In December 2013, the UK tax authority (HMRC) published draft clauses for inclusion in the UK Finance Bill 2014 relating to measures designed to reform certain aspects of the UK tax regime relating to partnerships and limited liability partnerships (LLPs).
On February 21, 2014, HMRC published revised guidance (the Guidance) on one aspect of the reforms, namely, disguised employment relationships in LLPs incorporated under the UK Limited Liability Partnership Act 2000 (LLPA) (the Salaried Members Rules).1 The publication of the Guidance was followed, on March 7, 2014, by the publication of revised draft clauses relating to the Salaried Member Rules (the Revised Clauses).
Taken together, the Guidance and Revised Clauses clarify a number of points relating to the application of the Salaried Members Rules, and the Guidance contains a series of worked examples as to how the rules will likely be applied in practice.
Condition A – Disguised Salary
With respect to Condition A, the Guidance and Revised Clauses contain the following clarifications and changes:
- Basis for, and timing of, application of Condition A. The Guidance contains detail as to when an arrangement (i.e. the terms and conditions governing when, and in what amounts, a member will be, or may be, paid in respect of services to be performed) pursuant to which it is reasonable to expect that the member concerned is rewarded by way of a "disguised salary" will be considered to be in place. HMRC note that a "broad and realistic" approach, taking into account "the commercial intentions and expectations of the parties," should be adopted when considering the existence (or not) of such an arrangement.
The Guidance also emphasises that Condition A is applied on a prospective basis which, broadly, means that once an arrangement is put in place, and a reasonable view taken as to whether the member concerned is rewarded by way of disguised salary pursuant to such an arrangement, the application of Condition A is not to be re-determined unless and until such time as the relevant arrangement is modified. For these purposes, an extraneous event (e.g. a revised profit forecast) that affects the expectation of the parties to the arrangement, but which does not result in the arrangement itself being modified, would not impact on the determination previously reached as to whether the member concerned is rewarded by way of "disguised salary."
- 80% test replaces "wholly or substantially" test. The Revised Clauses provide that Condition A will be satisfied where 80% or more of the member's drawings constitute "disguised salary."2 The decision to insert a percentage figure should provide greater certainty for LLPs and their members.
- Drawings on account of profit share. The Guidance confirms that the fact that a member is paid drawings on account of expected profits does not necessarily of itself convert such drawings into "disguised salary", provided that the member's drawings are a genuine variable share of the overall profits of the LLP. However, an arrangement pursuant to which a member's drawings represent a priority minimum payment, refundable only in defined circumstances, may be problematic for these purposes.
- Financial Caps. Where a member's share of profits is capped at a certain monetary amount, the Guidance notes that such a member's reward may not, in practice, be affected by the overall amount of the firm's profits.
Condition B – Significant Influence
With respect to Condition B, the Guidance includes the following clarifications:
- Types of decisions. The Guidance contains a non-exhaustive, indicative list of the type of decisions the exercise of which may constitute "significant influence" such as, for instance, the appointment of new partners, decisions as to where the firm conducts its business, strategic decisions, management of key contracts relating to the firm generally, formulating the firm's business plan, and approving major new clients or investments. Although this list is potentially helpful, it is neither prescriptive nor definitive, and it is not clear how many decisions a member would need to be involved in to render such a member as having "significant influence" over the activities of the LLP as a whole. Indeed, the Guidance itself notes such difficulties and also states that solely having a right to vote on any such matters is "unlikely, in itself, to constitute significant influence."
- Regulated activities. The Guidance notes where a member carries out "significant influence functions" for the purposes of the Financial Services and Markets Act 2000, the member may have "significant influence." Specifically, although functions CF3 (chief executive function) and CF8 (appointment and oversight function) would likely, in their own right, result in "significant influence" for the purposes of Condition B, CF4 (partner function) would not.
- Delegated powers. Where powers are delegated by LLP members to a management committee of the LLP which largely undertakes administrative functions (such as, for example, payment and issuing of invoices, accounting, and dealing with routine compliance), then the existence of such a committee may not necessarily result in non-management committee members being regarded as not having "significant influence." It is only where the management committee effectively runs the LLP that non-management committee members may be regarded as not having "significant influence."
- Indirect influence. "Significant influence" only covers direct influence, and any indirect influence (e.g. by being a director of another member of the LLP) is disregarded.
Condition C – Capital Contribution to the LLP
HMRC accepts that a number of LLPs may have decided to reorganize their capital following the publication of the draft clauses in December 2013. It further accepts that such LLPs may experience practical difficulties in obtaining loan finance for a large number of individuals by April 6, 2014. In order to address this concern, the Guidance and Revised Clauses provide that a member will not be regarded as a salaried member if (i) at April 6, 2014 there is an unconditional requirement for that member to provide the necessary additional capital, and (ii) such capital is contributed within three months from April 6, 2014.
With respect to new members, such members will not be regarded as salaried members if (i) at the point at which the individual becomes a member there is an unconditional requirement for that member to provide the relevant amount of capital, and (ii) such capital is contributed within two months of that individual becoming a member.
These are helpful amendments as they recognize the pressure, and practical difficulties, associated with arranging finance for a capital contribution by a set date.
The Guidance clarifies that the proposed anti-avoidance provisions are likely to be triggered if the capital contribution is provided as part of an arrangement whereby:
- it is derived from a non-recourse or limited recourse loan;
- it is derived from funds provided from the LLP itself (e.g. where funded by way of a loan from the LLP to the member or from a bank as part of an arrangement where there is to be a reduction in the firm's indebtedness to the bank);
- subject to the application of certain UK tax legislation, it is loaned back to the member by the LLP;
- the economic costs associated with it (e.g. interest paid or the costs of the interest) is otherwise born by the LLP, rather than the individual member; or
- it can reasonably be assumed, in the case of an individual brought into the LLP for a fixed term assignment, to have been made so that the individual fails the test for the duration of that assignment.
Although the Guidance repeats that the Salaried Members Rules only apply to LLPs formed under the LLPA, the annex to the Guidance sets out briefly how the Salaried Members Rules will apply to global structures (i.e. a multi-jurisdictional structure) that include such LLPs. The Salaried Members Rules only apply to members of an LLP in isolation, with the broader global arrangements largely ignored. As such, the Salaried Members Rules do not consider income from, influence in, or capital invested in other parts of the global structure. Further, the Guidance clarifies that the jurisdiction of residence of the member does not affect the application of the Salaried Members Rules, and that the relevant profit share for these purposes is the profit share derived from the LLP, and not any profit share derived from any other entity in the broader global group.
Although the Guidance and Revised Clauses are certainly helpful in clarifying certain aspects of the Salaried Members Rules, there remain some areas of uncertainty. Notwithstanding this, given the short timeframe to ensure compliance with the Salaried Members Rules, it is important that affected market participants once again consider whether the Salaried Members Rules will adversely impact existing arrangements in place with respect to the operation of any LLPs and, if so, take steps to amend such arrangements. In particular, this would include assessing whether any amendments should be made to an existing LLP agreement and related arrangements.