A recent court case has thrown new light on the grey areas of the rules for LLPs. We guide you through the conditions and the jargon.
Historically all members of a limited liability partnership (LLP) were treated as self-employed for tax purposes.
Each member of the LLP would be subject to Income Tax and Class 4 NICs on their profit share from the LLP. The tax treatment of the partners is beneficial as there is no PAYE or employer NI.
This meant it was tempting for an LLP to make everyone a partner even if, in reality, they were more like an employee.
In the face of this, the Salaried Member rules were introduced in April 2014 to ensure that members of an LLP more akin to employees are treated as employees for tax purposes, taxed under PAYE and subject to employer NI.
The three conditions
The Salaried Member rules ensure that an individual is treated as an employee if three conditions are met. If any of the conditions are not met, the rules do not apply.
The 3 conditions are:
- Condition A: Disguised salary
- Condition B: No significant influence over the affairs of the LLP
- Condition C: No significant investment in the LLP.
Condition A: Disguised salary
Condition A is met where it is reasonable to expect that at least 80% of the total amount payable by the LLP for the individual’s services as a member of the LLP will be disguised salary.
What is a disguised salary? This can be fixed or variable, but without reference to the overall amount of the profits or losses of the LLP, or not in practice affected by them.
Key points to note
- If the reward to an LLP member is fixed, or varies as a result of personal performance or the profits of a part of a business, then it is disguised salary. But if the reward varies with the overall profits of the firm, then it’s not disguised salary. This point was considered in the BlueCrest case discussed later in this article.
- The test is forward looking, based on reasonable expectation for the period the remuneration arises. There should be a re-test when remuneration arrangements change. For most LLPs this will be annual, to coincide with remuneration reviews.
- This test only relates to the amount payable related to the individual’s services. If a member is paid by the LLP without performing any work for them (for example if they are on gardening leave) this test will not apply.
Condition B: No significance influence over the affairs of the LLP
Condition B is less mechanical and more difficult to ascertain. It looks at the member’s influence over the LLP business as a whole. HMRC guidance says this condition is satisfied if a member has no significant influence over, or has influence over only a part of, the business.
What does ‘significant influence’ mean?
HMRC says the following decisions might be considered as having significant influence over the LLP business:
- Appointment of new members
- Determining areas of business
- Business acquisitions or disposals
- Content of the firm’s business plan
Key points to note
- This condition is looking at whether people are carrying a business together with a view to profit and whether the partners have a genuine say in the running of that business.
- Condition B is easier to fail in small LLPs. But in large LLPs it is likely that only the members of the leadership team will fail Condition B
- This point was considered in the BlueCrest case below and the judgement gave a wider definition of significant influence than HMRC had initially suggested in their guidance.
Condition C: No significant investment in the LLP
This condition is met if, at the relevant time, the individual member’s capital contribution to the LLP is less than 25% of the disguised salary they expect to be paid related to their performance during the relevant tax year.
Key points to note
- An undrawn profit share is not itself a capital contribution. But a member can agree to convert his share of undrawn profit to capital and increase his capital account.
- The rule requires significant investment assessment annually. This means at the beginning of every tax year, or whenever there is a change of circumstances which might affect the condition.
- Where someone is a member of an international group, the capital contribution must be made to the UK LLP not to any other member of the group.
BlueCrest Capital Management (UK) LLP v HMRC
What is the case about and why is it important? Before this July 2022 case, there had been no judicial consideration relating to the Salaried Member rules. So, until now, we have all had to rely on HMRC’s guidance. The case provides interesting insight into the application of Condition A and Condition B.
Condition A
A large portion of the members’ remuneration was by ‘discretionary allocation’, very common in the investment management sector. The question was whether these payments were sufficiently linked to the overall results of the LLP, or just based on the individual’s personal performance.
The court decided that the payments were more like bonuses paid to employees. And that, when the bonuses were allocated, the LLP did not consider the overall profits of the LLP but allocated them based on personal performance.
Condition B
The finding on significant influence was very interesting and broadened HMRC’s previous guidance.
The court found that the investment managers who had significant influence over the financial operation would be considered to have significant influence over the affairs of the LLP.
This shows that to fail Condition B it is enough to have responsibility for managing key investment portfolios. The members do not need to have influence over all aspects of the LLP or over managerial decisions.
This finding will be welcome news for senior investment managers in asset management businesses.
What are the key takeaways?
Following this recent court decision, HMRC has been sending more communications to LLPs regarding their compliance with the Salaried Member rules.
So, it’s critically important for all UK LLP businesses to have effective polices and procedure for reviewing the rules regularly. All the more so when there is a change in circumstances, such as when a member joins or leaves, or there are changes in the remunerations or capital contributions. It could be very costly for businesses that do not have evidence and documentation to support their position or the variation of remuneration packages.
If you would like advice on any of the above, please contact Stephen Kenny.
