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Changes to the tax rules with regard to LLP members

24 January 2014

New legislation is to be introduced concerning the test to be applied from 6 April 2014 to determine whether a member of an LLP is to be employed, or self employed, for tax purposes. The new test is much tougher than the first draft legislation published in 2013.

The new HMRC rules remove the effective presumption that a member of an LLP is to be treated as self-employed for tax purposes. Instead, if a member of an LLP fails 3 new statutory tests, the LLP member is to be treated as an employee for tax purposes. The 3 statutory tests are set out below. If an LLP member satisfies any one of the 3 statutory tests, his or her tax status will remain unchanged by the new rules.

For the LLP, the consequence of a member being re-characterised as an employee is twofold:

  • the employee's profit share must be paid through the PAYE system (with income tax and employee NIC deducted at source); and
  • the LLP will have an employer's NIC liability (at 13.8 per cent) on the amount of the profit share.

The profit share and related NIC will then become a deductible expense for the LLP and so reduce the taxable profits of the LLP for income tax purposes. The relevant partners would not be employees for any purposes other than for tax purposes.

The change in tax status is not intended to have any bearing on whether the member will be treated as an employee for other purposes. However, there will be an issue with regard to auto enrolment given the terms of that legislation. Further, it is likely that as LLPs react to the changed position an individual's status may change and employment tribunals may be sympathetic to treating members who are employees for tax purposes as employees and adopt a purposive approach to any review of their status.

The 3 statutory tests

As noted there are 3 statutory tests which the LLP member must fail before HMRC will treat an  LLP member as an employee for tax purposes

Test (A): disguised remuneration

An LLP member whose profit share comprises at least 80% "disguised salary" will fail Test (A).

An amount is "disguised salary" for these purposes if it:

  • is fixed
  • if it is variable, is varied without reference to the overall amount of the profits and losses of the LLP; or
  • is not in practice affected by the overall amount of those profits or losses.

The guidance notes issued by HMRC explain how HMRC intend to interpret Test (A).

With guaranteed profits and drawings, the guidance notes say the following:

"A disguised salary includes any sum that a member is reasonably expected to receive, whether or not the LLP makes sufficient profit.

The key point is not how the payment is described; rather that it is a sum that the member expects to receive and will not in practice vary with the profit even if it is expressed to be linked to profit. It may be theoretically possible that a member is required to repay part of their drawings but if these are unlikely events, they will be ignored."   

The test here is applied realistically at the relevant time - it is not a test applied with the benefit of hindsight.    

Test (B):  significant influence 

An LLP member who does not have significant influence over the affairs of the LLP as a whole will fail Test (B). In practice, it is likely that only membership of the LLP's management committee would meet this condition and equal voting powers with other members will not be enough to pass the test.

Test (C): capital contribution

An LLP member whose capital contribution to the LLP for the tax year is less than 25% of the member's expected disguised salary will fail Test (C).
Test (C) is applied on 6 April 2014 and on the first day of each subsequent tax year.      

Some LLPs will be able to adapt their arrangements to meet the test for self-employment now adopted and will therefore be able to maintain the status quo but others will find it difficult if not impossible to do so without major changes to the way in which they operate.

The government has given very little time for LLPs to react to the new legislation and it is likely that many relationships that were accepted by HMRC for tax purposes as genuine self-employment will now become employment with consequential increases in the national insurance burden for the LLP.

One outcome that is certain HMRC will raise more tax revenue by virtue of the change that has been made. 

For more information please contact Alan Julyan, Partner

T: +44 (0)20 7427 6407