HMRC Spotlight 63 Explained: Hybrid Partnership Schemes

Spotlight 63 is a public notice published by HM Revenue and Customs (HMRC) on 4 October 2023 and most recently updated on 16 May 2025.

HMRC publishes these "Spotlights" to warn taxpayers about specific tax avoidance schemes that it believes do not work.

Spotlight 63 specifically targets a tax avoidance arrangement being used by individual landlords who own buy to let properties. The arrangement involves transferring properties into a type of structure known as a hybrid partnership.

 Under HMRC Spotlight 63, “hybrid partnership” arrangements typically involve landlords transferring properties into an LLP with a corporate member and allocating profits so the company takes a significant share and claims full finance cost deductions. HMRC has made it very clear that it considers this arrangement to be ineffective, meaning it does not achieve the tax savings that its promoters have promised.

Key Point

Spotlight often signals that HMRC expects to challenge the arrangement and will be opening enquiries.

Lets look into one of the sample of HRMC letter sends when they open an enquiry on Hybrid Partnership

2.What gave rise to Hybrid Partnership Structure?

Section 24 Finance Cost Restrictions

To understand Spotlight 63 we need to know scheme was trying to solve.

The Finance (No 2) Act 2015 introduced what is commonly known as Section 24, which was phased in from April 2017 and became fully effective from April 2020.

Before Section 24, individual landlords could deduct the full cost of their mortgage interest payments from their rental income before calculating their tax. This was a significant benefit, especially for higher rate and additional rate taxpayers.

After Section 24 was fully in place, individual landlords could no longer deduct mortgage interest as an expense. Instead, they receive a basic rate tax credit (currently 20%) on their finance costs. This means that a higher rate taxpayer who was previously getting 40% relief on mortgage interest now only gets 20% relief. For landlords with large mortgage balances, the difference in their tax bills was substantial.

2.2 The Search for a Solution

Importantly, Section 24 does not apply to limited companies. Companies can still deduct their full mortgage interest as a business expense. This created a strong incentive for landlords to look for ways to get their properties into a corporate structure.

However, simply transferring properties to a limited company triggers Capital Gains Tax on the gain at the point of transfer, Stamp Duty Land Tax (SDLT) on the market value, and potential mortgage complications such as needing to refinance at higher commercial rates.

Various promoters marketed what they described as a "hybrid business model" which claimed to achieve the benefits of a corporate structure without these costs. This is the scheme that Spotlight 63 addresses.

3. How the Scheme Claims to Work

The arrangement follows a general pattern. Here is how the promoters typically set it up, explained step by step.

• The individual landlords (or their family members) set up a new limited company, often referred to as the corporate member.
• The landlords then set up a Limited Liability Partnership (LLP) with both themselves and the limited company as members. This is why it is called a "hybrid" partnership, because it has both individual members and a corporate member.
• The landlords transfer their rental properties into the LLP.
• The LLP agreement allows profits to be allocated on a discretionary basis. This means the members can decide how to split the rental income each year.
• In practice, the profits are allocated so that the individual landlords remain basic rate taxpayers. The remaining profits are allocated to the limited company.
• The limited company claims a full deduction for mortgage interest costs (which it is said to be bearing on behalf of the LLP), because Section 24 does not apply to companies.

3.2 What the Promoters Claimed

The scheme promoters advertised the following tax benefits to landlords:

• No upfront tax cost on transferring the properties to LLP.
• The base cost of the properties (the amount used to calculate Capital Gains Tax when the property is eventually sold) would be "uplifted" to market value at the date of transfer, reducing any future CGT liability.
• The individual landlords remain basic rate taxpayers and therefore are not affected by the Section 24 finance cost restrictions.
• The corporate member can claim a full deduction for its share of mortgage interest, because the finance cost restriction does not apply to companies.
• The corporate member pays Corporation Tax on its allocated profit at 19% or 25% rather than the landlords paying higher or additional rate income tax at 40% or 45%.
• Business Property Relief (BPR) could be claimed for Inheritance Tax purposes, meaning that no IHT would be payable on the property portfolio when the landlords die.

4.Why HMRC Says the Scheme Does not Work

HMRC has identified a number of specific reasons why this arrangement fails. Each of the claimed tax benefits is countered by existing legislation. Here is a detailed look at each one.

4.1 The Mixed Member Partnership Rules

Where a partnership has both individual and corporate members, and the corporate member is allocated profits that are more than what it would earn on an arm's length basis (that is, more than a fair return for the capital it has invested and the services it provides), HMRC can reallocate those excess profits back to the individual members for income tax purposes.

Since in most of these arrangements the limited company has put in little or no capital and does not provide any meaningful services to the partnership, it has no genuine commercial reason to receive a large share of the profits. The profits allocated to it are therefore "excess" and get taxed on the individual landlords instead.

Even if the individual landlord withdraws from the partnership to try to avoid these rules, they can still be treated as a partner for tax purposes and taxed on the excess profits.

IT MEANS:

Even though the partnership agreement says the company gets a large share of profits, HMRC will treat those profits as belonging to the individual landlords for tax purposes. The landlords end up paying income tax on the full rental profit at their marginal rate, just as they would have done without the arrangement.

4.2 Disposal of Income Streams

When the landlords transfer their properties into the LLP and then allocate profits to the corporate member, HMRC considers this to be a disposal of an income stream.

 Under these rules, the income that has been allocated to the company is still charged on the landlord (the person who originally had the right to that income).

This is another layer of protection that ensures the landlords cannot simply divert their rental income to a company to pay less tax.

4.3 Capital Gains Tax and the Transparency of LLPs

One of the key claims of the scheme is that transferring properties into the LLP "uplifts" the base cost to market value, reducing any future Capital Gains Tax when the properties are sold.

HMRC says this is wrong. Under s59A of the Taxation of Chargeable Gains Act 1992, LLPs are transparent for Capital Gains Tax purposes. This means that any dealing in assets by the LLP is treated as if it were carried out by the individual members directly. Each member is treated as owning a fractional share of the assets held by the LLP.

The consequence is that the base cost of the properties does not change when they are put into the LLP. The original purchase price and any improvement costs remain as the base cost. There is no uplift. When the properties are eventually sold, the full gain is still chargeable on the individual members.

4.4 Inheritance Tax and Business Property Relief (s105(3) IHTA 1984)

Some promoters claimed that putting rental properties into a hybrid LLP structure would qualify for Business Property Relief (BPR), which can reduce the Inheritance Tax liability to nil. If it worked, this would be a very valuable benefit.

HMRC says it does not work. Section 105(3) of the Inheritance Tax Act 1984 excludes businesses that consist wholly or mainly of "making or holding investments" from BPR. A property rental business is, in HMRC's view, an investment activity, not a trading activity. Putting the properties into an LLP with a corporate member does not change the fundamental nature of the business. It is still an investment business, and BPR is not available.

4.5 Stamp Duty Land Tax (SDLT) 

In the May 2025 update to Spotlight 63, HMRC added two important points about SDLT that were not in the original October 2023 version.

Transfer of properties to the LLP: A transfer into an LLP/partnership is a disposal only to the extent any underlying interest in the property passes to other members; if the members retain the same fractional interest, CGT may not arise, but where an interest is ceded (for example to a corporate member) a chargeable disposal can occur.

Changes in profit sharing: The LLPs in these arrangements fall within the definition of a "property investment partnership" for SDLT purposes. Paragraph 14 of Schedule 15 TO Finance Act 2003 applies when there is a transfer of interest in a property investment partnership. This happens whenever there is a change in the members' entitlement to the income profits of the LLP, for example when the discretionary profit shares are adjusted. Each such change can trigger a separate SDLT charge.

4.6 Annual Tax on Enveloped Dwellings (ATED)

Also added in the May 2025 update, HMRC highlighted that companies and partnerships with company members (including LLPs) that hold a beneficial interest in UK residential property valued at more than £500,000 are subject to the Annual Tax on Enveloped Dwellings (ATED).

5. Who Is Affected?

Spotlight 63 primarily affects the following groups of people:

• Individual buy to let landlords who have used the hybrid LLP structure, particularly those with larger portfolios who were seeking to avoid the Section 24 restrictions.

• Family members who were brought into the arrangements as LLP members or company shareholders.

• Scheme promoters who designed, marketed, and sold the arrangements.

The scheme was widely marketed over a period of approximately five to six years.

6. What Are the Consequences?

6.1 For Landlords

Landlords who have used this scheme face a range of potential consequences:

6.2 For Promoters

HMRC has made it clear that it will pursue the promoters of these schemes. The consequences for promoters include the following:

• DOTAS penalties: Scheme promoters must comply with the Disclosure of Tax Avoidance Schemes (DOTAS) legislation. If they fail to disclose a notifiable scheme within five days of it being made available or implemented, they face an initial penalty of up to £600 per day. If the penalty is calculated to be less than £1 million and HMRC considers this not to be a sufficient deterrent, the penalty can be increased to up to £1 million.
• Enablers penalty regime: Anyone who designs, sells, or enables the use of abusive tax avoidance arrangements that are later defeated by HMRC can face penalties under the enablers penalty regime.
• Promoters of Tax Avoidance Schemes (POTAS) regime: HMRC can use its powers under this regime to take further action against persistent promoters.
• Public naming: HMRC can publish information about tax avoidance schemes and the people involved in supplying and marketing them.

Up to When HMRC can look up ( time limit ) ?

A particularly significant risk for landlords is the extended time limits that may apply. Under normal circumstances, HMRC has four years from the end of the tax year to open an enquiry. Where there has been carelessness, this extends to six years. Where there has been a deliberate act, the time limit is 20 years.

 What Should Affected Landlords Do?

HMRC has set out clear guidance on what it expects from landlords who have been using these arrangements.

• Contact HMRC
• Get Independent Advice
• Check for Available Relief
• Consider the Mortgage Position

Conclusion

Anyone involved in such a scheme is advised to contact HMRC to discuss how they can settle their position by emailing spotlight63@hmrc.gov.uk and to consider taking independent professional tax advice.

If you have received a Spotlight 63 letter, it is important to act promptly and get specialist support. We have experience dealing with these cases and can help you review the arrangement, assess your exposure, and engage with HMRC to agree a settlement and minimise penalties where possible.