Change to LLP salaried partner rules
What is the issue?
The Finance Bill 2014, which was published on 27 March, is introducing legislation that will treat LLP members who are, in effect, providing services on terms similar to employment as 'employees' for tax purposes.
Why is this being introduced?
This is to address a perceived unfairness caused by the rule at section 863 of the Income Tax (Trading and Other Income) Act 2005, which has until now seen all individual LLP members treated as self-employed for tax purposes. Its purpose was to treat LLP members in the same way as partners in traditional partnerships.
However, HMRC is of the view that in deeming all individual LLP members to be self-employed, the existing tax rules go further than simply aligning their status with that of individuals in a traditional partnership. An individual has to have the characteristics of a partner to be determined as such in a traditional partnership. However, in an LLP, an individual needs only be registered as a member. In practice, HMRC believes that many LLPs have members who are engaged on terms similar to those of employees rather than traditional partners.
When is it being introduced?
Despite considerable lobbying from the accounting and legal professions in particular, the government is proceeding with its plans to make salaried partners employees for tax purposes from 6 April 2014.
These changes will be made by amending part 9 of the Income Tax (Trading and Other Income) 2005 Act as part of the Finance Bill 2014. Changes will also be made to national insurance legislation and the associated regulations.
In the absence of revised legislation setting out these changes, HMRC has published a revised technical note, Partnerships: A review of two aspects of the tax rules salaried members rules: revised technical note and guidance dealing with the new salaried partners rules.
Who will it affect?
- The salaried members rules apply only to LLPs formed under United Kingdom legislation (the LLP Act 2000).
- These rules do not apply to general partnerships or limited partnerships that are formed under Partnership Act 1890 and Limited Partnership Act 1907 respectively.
- The salaried member rules are tax rules. They are independent of employment law and vice versa.
Overview of the new rules
The new rules will treat an individual member of an LLP as an 'employee' for tax purposes, if the following three conditions are all met:
Condition A: disguised salary
Condition A is met if there are arrangements in place under which the member is to perform services for the LLP and it is reasonable to expect that the amounts payable by the LLP in respect of that member's performance of those services will be wholly, or substantially wholly, 'disguised salary'.
Disguised salary is an amount that meets any of the following requirements:
- it is fixed; or
- it is variable, but varied without reference to the overall amount of the profits or losses of the LLP; or
- it is not, in practice, affected by the overall profits or losses of the LLP.
Condition B: significant influence
This condition is met if the mutual rights and duties of the members and the LLP do not give the member significant influence over the affairs of the partnership.
Condition C: capital contribution
This condition is met if the member's contribution to the LLP is less than 25% of the disguised salary (see above) and it is reasonable to expect that it will be payable in a relevant tax year in respect of performance of services for the partnership.
To give LLPs more time to make the necessary arrangements, for individuals who are members at 6 April 2014, a firm commitment in place by 6 April 2014 to contribute capital within three months will be taken into account in determining whether condition C is met.
Where an individual becomes a member on or after 6 April, a two-month period will be allowed to provide the capital, again subject to there being a firm commitment to contribute the capital from the day of becoming a member.
What do I need to do?
If you believe that any of your LLP's members may be affected by these rules, you will need to consider the terms of their LLP agreement and the impact of the changes on the LLP's financial position.
Individual LLPs and their members will need to agree what, if any, changes they might wish to make to entitlements to profits or actual capital contributions to contribute more to the performance of their LLP, if they wish to legitimately avoid being caught by either condition A or C.
Arrangements made for anti-avoidance purposes
The salaried member rules contain anti-avoidance provisions to counteract attempts to circumvent the new rules by means of artificial arrangements.
The HMRC guidance note contains examples of arrangements that may help LLPs to conclude whether its members are, or are likely to be, affected. It also contains examples of the artificial structures or arrangements that could be used to place members outside the scope of the salaried member provisions but that would be caught by the anti-avoidance provisions.
If you require further advice or information about this change to the legislation and the changes your LLP may need to make to comply with it, we recommend that you contact your tax adviser.