Partnerships in International Taxation

Partnerships in International Taxation Presented by: Dr Michael McGowan Visiting Professor, King's College, London Date: 16 March 2022 Introduction - Tax treatment of partnerships is a complex area which has lent itself to very extensive tax planning. - This presentation focusses on meaning of "partnership" and how international tax law (including tax treaties) has sought to accommodate partnerships. - BEPS Action 2 on Hybrid Mismatches: proposals to counteract the effects of situations where entity (e.g. treated as a partnership) is used to create a hyb mismatch. Proposals now reflected in UK domestic law (Part 6A TIOPA 2010) and Articles 9 et seq. of EU Anti-Tax Avoidance Directive 2016 (as amended). - This material does not focus on BEPS Action 2 other than its recommendations for changes to Article 1 OECD Model Treaty. Identifying A Partnership  Section 1 UK Partnership Act 1890: "Partnership is the relation which subsists between persons carrying on a business in common with a view of profit." A very old definition. "Business" includes investment business amounting to little more than coownership.  Section 4(1) UK Partnership Act 1890: "Persons who have entered into partnership with one another are for the purposes of this Act called collectively a firm...."  Section 4(2) UK Partnership Act 1890: "In Scotland [unlike elsewhere in the UK] a firm is a legal person distinct from the partners of whom it is composed, but an individual partner may be charged on a decree or diligence directed against t firm...."  Partnership Act 1890 a codification of common law which is otherwise undisturbed (Section 46 Partnership Act 1890). The Scottish partnership provisions were added at the 11th hour.  Section 1121(1) Corporation Tax Act 2010: "In the Corporation Tax Acts, 'company' means any body corporate or unincorporated association but does not include partnership, a co-ownership scheme, [a form of investment fund] .....a local authority or a local authority association."  Therefore, identity of entities subject to corporation tax depends on identifying  what is and is not a partnership. Corporation tax can be charged on non-UK entities so meaning of "partnership", etc. in Section 1121 needs to encompass non-UK entities. • Courts have indicated that an "unincorporated association" in context of Section  1121(1) cannot include an arrangement for a business purpose: obiter dicta of Lawton LJ in Conservative Central Office v Burrell [1982] All ER 1. So it cannot include a partnership.  HMRC think this is too narrow (I largely disagree). Let us assume for presen purposes that Burrell correct.  If unincorporated association and partnership are therefore mutually exclusive, what is the key difference between a body corporate and a partnership? Increasingly it is hard to tell (one reason for 1997 introduction of US "check-the-box" rules).  A body corporate can of course have a business purpose like a partnership (although this is not essential - a body corporate can be a charity).  A body corporate can (like a partnership) have more than one member, although not necessary for a UK private limited company.  Members of a body corporate can have (indirect) unlimited liability while members of a partnership may have various degrees of limited liability (e.g. US LLPs and, subject to restrictions, UK 1907 Act LPs). [UK LLPs are in fact a form of body corporate usually deemed to be a partnership for tax purposes].  Interests in partnerships are not freely transferable (Section 31 Partnership Act 1890) but then nor (typically) are shares in a private limited company. Also easier to transfer interests in 1907 Act LPs than in a general partnership.  Nowadays management of large partnerships is often at least as centralized as that of companies, even if no formal legal split between membership and management. So centralized management often cannot be a meaningful point of distinction.  Legal personality cannot be the deciding factor: English law partnerships are creatures of contract and mutual agency (Section 5 Partnership Act 1980), with no separate legal personality (although note the concept of segregated "partnership property" in Section 20 Partnership Act 1890). But Scottish firms have a form of legal personality, reflecting their origin in pre-1707 French law. Scottish approach mirrored, and often reinforced, in US and many civil law jurisdictions.  Nature of Scottish partnerships hotly disputed: expert evidence in Major v Brodie [1998] STC 491 and oral argument in Supreme Court in Anson v IRC [2015] STC 1777. Supreme Court clearly did not want to pronounce on this area!  In particular, Scottish lawyers are divided on whether partners in Scottish partnerships are (like members of a UK LLP) just agents of the firm itself (a separate entity) or are also principals carrying on partnership business. If the latter, then the firm's separate personality is more qualified, although clear that the firm beneficially owns assets and partners do not.  Legal personality of Scottish partnership does not come about by incorporation/registration (CF French SNC or Delaware LLP). Nor does it (?) give rise to "perpetual succession" (see below). Also partners guarantee debts of firm. In short, a qualified form of legal personality ("alter ego" of partners) but somewhere in between an English partnership and a formal civil law partnership/ US limited liability partnership or, indeed, a company.  Also constitutional reasons why UK courts want to apply tax statutes uniformly to English and Scottish partnerships (leaving aside devolved taxes): see ex PARTE Gibbs 24 TC 221.  These reasons do not apply when classifying non-UK entities with legal personality which claim to be partnerships. Their governing law and formation procedures (e.g. formal registration) unlikely to be the same as English/Scottish law (CF French SNC). Also, different degrees of "legal personality", a concept which may mean different things in different systems (CF Germany).  Yet UK courts have been prepared to treat as partnerships, for non-tax purposes, nonUK entities with legal personality (or at least full legal capacity): Von Hell Feld vs Rechnitzer [1914] 1 Ch 748 (French SNC) and Oxnard Financing SA v Rahn [1998] All ER 19 (Swiss general partnership).  Moreover, for tax purposes, HMRC now regard Dreyfus v IRC 14 TC 560 as no longer good law: in that case, a French SNC with separate personality and formed registration was held not to be a partnership mainly on the basis that members not entitled under French law to profits as they arose (which was apparently an erroneous finding of fact).  Is "perpetual succession" the key difference i.e. an entity cannot be a partnership if it does not have to be dissolved if a member departs or becomes bankrupt?  If it is, this does not readily explain why HMRC now regard the SNC in Dreyfus as "transparent". Clear from case stated that the SNC had a form of "perpetual succession".  Also most modern partnerships (quite apart from UK LLPs) do not lack "perpetual succession" in any meaningful sense: Slaughter & May! This is even more clearly true of US LLPs, many of which do business in the UK and are taxed here as partnerships.  Danger in overfocussing on one differentiating factor (especially a very technical one), given the diversity of legal traditions (see the less definitive relevance of perpetual succession....aka "continuity of life"....in the pre-1997 US entity classification rules, and the current German rules).  Is entitlement of members to entity profits as they arise the key? Some have argued that this cannot be the hallmark of a partnership because it is not true of a Scottish partnership.... but that is very debatable.  Anson vs IRC did not definitively decide that a Delaware LLC was a partnership: it simply regarded it as "transparent" for UK foreign tax credit purposes. However, the Supreme Court found for the taxpayer on the basis of findings of fact on relevant Delaware law in the FTT.  FTT concluded that LLC lay somewhere between a UK company and a Scottish partnership: members entitled to profits as they arose and owned something akin to a partnership interest; but LLC carried on its own business without member liability, it beneficially owned its own assets and there was a distinction between members and managers.  Supreme Court agreed with FTT that a profit entitlement did not require a proprietary interest in LLC assets. Profit is an accounting concept, not a property law concept. [HMRC think that Anson wrong and that evidence about current entitlement to LLC profits under Delaware law is flawed].  Entitlement to profits as they arise is probably the "least bad" defining criterion for a partnership at present, and helps avoid an approach which is too parochial: see Ryall vs Dubois 16 TC 431. It also finds some support in the pre-1890 case law on English law partnerships, although post-1890, not all partners in an English partnership need have a profit share.  But it is an esoteric criterion, especially if the entitlement can be purely contractual (what is then the difference between a partnership interest and a profit-related loan or total return swap?).  It also requires detailed review of non-UK law in many cases. Key classification issues are therefore "resolved" (expensively) via complex and abstruse concepts, with need for expert evidence. Unsatisfactory approach given large differences between corporation tax and income tax base, e.g. how tax base defines and gradual reversion to "classical" system of taxing company distributions.  US largely dropped use of such structural factors for entity classification in 1997 and adopted "check the box", to make life simpler and more practical. HMRC do not want to go down the same path but seem to have no satisfactory alternative. Their published criteria on "transparency" (not partnership status) too English law-centric and based on Memec case (which I regard as wrongly decided). Status of some criteria unclear post-Anson.  Anson should not be relevant anyway re non-UK entities which are clearly incorporated (e.g. a Delaware Inc.). I very much doubt that UK courts will generally accept the existence of "transparent companies". These should simply be regarded as bodies corporate (and therefore companies) for UK tax purposes. introducing some form of UK "check the box" equivalent need not lead to a free-for-all.  As a policy matter, should UK treat more so-called "partnerships" as companies for corporation tax and other tax purposes?  This would be a marked retreat from trends of last 20 years (especially LLPs) but strengthens corporation tax base.  Also more consistent with spirit of original 1965 scheme of corporation tax...although that was conceived in a very different world.