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New Tax Rules for LLP Members
- AuthorTanya Shillingford
This note has been updated following the publication of HMRC’s most recent guidelines on 21 February 2014
The Government has issued draft anti-avoidance legislation as part of the Finance Bill 2014, which overrides the current presumption that a member of an LLP is self-employed for tax purposes and is not an employee. This is in response to HMRC concerns that individual members of LLP’s are benefiting from being treated as self-employed for tax purposes, in circumstances where those members are effectively in the position of an employee.
The consequences of being treated as a salaried member are potentially wide ranging: significant incremental National Insurance, the requirement to deduct tax at source and associated cash flow disadvantage, administration of P11d’s and other payroll reporting, potentially the triggering of pensions auto enrolment, to name a few.
The details which have been released include draft legislation, together with a Technical Note and Guidance from HMRC, the final version of which was issued on 21 February 2014 (Updated Guidance). The Updated Guidance contains a host of examples of circumstances where it will or will not be presumed that a member is self-employed for tax purposes.
The new rules will apply to all UK LLP’s, but will not apply to general or limited partnerships or to LLP’s formed under the law of jurisdictions outside the UK.
Under the new rules, a member of an LLP will be treated as “a salaried member” (i.e. employed), unless he fails any of the following three tests:
A. The member is remunerated for his services “wholly or substantially wholly” (80% or more) with “disguised salary”. Disguised salary is remuneration which is either fixed or, if variable, the variable element does not relate to the profits of the LLP as a whole. Therefore in order to fail this test, at least 20% of a member’s profit share must be directly linked to the overall profitability of the LLP. According to the Updated Guidance, this should be applied looking forward and, once a reasonable view has been taken as to the status of the member for tax purposes on the basis of the arrangements, that view will remain valid until such time as the arrangements change e.g. if there are changes to the member’s remuneration or the LLP’s remuneration policy. The Updated Guidance also make it clear that the test is measured by reference to profit share and not payments made on account of an expected profit share.
B. The member does not have significant influence over the affairs of the LLP. “Significant” has not been defined, although the Updated Guidance summarises the test as “Put simply can it be said that the individual is the business rather than merely working for the business?” Although the Updated Guidance provides a number of examples, this is still the most subjective of all the tests and therefore one of the more difficult ones on which to be certain as to whether or not it has been failed, except perhaps in the case of very small LLPs.
C. The member’s capital contribution is less than 25% of his annual “disguised salary” (as in A above). This test must be met from year to year, so e.g. an increase in fixed pay may require a further top up capital contribution to avoid it applying. According to the Updated Guidance, when a new member joins he will be allowed a two month period within which to make his capital contribution.
There are also some anti-avoidance rules designed to prevent schemes aimed at getting round these conditions. One such example that has been given by HMRC, is of a member who makes a capital contribution, but is funded by a non-recourse loan which is ultimately backed by the LLP. However the Updated Guidance suggests that genuine commercial arrangements amounting to a contribution of risk capital should be acceptable.
The Finance Bill 2014 is currently going through Parliament and is expected to receive Royal Assent in July 2014. However, the new rules will take effect from 6th April 2014, although in the Updated Guidance HMRC states that in relation to Condition C, three months will be given to members to make their capital contribution, provided that an unconditional commitment to make the contribution is in place when the new rules take effect.
This guide is for general information and interest only and should not be relied upon as providing specific legal advice.