At the beginning of each tax year on 6 April, UK LLPs are required to assess whether their members should be taxed as employees or as self-employed, depending on their “disguised salary”.

Although legally a member of an LLP cannot simultaneously be its employee, legislation introduced in 2014, known as the salaried members rules, means an LLP member could be taxed as though he or she was an employee if certain conditions are met.   

What do LLPs need to know about these rules, and why is it important to focus on them now, before the new tax year?

In this article we set out a brief reminder of the conditions and some of the main pitfalls to look out for when re-testing. 

HMRC focus on salaried members rules

These rules are very much on HMRC’s radar, particularly since the First-Tier Tribunal’s decision in BlueCrest Capital Management (UK) LLP v HMRC, the first case which directly salaried member rules.  Until recently, UK LLPs have had to rely only on the legislation and HMRC’s guidance. 

Increased levels of profitability within professional services firms over recent years will mean that fixed share partners will need to contribute further capital to the business in order to ensure they continue to be taxed as self-employed members. 

Higher profits will also mean the costs of getting the assessment wrong are greater than usual. In BlueCrest, HMRC sought to impose on the LLP (with partial success following the LLP’s appeal to the Tribunal) a tax and national insurance bill of more than $150 million.  

When do UK LLPs need to test?

The mandatory re-test date of 6 April is in addition to the re-tests required:

  • upon the admission of a new member to the LLP;
  • whenever the LLP’s next remuneration year starts; and
  • if triggered under the legislation by changes in the relevant arrangements, such as a change in the basis of remuneration, control or capital contribution;

What happens if a partner is deemed an employee for tax purposes?

If an LLP member has none of the three hallmarks of partnership described below, his or her remuneration will be subject to tax and national insurance contributions (“NICs”) as an employee, meaning:

  • income tax and NICs will need to be deducted at source by the LLP and accounted to HMRC in accordance with the PAYE regulations which apply to employees;
  • unlike with self-employed members, the LLP will be required to pay employer’s national insurance on the member’s income, at 13.8%; and
  • the LLP may suffer penalties for late payment of tax.

What are the criteria required to be taxed as self-employed?

In summary, in order to be taxed as self-employed, an LLP member must have at least one of the three key hallmarks of partnership:

  1. variable remuneration which goes up and down based on the LLP’s profits (“Condition A”);
  2. significant influence over the affairs of the LLP (“Condition B”); or
  3. a capital contribution of greater than 25% of his expected fixed profit share (“Condition C”).

1. Condition A: Disguised Salary

Members relying on Condition A must, in summary, have less than 80% of their remuneration classed as “disguised salary”.  

“Disguised salary” means remuneration which is either fixed or, if it is 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:

  • where members are paid variable bonuses based on personal performance (unless the bonus is a proportion of the LLP’s overall profits); and
  • where remuneration is calculated by reference to the turnover of an office, department or of an international grouping (such as many international law firms), rather than the profits of the LLP as a whole. These may be examples of disguised salary, notwithstanding that the amounts in question may vary 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 expectations will affect the balance between a member’s fixed share and his/her 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.

2. Condition B: Significant Influence

Members relying on condition B must have significant influence over the affairs of the LLP.  To qualify for this condition the member must have power to control the direction of the business, such as appointing new members, moving premises, expanding the scope of the LLP’s business and setting strategy. 

A key pitfall for this test is when LLPs confuse management powers with administrative responsibilities.  HMRC guidance explains that administrative functions – such as paying invoices, filing accounts and tax returns, dealing with suppliers and handling routine compliance matters – will be unlikely to meet Condition B. 

Although members in a small LLP may often be in a position to rely on Condition B, this will not always be the case if (for example) much of the management power is vested in a single member or committee of members, or if the direction of the LLP is largely controlled by a parent entity.   

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.

3. Condition C: Capital Contribution

For LLPs that are too large for Condition B to apply, Condition C is a common approach to avoid fixed share partners being taxed as salaried members.  This is achieved by having them contribute 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 or her capital contribution is 25% or more of their 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 partner remuneration;
  • financial information, such as profitability targets and forecasts; and
  • 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. LLPs should not just make a judgment about a member’s tax status, but make sure that they record the basis on which that assessment has been made, to evidence the LLP’s expectations.


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