Qualifying partnerships and the VAT group challenge

Changes to the qualifying partnership rules have resulted in many private equity businesses changing the structure of limited partnership funds. Care should be taken to ensure that this does not cause VAT problems.

Changes to the definition of a ‘qualifying partnership’ have meant that certain types of limited partnership now fall under the qualifying partnership rules. This means they may be required to file UK GAAP or IFRS compliant accounts at Companies House, which would be a new requirement for many limited partnerships. Affected entities have been looking for solutions.

“Those affected include limited partnerships that have just one general partner which is a limited company,” explains Robert Facer, a VAT expert at Moore Stephens. “A solution for them could be to add a second general partner or to substitute the limited company for an LLP. This may be successful in removing them from the qualifying partnership definition – but it could have unwelcome VAT consequences.”

VAT group membership

 Under current rules, partnerships are not able to join VAT groups, which are reserved for corporate entities. However, HMRC’s policy is that the business of an English limited partnership is seen as being carried on by the general partner(s), for VAT purposes. “This means that, if there is only one general partner, it is possible to include the general partner (and, therefore, the limited partnership business) in a VAT group with the manager of the limited partnership fund,” Robert says. The benefit of including the manager and the fund in the same VAT group is that no VAT arises on the management fees. “This approach is accepted by HMRC and is commonly referred to as the ‘standard VAT model’. It’s used widely in the private equity world, where various limited partnerships holding investments each have a single general partner and so can join a VAT group with the manager.”

But what if that limited partnership adds a second general partner, or a new general partner is substituted, in order to escape the qualifying partnership rules? “Potentially you solve one problem but create another as, depending on the precise circumstances, the limited partnership business could drop out of the VAT group,” Robert says. As a consequence, VAT would be chargeable on the manager’s fees, which the limited partnership is unlikely to be able to reclaim.

The good news is that alternative solutions do exist. “Limited partnerships can keep themselves outside the qualifying partnership rules without jeopardising their membership of a VAT group,” Robert says. “We can help clients find the right solution for them.”

VAT grouping rule changes

 The ‘standard VAT model’ described above relies on what could be called ‘indirect VAT grouping’. That is to say, the limited partnership business is brought within the VAT group by virtue of the general partner becoming a VAT group member. Matters would be considerably simpler if a limited partnership could become a VAT group member in its own right (let’s call it ‘direct VAT grouping’). Although the VAT grouping rules in the UK currently do not allow direct VAT grouping of a limited partnership, this may become possible in the future. On 16 July 2015, the Court of Justice of the European Union (CJEU) published its judgment in the Larentia + Minerva case (C-108/14). In the judgment, the CJEU said that EU Member States should allow limited partnerships to join a VAT group (subject to meeting the normal conditions), unless excluding them is justified for the purposes of preventing VAT evasion, avoidance or abusive practices. The opinion of the Advocate General (which is not legally binding) is that such an exclusion cannot be justified on the basis of the legal form of the entity alone. It would therefore seem possible that the UK VAT grouping rules will have to be amended to allow limited partnerships (and possibly others) to join a VAT group.

We will provide a further update once HMRC’s reaction to this case becomes clear. In the meantime, businesses using the standard VAT model that have made changes to the structure of their limited partnerships should review the VAT implications, if they have not already done so.

For advice on this or any other VAT issues, please contact the VAT team.

Leave a comment

 Security code