On 28th February HMRC published its long-awaited updated guidance on the changes to the taxation of the members of LLPs. In particular, it has clarified some of the issues around ‘salaried members’ – i.e. those members who will from 6 April 2014 be taxed as employees rather than as self-employed.
Understanding the new rules is critical, as wrongly classifying a member of an LLP as self-employed for tax purposes could give rise to substantial additional liabilities for tax and employer’s national insurance contributions on the member’s remuneration, together with interest and penalties. The LLP could also be in the uncomfortable position of having to try and claw back monies already paid to its members, if it has made payments in the mistaken belief that those members could be paid gross of tax. Clearly, it is critical for firms to be sure of each member’s tax status.
Ten key points to note from the new guidance are:
- It is confirmed that the rules will apply only to English LLPs. The taxation of partners in other kinds of partnerships will continue to be assessed by reference to case law;
- it is confirmed that if a member’s ‘disguised salary’ (i.e. remuneration not linked to the profitability of the LLP) is less than 80% of his remuneration, he will not be treated as a salaried member;
- disguised salary will not include the profit share of a member who is merely an investor and who does not work for the LLP. Similarly, it will not include the profit share of a member who is on garden leave or who otherwise is not providing services for the LLP;
- a member’s drawings will not normally be disguised salary, unless they need not be repaid should there be a shortfall in the LLP’s profits or, in certain circumstances, if a member’s drawings are paid out in priority to those of other members;
- a profit share allocated on the basis of personal performance may or may not amount to disguised salary, so care will need to be taken – ‘eat what you kill’ arrangements relating to profits will not amount to disguised salary;
- profits received by valve partners of a UK LLP in an international firm (whose profit share is transferred to the overseas parent firm) are likely not to be disguised salary;
- a member of an LLP who is also a partner in an overseas affiliate will be assessed by reference to his membership of the UK LLP, so capital, control or profit shares in an affiliate will not help a member to avoid being classed as a salaried member;
- one way to avoid being classed as a salaried member is to have significant influence over the LLP. However, HMRC has confirmed that merely having a vote on important matters is not of itself sufficient;
- a further way to avoid being classed as a salaried member is for the member to contribute at least 25% of his disguised salary as capital to the LLP. Existing members who are obliged to contribute capital on 6 April 2014 will have 3 months from that date to make the required capital contribution and new members joining after 6 April 2014 will have 2 months to do so;
- genuine and long-term restructuring (e.g. of an LLP’s capital contributions) will not trigger the anti-avoidance rules.
With just six weeks to go until the new rules take effect, LLPs must act now in order to avoid uncertainty and the potentially costly consequences of getting a member’s tax treatment wrong. LLPs should now be in a position to act on the new rules, as the latest guidance includes 61 example scenarios, many of which illustrate well the circumstances of professional LLPs.