In its policy paper entitled "Partnerships Review: Proposed NICs changes for (i) Disguised Employment and (ii) Profit Deferral under Alternative Investment Fund Managers Directive" which was finalized on 15 October 2013 and published in response to industry comments and feedback in connection with its consultation paper entitled "Partnerships: A review of two aspects of the tax rules" (published on 20 May 2013), HM Revenue & Customs („HMRC‟) announced two further proposals, namely:
- To ensure that „salaried members‟ of Limited Liability Partnerships ("LLPs") qualify as „employed earners‟ for National Insurance Contributions („NICs‟) purposes, so that they are subject to Class 1 NICs rather than Class 4 NICs; and
- To align the tax and NICs treatment of partners in managers authorised by the UK Financial Conduct Authority („FCA‟) of Alternative Investment Funds constituted as partnerships or LLPs (referred to in this memorandum as „AIFM partnerships‟), with the requirement for a certain proportion of a partner‟s remuneration to be deferred under the relevant regulatory rules.
References in this memorandum to „partners‟ are either to partners of partnerships or members of LLPs, and references to „partnerships‟ include general partnerships, limited partnerships and LLPs.
The first proposal seeks to amend the NICs legislation by disapplying the current rule that deems LLP members not to be employees, and also seeks to ensure that no Class 4 NICs charges arise on LLP members categorized as „employed earners‟. The concept of a „salaried member‟ is defined in the 20 May consultation paper and is explained in more detail in our earlier memorandum "Proposed Changes to UK Tax Treatment of Partnerships and LLPs". (Currently, the rate of employer‟s Class 1 NICs is 13.8% of an employed earner‟s earnings, and the rate of Class 4 NICs is 2% of a self-employed person‟s profits above a certain threshold).
The second proposal seeks to adapt the UK tax treatment of certain partners in AIFM partnerships to allow compliance with the FCA‟s AIFM Remuneration Code without suffering any adverse tax consequences. The AIFM Remuneration Code applies to Alternative Investment Fund Managers („AIFMs‟) which are authorised by the FCA as so-called „full-scope UK AIFMs‟ (i.e. not to small AIFMs), and contains rules for remuneration of senior management or other staff whose professional activities have a material impact on the risk profiles of the AIFM, or of the funds managed by the AIFM. The FCA expects such AIFMs to implement the AIFM Remuneration Code for new awards of variable remuneration to relevant staff for full performance periods following that in which the AIFM becomes so authorised.
The AIFM Remuneration Code states that its application should be proportionate to the size, internal organisation and the nature, scope and complexity of the AIFM‟s activities. The FCA is currently consulting on draft amendments to the AIFM Remuneration Code, and on proposed guidance, which concentrate on how the Code is to be applied in light of this proportionality principle.
The AIFM Remuneration Code requires at least 40% (and in some cases 60%) of the variable remuneration component of certain partners‟ total remuneration to be deferred over a period of at least 3-5 years, unless the life cycle of the relevant fund is shorter. At present, partners are subject to income tax and Class 4 NICs on their share of the partnership‟s trading profits on an arising basis, whether or not they actually receive a distribution of those profits out of the partnership. In the case of an AIFM partnership, this either means that the partner in question has to suffer „dry‟ income tax and NICs charges in respect of remuneration deferred under the AIFM Remuneration Code, or the AIFM partnership risks non-compliance with the AIFM Remuneration Code by paying out to the relevant partners a portion of the profits that would otherwise have been deferred in order to fund the income tax and NICs liabilities.
In summary, the UK tax rules have not kept pace with regulatory changes, and the FCA is working together with HMRC and industry representatives to put in place a statutory tax mechanism that would allow AIFM partnerships to comply with the AIFM Remuneration Code in a way that would not result in partners paying income tax or NICs (whether Class 1 or Class 4) on partnership profits which they cannot access in the relevant base year owing to the remuneration deferral requirements under the AIFM Remuneration Code.
The new tax rules will have effect from 6 April 2014.