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IFS points to 'substantial tax break' for wealthy

IFS points to 'substantial tax break' for wealthy

The current tax treatment of partnerships means some of the wealthiest individuals enjoy a substantial tax break, according to the Institute for Fiscal Studies (IFS) think tank.

In its 22-page report “The characteristics and incomes of the top one per cent” published this month, the IFS examined the financial characteristics of income tax payers falling in the top 1 per cent.

It found the top earners paid 27 per cent of all income tax in the UK in the 2014/15 tax year, the period examined by the IFS.

At the same time 18 per cent of the highest income tax payers in the UK derived their main income from being members of a partnership, either a limited liability partnership (LLP) or other types. 

The tax advantage for partners in such businesses is they don’t pay the full national insurance contributions that they would as an employee, while the partnership doesn't pay the employers national insurance contributions a company would.

Employers national insurance contributions in the UK is currently 12 per cent of salary, which a partnership can distribute to its partners instead.

Another top-income group identified was people who own businesses and receive the bulk of their income from dividends, which are taxed at a lower rate than income. 

The IFS described the partnership structure as “a policy choice [that] provides substantial tax breaks to some of the highest-income people in society.”

The report added: "The importance of partnership income in the top 1 per cent grew steadily, largely at the expense of employment income, over the eight years leading up to the financial crisis, even though the total number of partners was falling over that period.

"The share of top 1 per cent income from dividends over that period was mostly stable, despite the number of owner-managers growing more quickly than the number of employees."

But George Bull, senior tax partner at RSM, said partners actually pay income tax at a higher rate than appears to be the case.

This was because, if they worked as employees, costs such as those incurred by entertaining clients in the course of generating business would be paid by their employers.

But in a partnership, the cost is effectively borne by the partners, though they cannot set this against their income tax bill.   

This means, according to Mr Bull, that the effective income tax paid by partners was 5-7 per cent higher than it appeared to be. 

He said: “As the new UK Prime Minister announces a series of policy measures which will have to be funded by increased taxation or by borrowing, his Chancellor of the Exchequer will be keeping a watchful eye open for ways of increasing UK tax and national insurance contributions.

"Sooner or later he is certain to consider whether individuals who are self-employed, partners in partnerships or members of limited liability partnerships should see their current NIC regime replaced by something more akin to the higher level of NIC paid jointly by employees and employers. We think that would be unjustifiable.”