Changes to the taxation of members

Under existing rules, individuals who are members of an LLP are taxed as if they are partners in a traditional partnership, even if they are engaged on terms akin to those of employees.

HMRC argues that this produces unfairness in the tax system as an individual member of an LLP who is treated as a partner receives more favourable income tax and national insurance treatment than an individual who is an employee on similar terms. The government proposes making changes to employment tax rules to remove the presumption that all individual LLP members are treated as partners and hence self-employed for tax purposes; and set out the factors which will be taken into account in deciding whether an individual member of an LLP should be treated as an employee for the purposes of employment taxes.

Test for a salaried member

Members will be judged by two conditions:

1. A salaried member of an LLP is an individual member of that LLP who, on the assumption that the LLP member is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership.

   HMRC will apply their normal employment status tests to see whether this condition applies. Even if the member passes the first test, then the second will be applied.

2. A salaried member of an LLP includes an individual member of the LLP who does not meet the first condition but who:

   • has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;

   • is not entitled to a share of the profits; and

   • is not entitled to a share of any surplus assets on a winding-up.

Given that many of those affected are likely to be accountants and solicitors, HMRC is wise to firms seeking to avoid the second condition. Any risk or entitlement will be ignored if, having regard to all the circumstances and in particular the total economic rewards available or likely to be available to the member, it is reasonable to regard the risk or entitlement as insignificant.

What is insignificant? HMRC's view is that an entitlement to share in profits which, for practical purposes, would never be more than 5% of any fixed entitlement would be unlikely to be regarded by HMRC as significant.

The consultation paper makes it clear that they would be concerned if taxpayers tried to circumvent the proposed changes that were intended to have no practical effect other than to disapply the legislation. A targeted anti-avoidance rule will be introduced to prevent such arrangements. How such a measure would discriminate between legitimate and abusive tax planning is entirely unclear.

Salaried member status

If a member is judged to be a salaried member, then that person will be treated in relation to their work for the LLP as an employee for both income tax and national insurance purposes (including benefits in kind). One unintended consequence might be that a tier of formerly self-employed members is able to claim employment rights against their employers.

One of the few upsides of the changes for LLPs is that the costs of employing salaried members will be deductible in the calculation of the profits of an LLP.

Lack of clarity

The new rules are intended to apply from 6 April 2014 (there will be no grandfathering for arrangements entered into before this date).

In the run-up to implementation, it is essential that HMRC provides clarity as to how they will be applied.

There appears to be a lack of understanding by the government on the purpose and benefit to the wider economy of LLPs. The consultation contains statements such as, 'The LLP is a body corporate and has little in common with a traditional partnership apart from its tax treatment', which disregards the reality of how LLPs are run in comparison to companies and the risk of clawback against the members if the LLP is wound-up. Lobbying to other elements in government, for example the Department for Business, Innovation and Skills (BIS), might well result in a softening of HMRC's proposals.