- When is a member of an LLP an employee?
By way of a summary of current UK tax legislation, a member in an LLP is treated as self-employed even if that member is actually an employee. This is an automatic presumption and HMRC’s position has long been that salaried members in an LLP will be treated as self-employed for both income tax and for the purposes of national insurance contributions (NIC).
HMRC issued draft legislation and guidance on 10 December 2013, designed to combat the disguised employment relationships of certain LLP members.
Revised guidance was issued on 21 February 2014, which had been substantially expanded. The revised guidance both clarifies certain points and includes useful examples, however, it also raises some additional concerns.
Will it affect you?
HMRC has re-confirmed that the new legislation will only apply to LLPs formed under the Limited Liability Partnership Act 2000. The new legislation will not impact those LLPs formed under laws outside the UK or to those entities outside the UK that have structures that are broadly equivalent to a UK LLP.
However, HMRC’s position relating to the UK members of e.g. US LLPs will need to be monitored. HMRC have not ruled out the possibility that non-UK LLPs will be caught by the new provisions. Any US head-quartered LLPs may want to consider their current operations as HMRC have intimated that they are likely to review this area in the foreseeable future.
It does seem a strange result that salaried members of UK LLPs will not be treated in like manner with UK resident members of existing US LLPs or Jersey LLPs. However, it is doubtful that attempts to circumvent the new legislative provisions by creating a new US LLP, for example, would be successful because of the targeted anti-avoidance rule (TAAR) contained within the legislation.
The effect of the TAAR will be to disregard tax motivated arrangements that are entered into in an effort to circumvent the new rules.
There are three conditions laid out in the new legislation:
1.1 Condition A: Disguised Salary
A member of an LLP will be treated as an employee where at least 80% of their compensation is “disguised salary”. This compensation should be provided in return for the member’s services, and it is thought that, therefore, this would not capture a member on gardening leave. The draft legislation explains that compensation will be treated as “disguised salary” if one of the following conditions are satisfied:
- it is fixed;
- it is variable, but varied without reference to the overall of the profits or losses of the LLP; or
- it is not, in practice, affected by the overall amounts of those profits or losses.
Non-cash benefits provided by the LLP (which would be taxable as benefits in kind if the members were employees) will not be taken into consideration when assessing whether Condition A is satisfied. In the event that the member is found to be a salaried member, however, any such benefits in kind will be subject to employment taxes.
HMRC lists 28 examples in respect of Condition A alone in an effort to differentiate between those payments considered guaranteed, e.g. by virtue of the fact that a junior partner has a preferential profit allocation, or a profit-related bonus linked to that member’s performance and those payments that relate to the profits of the LLP. It is clear that it will not always be straightforward to determine the difference between a profit related bonus and shares of profit awarded on personal performance.
1.2 Condition B: Significant Influence
The second condition is satisfied when the individual member does not have “significant influence” over the affairs of the LLP. This condition is likely to be problematic for many large LLPs, as the purpose of this condition is to ensure that those individuals who do not have a real say in the business are treated as salaried members.
HMRC makes it clear that the ability to vote or to express a view is unlikely to constitute significant influence. Where all the members of an LLP meet for monthly meetings in order to discuss and make the major business decisions and where all such members participate equally in the management of the business clearly Condition B will not be satisfied.
Each LLP will have to be considered on a case by case basis as certain larger partnerships may not operate in a manner that ensures that all of the members have significant influence over the affairs of the partnership. In larger LLPs, for example, the management committee may have the requisite influence over the affairs of the firm for those members to fail Condition B. The remaining members will be unlikely to have the necessary “significant influence” and Condition B will be satisfied.
In respect of Conditions A and B, the tests will be applied for existing members on 6 April 2014. New members will be subjected to the test at the time when they become members.
1.3 Condition C: Contribution to the LLP
The third condition relates to the level of investment made by the member in the LLP. The test is whether the member’s contribution to the LLP is less than 25% of the “disguised salary” payable for the year, the amount that demonstrates whether the member has a real risk resting on the success or failure of the business. Where the member has contributed less than 25% of his remuneration, that test is satisfied and the member will be regarded as a salaried member.
The initial legislative changes were met with concern; changes were made, therefore, to allow members a three month period from 6 April 2014 for members affected by the legislation to obtain loan finance and to ensure that the requisite capital contributions are made. The members have to unconditionally commit to providing any such additional finance as is required to ensure that this test is not failed.
It is thought that many LLPs will look to reorganise their capital structure to ensure that members achieve the 25% requirement. A specific definition of “capital contribution” will be included within the body of the legislation. Consideration should be given to the TAAR, as HMRC have stated in their guidance that they would consider the TAAR if the main purpose of the lending arrangement (to increase the capital contribution) was to secure that the individual was not a salaried member and e.g. the LLP rather than the individual member pays or otherwise bears the cost of the interest on the loan.
It is worth pointing out that the three conditions are to be applied LLP by LLP and should not be assessed at group level. For example, any capital contributions that are provided to the US parent LLP do not count towards condition C; it is the amount of capital that is contributed to the UK LLP that will determine whether Condition C is satisfied or not.
Helpfully, non-statutory clearances will be available but only after the Finance Act 2014 has received Royal Assent.