One of the key decisions taken when establishing or managing an LLP is whether to have different classes of members (often colloquially referred to as “partners”).
Different classes of members will often have different rights to share in the profits and/or capital of the LLP, different voting rights, and perhaps different rights to access certain books and records. Many UK professional services firms will have two tiers, equity partners and fixed share partners.
One area which is often the source of confusion is the distinction between “fixed share partners” and “salaried partners”, particularly as the terms are often used interchangeably.
In this article we discuss the key distinctions between these two classes and why the differences matter.
Employment status: employee or member?
The fundamental difference between fixed share partners and salaried partners is employment status. Legally, a member of an LLP cannot simultaneously be an employee of the LLP.
Fixed share partners are full members of the LLP, not employees, and should be registered as such at Companies House. Their statutory employment rights and protections are largely limited to those which are available to “workers” and not employees engaged under a contract for service. They therefore have protection from discrimination and victimisation and certain rights in relation to whistleblowing. However, their rights largely arise under contract, in the LLP’s members’ agreement or other documents governing their membership, such as an offer letter or deed of adherence.
Conversely, despite being given the title “partner”, salaried partners are employees of the LLP and not members. Accordingly, salaried partners have significantly more statutory rights on account of their employment status, such as protection from unfair dismissal and rights to maternity, paternity and other parental leave and pay.
Voting rights, influence and decision-making
Voting rights often present another key area of differentiation.
As employees, salaried partners usually have very limited, if any, voting rights. They typically don’t participate in formal decision-making processes, but there may be a right (more often merely an expectation) to be consulted in the case of significant decisions affecting the firm.
Fixed share partners, on the other hand, may have greater voter rights than salaried partners. The extent of fixed share partners’ voting rights can vary greatly from business to business. Voting rights of fixed share partners, if any, will be as set out in the members’ agreement. Some firms adopt a “one person one vote” model, but weighted voting – where equity partners have a greater number of votes than fixed share partners – is more common. The fixed share partners might only be permitted to vote on certain specified decisions, with other fundamental decisions reserved for the equity partners.
Capital contributions, remuneration, and profit sharing
Further key differences between salaried partners and fixed share partners is the requirement to contribute capital to the LLP and the manner in which they are remunerated.
Salaried partners typically do not contribute to the capital of the LLP and have no interest in the profits or assets of the LLP. A salaried partner, as an employee and as the name denotes, receives a fixed salary determined in the same manner as salaries for other employees. Salaried partners have no interest in the profits of the LLP, unless they have a bonus which is based on the firm’s overall profitability. The benefit for the salaried partner is that they will receive a guaranteed income regardless of the profitability of the LLP.
In contrast, fixed share partners are often required to contribute to the capital of the LLP (particularly to ensure that the salaried members rules do not apply – see below). Unlike salaried partners, fixed share partners’ remuneration is typically comprised of a fixed sum of profits akin to a salary as well as a small interest in the profits of the LLP (for example they may each hold one equity point or unit).
Taxation
Salaried partners, being employees, are subject to PAYE, which means their income tax and employee National Insurance contributions (NICs) are deducted at source by the employer. The LLP is also required to pay employer’s NICs, which is now at the rate of 15% following a recent increase.
Members of the LLP will, on the other hand, be taxed as self-employed individuals, unless caught by the salaried members rules, which apply to LLPs incorporated under UK law. Accordingly, they are responsible for handling their own tax affairs, including calculating and paying income tax and NIC on their profit share. In practice, many firms operate a “tax reserve account” in which the firm retains an amount from the partner’s profit share to account to HMRC for any tax liability in respect of that profit share.
The central tax benefit to having fixed share partners over salaried partners is that the LLP is not required to pay employer’s NICs on fixed share partners’ profit shares, provided that the salaried members’ rules do not apply. This often means, in practice, that members of an LLP formed under UK law who have a fixed share of the LLP’s profits will need to make significant contributions to the LLP’s capital. See our recent article on this subject for further details.
The salaried members rules do not apply to LLPs which are formed under the laws of a jurisdiction outside of the UK, making such entities advantageous to overseas firms operating in the UK, particularly in conjunction with the availability of cash-based accounting for these entities, as we discuss here.
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Fox Williams has extensive experience advising professional services firms and partners on all aspects of partnership law. Our team is ranked Band 1 in Chambers for Partnership, reflecting our in-depth expertise and understanding of the issues that matter most to LLPs, partnerships, and their members.
If you require further information or assistance about any of the points raised in this article please get in touch.
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