When LLPs were introduced in 2000 the intention was that they would be taxed in the same way as traditional partnerships. However tax legislation went one step further and ITTOIA 2005, s 863 confirms that a member of an LLP is to be treated as self-employed. This has led to an increase in the number of fixed share partners in LLPs.
In May 2013 HMRC issued a consultation document on disguised employment in LLPs. The consultation closed on 9 August 2013 and in December 2013 HMRC released draft provisions which will form part of the 2014 Finance Act when enacted. These draft provisions move away from the original proposals and instead will use a mechanical test with three conditions. Where all three conditions are met the LLP member will be taxed as an employee.
Condition A is the member performs services for the LLP and the amounts payable are payable ‘wholly or substantially wholly’ disguised salary. Amounts payable will be disguised salary if it is fixed or variable without reference to the overall amount of the profits/ losses of the LLP, or it is not affected by the overall profits / losses of the LLP. Substantially wholly is taken to mean 80%.
Condition B is that the member does not have significant influence over the LLP’s affairs. This is a difficult condition and in large partnerships many partners will be caught by this condition. In reality these LLPs are run by a management board and other members, while they can vote on particular matters they have no real influence. The influence must be over the LLP as a whole. It is not enough to be responsible for a particular service line or office.
Condition C is that the member’s capital is less than 25% of their expected profit share (which is fixed or variable as described under condition A).
To be caught by the new rules the member must be caught by each of the three conditions. Therefore if the member is outside one of the conditions the salaried members legislation cannot apply.
Looking at each of the conditions in more detail:
This is to identify those members who are working for the LLP on terms similar to employees. However the test is limited to the payment aspects. The test is applied at the later of the date the member first joins the LLP and 6 April 2014. The test is only revisited if there is a change in circumstances. The test looks at expected profit allocations and it is not revisited with the benefit of hindsight. However, the test is framed in terms of the profit share that it is ‘reasonable to expect’ so unrealistic rewards and events that are unlikely to be triggered are ignored.
This looks at the role of the individual in the LLP and whether the individual has significant influence. The mutual rights and duties of the members are ignored for these purposes. In reality only members of management of the entire LLP will fall outside this condition.
The test is applied at the later of the date the member first joins the LLP and 6 April 2014. The test is only revisited if there is a change in circumstances.
This looks at the level of investment in the LLP. The test is whether the amount contributed is less than 25% of the disguised salary. This test is applied at the later of the date the member first joins the LLP and 6 April 2014 and is revisited at the beginning of each tax year. Capital contribution includes capital contributed in line with the LLP agreement, long term loans made to the LLP and undrawn profits to the extent that they have been converted into capital.
Where a member is caught by all three conditions the profit share is treated as employee remuneration and taxed under PAYE and the LLP is liable for employers’ National Insurance. This means that, for tax purposes, the member ceases to be self-employed and will no longer be included in the LLP tax return. As this represents a cessation there will be an opportunity to get overlap relief.
The LLP will be entitled to a tax deduction for the ‘salary’ and the employers’ National Insurance.
For non-tax purposes these individuals are still members.
LLPs need to review their composition of members before 6 April 2014 and ascertain how these provisions will affect them and whether any changes can be made to fall outside one of the conditions.