A reminder in light of HMRC’s recent crackdown
A recent change in HMRC’s partnership manual at PM259310 may be a cause for concern for members of limited liability partnerships (LLPs) set up as ‘salaried partners’. HMRC seems to have taken a tougher approach to the ‘salaried member’ rules, which could classify some members as being employees, with the result of significantly more national insurance contributions payable.
Although details of which firms HMRC is starting to probe under these revised guidelines are confidential, it may affect private equity firms as well as legal and accountancy businesses.
The changes appear in the updates to the manual section and are as follows:
Anti-avoidance: genuine finance
Edited PM259310. Change clarifies that even if an arrangement results in a genuine contribution by the individual to the LLP if there is a main purpose of securing the salaried members rules do not apply then the TAAR can still be triggered.
Example added to show how the legislation applies to arrangements where members alter their capital contributions in order to ensure they don't meet Condition C.
The Limited Liability Partnership (LLP) salaried member rules were introduced by Finance Act 2014 to remove the presumption that all LLP members were self-employed and to tackle instances of employment relationships being disguised through LLPs.
The salaried member legislation is intended to apply to those members whose terms of membership are more like the terms of an employee than those of a partner in a traditional partnership.
A key point is that to be a salaried member, the individual has to perform services for the LLP in the individual’s capacity as a member.
This means that the salaried member provisions do not apply to:
The salaried member legislation is based on the tests set out in the legislation. Only if an individual satisfies all three conditions are they a salaried member. If there are other factors present that would be seen as indicators of employment then they are not taken into account for the purposes of the salaried member legislation.
Condition A: disguised salary
Condition A requires the LLP to consider the position of members who, in their capacity as members, are remunerated for performing services for the firm, and to decide if their remuneration is, in substance, a ‘disguised salary’ rather than a profit share.
Members’ level of reward may vary, just as the rewards received by many employees varies through salary increases and bonuses. What matters is that any such variation is not determined by reference to the firm’s profits as a whole.
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 in that individual’s capacity as a member of the LLP will be ‘disguised salary’.
The legislation says that an amount is a disguised salary ‘if it:
a) is fixed
b) is variable, is varied without reference to the overall amount of the profits or losses of the limited liability partnership, or
c) is not, in practice, affected by the overall amount of those profits or losses.’
Basically, if the reward is fixed or varies as a result of personal performance or the profits of a part of the business, then it is disguised salary; if the reward varies with the overall profits of the firm then it is not disguised salary.
Example
Karen, Mirela and Radha are members of Kamira LLP and anticipate earning a profit of approximately £100,000. At the start of the period, they allocate themselves ‘salaries’ of £20,000, £40,000, and £40,000 respectively, and agree that the actual total profit will be distributed according to these ‘salaries’. If the LLP’s overall profits are higher or lower than £100,000, each partner will share in the surplus or deficit based on their agreed ‘salary’ proportions.
It's crucial to realistically interpret the agreement's substance. While they refer to these sums as salaries, they are not fixed amounts. Instead, these figures serve as a method for distributing the anticipated profits. These amounts are benchmarks for profit allocation, with the members' actual share of profits varying based on the LLP's overall profits. The term ‘salary’ is used for convenience, but it does not reflect a fixed payment.
It should be noted that payments made in anticipation of an expected profit share are not considered disguised salary. These amounts are conditionally paid and will later be reconciled with the actual profits, potentially resulting in either additional profit owed to the partner or a debt owed to the LLP. In this scenario, the compensation for services is a share of the profit, with the interim payments serving as a method for accessing the profits.
Condition B: significant influence
Condition B aims to distinguish between a partner in a traditional partnership, who is integral to the business, and someone who merely works for the business. An individual member who exerts significant influence over the business as a whole will not meet Condition B and, therefore, will not be considered a salaried member.
A UK LLP is a corporate body governed internally by the members' agreement, similar to how a partnership is governed by a partnership agreement. Consequently, members have considerable flexibility in organising the LLP's affairs.
To determine if a member has significant influence over the LLP's overall affairs, one should start with the terms outlined in the LLP agreement, including any specific terms for that member. However, when applying Condition B, it is crucial to consider practical realities. The key question is whether, based on a realistic view of the facts, the individual has significant influence.
Given the diverse activities of LLPs and their organisational flexibility, it is impossible to specify all factors that indicate significant influence. The size of an LLP also affects its management. As an LLP grows, it is likely that management will be delegated, condition B assesses significant influence over the entire LLP and can be satisfied if a member has significant influence over only a part of the business.
Example
Glenn and Yogi are members of Excel LLP and have recently admitted John as a partner. The LLP Agreement has not been updated since before John's admission. In practice, Glenn, Yogi and John all participate in running the business, with Glenn having a casting vote.
Although the written agreement was not amended when John was admitted, the implied terms of his admission include that he would have a significant role in the business. As a result, Condition B is not satisfied, and John is not considered a salaried member. The fact that Glenn has a casting vote does not mean that only he can meet Condition B. More than one person can have significant influence, and that influence can manifest in different ways.
Sometimes, an individual who appears to have no formal role in managing the business may still wield considerable influence. If, based on a realistic view of the facts, the other members defer to this individual's views, then that individual can fail Condition B.
The test for Condition B should be applied when the individual becomes a member and must be reassessed when arrangements change, affecting whether the individual acquires or loses significant influence, thus altering their Condition B status.
Condition C: contributions to the LLP
Condition C evaluates the level of investment made by an individual member in the LLP. It is not satisfied if the member has made a significant investment in the business, implying they have a real financial risk based on the business's success or failure.
The general rule for Condition C is that it is met if the member's capital contribution to the LLP is less than 25% of the disguised salary expected to be payable to the member for their performance during the relevant tax year.
Condition C is based on the capital the member has committed to contribute, not necessarily what has been actually contributed. If the member fails to make the committed contribution, the test is reapplied retrospectively to the date of joining (or from 6 April 2014).
The capital contribution is compared to the disguised salary for the relevant tax year. This figure might differ from the one determined for Condition A, which is based on the relevant period, not the tax year.
If a member joins or is expected to leave partway through the tax year, the capital contribution is adjusted proportionally (pro rata) before comparing it to the disguised salary for the tax year.
The test is applied annually. If there is any change in the capital contribution during the year, the test must be reapplied.
An individual may borrow money to make the capital contribution. This is acceptable as long as the contribution is genuine, intended to be enduring, and involves real financial risk.
Some types of financing arrangement will trigger the Targeted Anti-avoidance Rule (TAAR). These include:
HMRC would not consider genuine and long-term restructuring that causes an individual to fail one or more of the conditions to be contrary to this policy aim. This includes loan finance arranged for the individual member by the firm, provided that the loan is full-recourse, so that the risk is that of the individual and the individual bears all the costs of the loan.
The TAAR will apply where the individual does not bear all the risks and costs of the loan; or where the loan comes from the firm or a party linked to the firm. If the lender provides a single loan facility for the firm and its members, the TAAR is likely to apply if the loan to the member affects the level of loan available to the firm.
In applying TAAR, HMRC will take into account the policy intention underlying the legislation, which is to provide a series of tests that collectively encapsulate what it means to be operating in a typical partnership. A genuine and long-term restructuring that causes an individual to fail one or more of the conditions is not contrary to this policy aim.
In summary, Condition C is not satisfied if the individual member has made a significant investment in the business so they have a real risk resting on the success or failure of the business.