Following widespread requests for clarification of the draft legislation on disguised employment of members of limited liability partnerships (“LLPs”)1, which was published on 10 December 2013, on 21 February 2014 HM Revenue and Customs (“HMRC”) published a detailed technical note
uidance_SalariedMembers_PartnershipsReview.pdf) to explain how these new rules (the “Salaried
Members rules”) are intended to operate. HMRC subsequently published revised draft legislation on 7
March 2014 to implement the changes announced in the technical note. The UK Government confirmed
in its Budget 2014 announcements on 19 March 2014 that the Salaried Members rules will take effect on
6 April 2014 as planned.
If a member of a UK LLP is treated as a „salaried member‟ under the Salaried Members rules, the
consequences could be very costly for the LLP, particularly as it will have to meet the 13.8% employer‟s
social security (National Insurance or “NI”) charge for each salaried member out of its own funds. The
LLP will also have to withhold income taxes and employee‟s NI from each salaried member‟s income.
From a salaried member‟s perspective, the income tax and NI cost is potentially greater than it would
otherwise be if he or she were taxed as a partner. Also, salaried member status does not in itself confer
statutory UK employment law protections on the member, as these are only available to persons who are
employees as a matter of UK employment law, which is a facts-based test.
The Salaried Members‟ rules are part of a wider review by the UK Government on certain aspects of partnership
taxation, details of which are summarized in our earlier Memoranda:
Autumn Statement: New Changes to UK Tax Treatment of Partnerships and LLPs – 6 December 2013
Proposed Changes to UK Tax Treatment of Partnerships and LLPs: Further Update – 21 October 2013Fried Frank Client Memorandum
Who does this affect?
The Salaried Members rules will only apply to members of LLPs formed under the UK Limited Liability
Partnership Act 2000. HMRC indicates that the UK tax treatment of members of equivalent foreign
bodies will depend on whether HMRC views the entity as opaque or transparent and, if the latter, whether
the entity in question is a partnership for the purposes of UK partnership law. It therefore seems that if a
non-UK LLP is a partnership under UK partnership law, the members of that non-UK LLP will be taxed as
partners unless they are regarded as employees as a matter of UK employment law, in which case they
will be taxed as employees.
For an LLP member to qualify as a „salaried member‟ under the Salaried Members rules, and hence
treated as an employee for UK tax and National Insurance purposes, three conditions (A, B and C) must
. This Memorandum considers these conditions in the light of certain points raised by the
technical note that are likely to be particularly significant for those professional firms and investment
managers that are constituted as UK LLPs.
Condition A: Disguised Salary
Under the revised draft legislation, condition A will be met if, broadly, there are “arrangements” in place as
a result of which it is reasonable to expect that at least 80% of the amounts payable by the LLP to a
member for the provision of services to the LLP by the member in his capacity as such will consist of
“disguised salary” (the “reasonable expectation” test).
HMRC takes a broad view of “arrangements” for this purpose, citing various factors to be taken into
account, including the financial position of the LLP, the terms and conditions of remuneration, budgets,
cash flow forecasts, financial projections and the commercial expectations of the parties as to the overall
The “reasonable expectation” test appears to be partly subjective, partly objective. On the one hand, it
requires the LLP to look at the substance of the matter on a realistic view of the facts, taking into account
the expectations of the parties to the arrangements. On the other hand, where there is a range of
possible outcomes, HMRC will interpret a “reasonable expectation” to mean the most realistic possible
„Disguised salary‟ for this purpose means, broadly, an amount that is either a fixed amount or an amount
that can be varied without reference to the overall profits or losses of the LLP‟s whole business (as
opposed to a particular part of the business), or an amount which, in practice, is unaffected by the overall
amount of such profits or losses. HMRC indicates that a payment from a profit share will not be disguised
salary simply because there is a fixed profit allocation method (whether by reference to initial awards of
fixed sums or overall performance), even if the LLP‟s profits are highly predictable and consistent from
year to year, since the amount of payment still varies according to the amount of the LLP‟s overall profit.
The technical note lists some examples of „disguised salary‟, which include:
These conditions are summarized in our earlier Memorandum of 12 December 2013 (Further Proposed Changes
to the Tax Treatment of Partnerships and LLPs), together with a brief explanation of the UK tax consequences.Fried Frank Client Memorandum
payment by reference to the number of tasks performed or pieces of work done;
bonuses based on personal performance without reference to the success of the business;
guaranteed payments (i.e. amounts paid to members regardless of whether the LLP is profitable
or not); and
In addition, the technical note contains several examples of practical situations involving certain types of
payments, with explanations as to the circumstances in which they will or will not count as disguised
salary. For example, a bonus awarded at the discretion of a remuneration committee will not be
disguised salary if it genuinely represents a share of the profit of the LLP‟s whole business. Also, where a
professional firm operates a remuneration system under which each member is paid a profit share
according to the amount of fees he or she has brought in (the „eat what you kill‟ model), HMRC would not
consider such a payment to consist of disguised salary. Drawings on account of expected profits are
unlikely to consist of disguised salary unless they represent priority minimum payments which are
refundable only in the event that the LLP‟s profits are insufficient to cover all the members‟ drawings (in
which case the drawings may count as disguised salary if, in reality, the LLP‟s profits always exceed
minimum drawings, since the drawings would effectively be a non-refundable reward for services).
The technical note also highlights some important considerations for the investment management
industry where disguised salary is concerned. For example, investment managers constituted as UK
LLPs may enter into investment management agreements or advisory agreements with their US
associates under which certain LLP members are to provide services to the US associate in consideration
for a fee to be allocated to the LLP, where the fee is based on the profits of the US associate, yet also
represents remuneration for those members, plus an amount to cover the LLP‟s business costs, in
addition to a „cost plus‟ markup. Under these circumstances, HMRC would not consider such a fee to be
variable by reference to the UK LLP‟s profits, but rather the profits of the associated US firm. In addition,
the „cost plus‟ element would be based on the members‟ remuneration and the LLP‟s business costs
rather than the LLP‟s profits. On that basis, HMRC would likely view the whole fee as disguised salary.
The above example would, however, need to be considered in the context of the particular circumstances
of the relevant agreement, and also whether the other two conditions have been satisfied. Where a UK
LLP is part of a global organizational structure, as in the above example, the key question is whether the
members‟ remuneration is variable by reference to, or affected in practice by, the profits of the UK LLP‟s
whole business as viewed in isolation from the wider global business, notwithstanding the fact that the UK
LLP may be engaged in transactions with other parts of the organization, or that the remuneration may
also vary in line with the business profits from those other parts. If it is, then the remuneration would not
be viewed as disguised salary.
Each case will ultimately depend on its own facts, and will need to be considered in the light of the
Condition B: No Significant Influence
Condition B will be satisfied if, broadly, the LLP member is not given significant influence over the LLP‟s
affairs. The key consideration here, according to the technical note, is the role played by the relevant Fried Frank Client Memorandum
member in the LLP‟s business, and whether he or she has a real say in setting its direction and strategy.
For example, in the case of an investment manager LLP, a member who sets the investment strategy,
decides which markets the firm will invest in, reviews the performance of funds under management, and
takes action to correct underperformance, will be regarded as having significant influence, and so
condition B will not be satisfied. Also, members of the board or management committee of a large
professional firm are likely to have significant influence.
The technical note contains a non-exhaustive list of the types of important business decisions that might
be involved in determining whether a person has significant influence for these purposes, such as
decisions on important financial commitments, appointment of key personnel, approving major new
clients, or deciding on the firm‟s marketing strategy. In practice, however, different people may be
involved in making different decisions of these types, and the ability to make one kind of important
business decision does not necessarily give that person significant influence for these purposes.
Ultimately, it is a question of fact in each case whether or not a person will be regarded as having
“significant influence” for the purposes of the Salaried Members rules.
Condition C: Capital Contributions Less than 25% of Expected Disguised Salary
Condition C will be satisfied if, broadly, a member makes a capital contribution that is less than 25% of his
or her expected disguised salary payable by the LLP for the tax year.
Capital contributions for these purposes are based on the amount of money or other property that the
member has invested as capital in accordance with the LLP agreement for the permanent endowment of
the firm. The amount of capital contribution for this purpose can also include, for example, long-term
loans repayable to the member only upon his resignation or on winding up of the LLP, or undrawn profits
that have been converted into capital by agreement. It does not include short-term loans or undrawn
profits that can be withdrawn at any time, nor does it include sums that the member may be called upon
to pay at a future date.
The technical note also confirms that one of the aims of the targeted anti-avoidance provision (TAAR) in
the Salaried Members rules is to exclude, in calculating whether the 25% threshold is reached, capital
contributed as part of arrangements whose main purpose is to enable the member to avoid being a
„salaried member‟. In essence, the TAAR will be relevant if there is no intention for the arrangements to
have permanent effect or otherwise pose an economic risk to the member. HMRC will consider the TAAR
to be relevant if capital contributions are derived from the following arrangements:
non-recourse or limited recourse loans;
loans from the LLP to the member;
loans from a bank to the member under arrangements in which the LLP‟s indebtedness to the
bank is reduced;
loans to the member in which the LLP bears the cost of the interest; and
capital provided that exceeds the 25% threshold, but only for the duration of a fixed term
assignment, at the end of which the capital is to be repaid to the member.
This is not an exhaustive list, and each case will depend on its own facts. However, the basic principle is
that HMRC will accept that a genuine contribution by the individual to the LLP, intended to be enduring Fried Frank Client Memorandum
and giving rise to a real risk, will not trigger the TAAR. It should also be noted that capital contributed on
or before 5 April 2014 as a result of such arrangements will not trigger the TAAR, even if the TAAR would
otherwise be in point.
The revised draft legislation also extends the TAAR to situations in which non-member individuals provide
services to an LLP through a non-individual intermediary member (e.g. a company) that receives amounts
which would otherwise constitute disguised salary, under arrangements whose main purpose is to avoid
the individual being treated as a salaried member.
Other General Points about ‘Salaried Member’ Status
Rights Equivalent to UK Statutory Employment Rights
Interestingly, if an LLP agreement entitles each member to an equivalent to statutory sick pay,
maternity/paternity leave, holiday entitlement and termination rights, such entitlements are not taken into
account in determining whether a member is a „salaried member‟ for the purposes of the Salaried
Members rules, even though these features may make the member look like an employee.
Residence of Member
The fact that an LLP member is non-UK resident is not a factor in determining whether he or she is a
„salaried member‟. If he or she is a „salaried member‟ under the Salaried Members rules, the normal
employment income rules for non-UK resident employees will determine the extent to which the individual
is subject to UK income tax. Broadly, non-UK resident employees are subject to UK income tax to the
extent that their earnings are from duties performed in the UK.
When Do These Conditions Need to be Considered?
For those who are already LLP members as at 6 April 2014, conditions A and B will need to be tested by
reference to their status as at 6 April 2014. For individuals who are admitted to the LLP after that date,
these conditions will need to be tested as at the date of admission. These conditions will only need to be
re-tested if, for example, a member‟s remuneration package changes so that a greater part of his or her
reward is calculated by reference to the LLP‟s profits.
As far as condition C is concerned, to cater for the fact that many LLPs may struggle to ensure that
existing members have the requisite amount of capital in place by 6 April 2014, HMRC has allowed a
grace period of three months from 6 April 2014 to allow existing members to obtain loan finance to enable
them to increase their capital contributions so that they reach, in aggregate, an amount equal to at least
25% of expected disguised salary, provided that there is an unconditional requirement in place on 6 April
2014 for the relevant member to provide the requisite capital, and the capital is contributed within three
months of that date. New members admitted to the LLP after 6 April 2014 will have a grace period of two
months from the date of their admission to obtain financing for the same purpose. The revised draft
legislation reflects these grace periods.
Some commentators have suggested that the technical note represents a “modest step in the right
direction” in terms of addressing real issues affecting large numbers of UK LLPs. However, a major
concern is that there is little time left for firms to assess the impact of the Salaried Members rules and
respond accordingly. This is not helped by the fact that firms will not be able to seek a formal clearance Fried Frank Client Memorandum
from HMRC as to whether or not particular cases will be caught by the Salaried Members rules until the
legislation receives Royal Assent (which is expected in July 2014), assuming the circumstances make the
firm eligible to apply for a clearance in the first place, which may not always be the case.
Accordingly, as a practical measure, UK LLPs will need to review their membership base and consider
whether certain members are likely to be regarded as „salaried members‟ under the Salaried Members
rules. Once such members have been identified, it will then be necessary to agree on deeds of variation
before 6 April 2014 which commit those members unconditionally to contribute capital, before 5 July
2014, of an amount equal to at least 25% of their expected disguised salary for the tax year.