TECHNIC AL


Update on Salaried Members of LLPs HMRC give just six weeks’ notice


LAURENCE PARRY, PRIVATE CLIENT PARTNER, CORDIUM T


he updated consultation on salaried members of LLPs that was released on 21 February by Her Majesty’s Revenue and Customs (HMRC)


is the final process that started in the 2013 Budget. A consultation document was issued in May last year and HMRC responded in December. This document marks the final update on the topic. There are two issues which HMRC have sought to tackle:


• Profits of any partnership (not just an LLP) being allocated to a partner who is not an individual (typically a corporate) – ‘mixed member partnernships’;


• LLP members who have historically been treated as self-employed, but who in reality are more akin to an employee.


Throughout, HMRC have been focused on changes to the taxation of LLPs starting on 6 April 2014. It has been a feature of this process that HMRC have shown a lack of commercial awareness of the issues affecting businesses. LLPs have been given a very short period of time to work out if and to what extent they are affected. It also gives LLP members the same period to work out the cash flows arising from a potential cessation.


When you consider the knock-on effects of ‘employment’ taxation (employment-related securities, benefits in kind, pension contributions), there is really no time, and for a government that is supposed to be pro-business, it is an embarrassment. Unfortunately, unlike in Armageddon there is no Bruce Willis to save the day, even when there is apparently ‘no time’.


There have also been no changes to proposals on the taxation of mixed member partnerships.


So what is the effect of the latest consultation? The legislation has not been redrafted, but HMRC have issued new examples and guidance. For many in the regulated sector the revised guidance offers some helpful relaxation. To recap, a member of an LLP will be treated as an employee for tax purposes, and tax purposes only, unless they meet one of three conditions. (The legislation is written in the double negative – that they will be treated as an employee unless they fail all three conditions – however, it is easier to consider, and explain, in the positive).


The three conditions are:


• That the remuneration received by the LLP member is not wholly or mainly ‘disguised salary’;


• That if the remuneration is disguised salary, that the LLP member contributes at least 25% of this disguised salary as a capital contribution to the LLP;


64


• That the LLP member has significant influence over the running of the LLP.


Commencement As stated above, these rules start on 6 April 2014. HMRC state that the decision as to the status of the LLP member is as at that date, and will not be revisited unless circumstances change. However, each of the tests can be examined to test the reasonableness of that assumption as at 6 April. If the member joins post 6 April, it is the circumstances at that date that are relevant (with the same tests of reasonableness).


Interestingly, although income tax is an annual tax, HMRC take the view that you look at the overall arrangement for the foreseeable period in determining whether the ‘disguised salary’ test is met. In particular, two examples in the revised guidance (one of which is a start-up fund management venture) look at a three-year period, and given expected profits in year three, the individual member does not have a ‘disguised salary’ even in years one and two, although he or she receives a fixed draw.


LOOKING AT THE THREE CONDITIONS IN TURN


Condition A – Disguised salary HMRC are only considering payment for services in the status as a member of the LLP. Payments to companies, investors and former partners during a ‘sunset’ phase are not at risk. Equally, payments that aren’t for services as a member, e.g., rent for a property, are not in point.


Also the ‘disguised’ salary element must be at least 80% of the total expected remuneration. If the ‘disguised salary’ part is less than 80%, then the member will not be a ‘salaried member’.


‘Disguised salary’ is defined in the draft legislation as being remuneration that:


1. Is fixed; 2. If it is variable, is varied without reference to the overall amount of the profits or losses of the limited liability partnership; or


3. Is not, in practice, affected by the overall amount of those profits or losses.


HMRC then take 14 pages to give examples of the above. The hoops that HMRC have forced themselves into with this legislation can be seen from examples 14 and 22 in the draft guidance. These are repeated in full below:


EXAMPLE 14 This example looks at bonuses and remuneration committees.


J works for the ABC LLP. He will receive a salary of £100,000 plus a bonus determined by a remuneration committee, at their discretion. For the purposes of this legislation, the question is about the terms governing the remuneration committee’s exercise of its discretion in determining the bonus payable. If the bonus paid is genuinely a share of the profit of the business, it will not be considered as disguised salary.


In this case, more information is needed to determine whether the award is determined as an additional share of the overall profits of the firm or not. What are the terms of reference for the committee?


If the bonus is an additional share of the overall profit of the business, the next question is how realistic is it that any profit share will be 25% or more of the fixed salary of £100,000 (such that less than 80% of the total rewards will be disguised salary). As stated above, those rewards that are unrealistic and are unlikely ever to be triggered are ignored.


EXAMPLE 22 This example looks at how a team leader can be rewarded for the results of their team by the way the profits are allocated.


Towards the end of the year, the performance of the members is assessed and additional profit share units are allocated to members based on their performance during the year. This also takes into account the performance of the team for which they are responsible.


Condition A is not satisfied. Although the profit share units are allocated partly on the basis of personal performance, all that is happening is that the proportion of the profits going to each member is being set. How much each member will receive depends upon the amount of the overall profit.


To return to the cake analogy, their performance partly determines how large the slice is, but the actual amount of money depends on the size of the cake. A bigger slice of a smaller cake may be smaller than a larger slice of a bigger cake.


So as long as LLPs are profitable overall, then it should be possible to demonstrate that the sharing of that profit is not a ‘disguised salary’. However, this will require careful documentation and communication with LLP members.


There are likely to be issues where some LLP members have fixed draws where the LLP makes losses, or indeed where a priority draw causes other


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72