Under the current tax rules, all members of an LLP are automatically treated as self-employed for tax purposes, including those who only take substantially ‘fixed salary’. This means that they pay tax on their LLP profit share through the self-assessment system and do not suffer tax/NIC under PAYE. Similarly, the 13.8% employers’ NIC cost is avoided.
HMRC now consider that this treatment has been far too generous since, in substance, the status of many fixed salaried partners is more akin to acting as an employee. Thus, from 6 April 2014, specific new legislation will apply to treat the majority of ‘salaried’ partners as having an ‘employee’ status for tax purposes.
These rules apply to any LLP partner where all the following three conditions are satisfied:
- Condition A – The partner’s reward is wholly or substantially (taking to mean 80% or more) a ‘disguised salary’ – i.e. remuneration that is fixed or is variable by reference to individual performance targets. A profit share that varies by reference to the firm’s profits as a whole would not be treated as part of a ‘disguised salary’ arrangement.
- Condition B – The partner does not have significant influence over the LLP’s business. There is no definition of what a ‘significant influence’ means, which creates a great deal of uncertainty with the application of this test.
- Condition C – Less than 25% of the partner’s expected ‘disguised salary’ for the relevant tax year is contributed as capital. This condition has to be reconsidered any time there is a change in the partner’s capital contribution or other change in circumstances. Given this is a reasonably objective test, firms should be able to take their vulnerable ‘fixed share’ partners outside these rules by increasing their capital contribution requirement.
Where partners fall within the ‘disguised salary’ rules for LLPs, their earnings will be subject to PAYE and employees’/employer’s NICs. Furthermore, they will also be within the ambit of the employment-related securities and disguised remuneration legislation.
Partners in an ordinary partnership (as opposed to an LLP) are not caught by the ‘disguised salary’ regime. The question of whether they are acting as genuine partners or working as employees will still be decided on the precise facts of each case.
11 February 2014