Two important dates for the diary for UK LLPs:

  • 6 April
  • 1 May (or whenever your LLP’s next remuneration year starts)

These two dates are important because both are mandatory re-test dates for UK LLPs to assess whether their members should be taxed as employees or as self-employed based on their ‘disguised salary’. Getting this assessment wrong will lead to significant costs and disruption should a member unexpectedly switch to being an employee for tax purposes, as the LLP would face having to pay employer’s national insurance on the member’s income and may suffer penalties for late payment of tax.

These mandatory re-test dates are in addition to the re-tests triggered by changes in the relevant arrangements, such as a change in the basis of remuneration, control or capital contribution.

A brief reminder of the conditions and some of the main pitfalls to look out for when re-testing:

Condition A: ‘Disguised Salary’

Members relying on condition A must, in summary, have less than 80% of their remuneration classed as ‘disguised salary’ – which means remuneration which is fixed or, if variable, is varied without reference to the overall amount of the profits of the LLP or is not, in practice, affected by the LLP’s profits.

A common pitfall when assessing disguised salary is to fail to realise that variable remuneration will still be disguised salary unless it is variable by reference to the overall profits of the LLP.

Examples of where this confusion may arise include: (i) where members are paid variable bonuses based on personal performance (unless the bonus pool is a proportion of the LLP’s overall profits) and (ii) where remuneration is calculated by reference to the performance of an office, department or of an international grouping (such as many international law firms), rather than the LLP as a whole. These are examples of disguised salary, notwithstanding that the amounts in question may vary unpredictably from year to year.

A second pitfall to avoid is failing to consider if the reasonable expectations as to the LLP’s profits have changed since the last time the condition was tested. A change in those reasonable expectations will affect the balance between a member’s fixed share and his variable share of profits. The point is particularly easy to miss for members who have a fixed number of profit ‘units’ or ‘points’, since the number of units or points allocated to the member might stay numerically the same, but the expectation as to the value of those units or points can change.

Condition B: Significant Influence

Members relying on condition B must have significant influence over the affairs of the LLP.

When re-testing this condition, it is important to check that the individual’s role has not changed and still encompasses control over the whole of the LLP and not just, for example, a particular office or business line.

Condition C: Capital Contribution

Many members rely on Condition C to avoid being a salaried member, by contributing not less than 25% of their Disguised Salary as capital to the LLP.

The critical issue to be aware of is that there is no grace period to contribute increased capital if an existing member’s remuneration is increased beyond where his capital contribution is 25% or more of his remuneration. This is one reason it makes sense always to require partners to maintain sufficient capital to provide a buffer to account for remuneration increases and to make the contribution of capital a condition to any remuneration increase taking effect.

Practical Steps

Once an assessment has been made as to whether a member should be taxed as an employee or self-employed, the LLP should ensure that the basis on which that judgment was reached is appropriately documented. There are a range of documents that LLPs will have or generate that should support the judgment as to a member’s status. These might include an up-to-date members’ agreement setting out management roles and the basis of remuneration, financial information, such as profitability targets and forecasts, as well as other records relating to remuneration, such as management or remuneration committee minutes.

LLPs should be ready for their assessment of their members’ tax status to be scrutinised by HMRC at any time. An investigation may be triggered by HMRC reviewing a member’s tax returns, the LLP’s PAYE filings, or HMRC may simply choose to investigate a firm without any clear trigger. It is wise to be prepared.


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