountants