On 20 May HMRC published a consultation document to review two aspects of the current tax treatment afforded to members of Limited Liability Partnerships and 1890 Partnerships:
(i) the presumption that members are self-employed for tax purposes, so called 'disguised employment', that is, HMRC's attempt to tackle their perceived abuse of membership of LLPs to avoid employment taxes; and
(ii) perceived manipulation of profit and loss allocations to
generate a tax advantage by, for example, the use of corporate
members by both LLPs and general partnerships (for further details
please see
' Corporate Members - Manipulating Profit and Loss
Allocations?')
This briefing note addresses issues arising from part (i) of the Consultation.
The Current Position
The current tax rules as applied mean that individuals who are members of an LLP are taxed as self-employed, and therefore the LLP is not required to operate PAYE for members, nor pay Employer's National Insurance Contributions. A small number of cases have (largely unsuccessfully) challenged this presumption of self-employment. These cases have usually been brought by individual members seeking employment law protection, which is more favourable to an employee than that available to a self-employed member. The recent case of Tiffin v Lester Aldridge LLP [2012] EWCA Civ 35 outlined various factors which would indicate that a member of a LLP is a 'partner' rather than an employee. These factors all include some element of risk, where a member has: a share in the profits of the LLP; a prospect of a share in the surplus of assets on a winding up; contributed to the LLP's capital; and/or assumed some role in the management of the business.
The Consultation
HMRC is concerned to prevent a member of an LLP benefiting from self-employed status if the terms of his or her relationship with the LLP would otherwise amount to employment for tax purposes. HMRC provides the following examples: members who are engaged on standard terms as part of a mass recruitment exercise; or employees of a company who then become members of a successor LLP on essentially identical terms. The proposal is to remove the tax presumption that all members of LLPs are self-employed and in some cases, deem that a member is an employee for tax purposes. HMRC's proposal is that a member's status will be assessed on the basis of two conditions and if an individual member meets either condition he or she will be classed as a 'salaried member'.
The First Condition
A "salaried member" of a LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership.
This condition will be determined by reference to the tax test of what constitutes an 'employee', with consideration of such factors as the degree of control the LLP has over the individual partner, financial risk, the requirement for personal service and the ability to profit from sound management1. This is and has for a long time been HMRC's standard test as applied to partners of traditional '1890s' partnerships to determine their tax status (employed/self-employed), and merely brings LLPs within that same scope.
The Second Condition
A "salaried member" of a LLP includes an individual member of the LLP who does not meet the first condition but who:
(a) has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
(b) is not entitled to a share of the profits; and
(c) is not entitled to a share of any surplus assets on a winding-up.
Therefore if a member is not required to repay drawings, or there is no risk to a member's capital contribution or the member only receives a "fixed" salary or guaranteed profit return, the member may not meet the second condition. HMRC have made it clear that they will ignore any insignificant risk or entitlement, determined in light of all the circumstances and the overall package of benefits available to the member from the LLP. HMRC states that an entitlement to variable profit share that could never be more than 5% of any fixed entitlement would be unlikely to be regarded as significant by HMRC.
Salaried Members
Salaried members' earnings will remain liable to income tax but the LLP will be required to collect and pay that tax on a PAYE monthly basis (not twice yearly) as for all employees. The LLP will also need to collect and account for and on behalf of the member for primary (Class 1) NICs, and the LLP will be liable to pay secondary NICs i.e. employer's NIC (currently at 13.8%) – a significant expense! The salaried member will also be subject to the benefits in kind rules. However, the costs of employing salaried members will be deductible in the computation of the profits of a LLP.
Anti-Avoidance
An anti-avoidance rule will be introduced so as to disregard any artificial arrangements put in place simply to prevent either of the above conditions from applying.
The Government proposes to introduce legislation effective from 6 April 2014.
Risk to LLPs
We recommend that LLPs undertake a review now of the risk that any of its members may be classified as 'salaried members'. Sensible, commercial arrangements may avert the risk of certain members unintentionally falling within this 'salaried' definition, and the LLP's membership documentation should certainly be reviewed. In particular, do you have junior level individuals who are members of the LLP? Act now!
Footnotes
1. The ability to profit from sound management is part of the HMRC test for establishing employment status – please see http://www.hmrc.gov.uk/manuals/esmmanual/esm0547.htm
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
