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Over the last few years we have seen more and more legal practices converting to limited liability partnerships (LLP), and have assisted more than 60 of them ourselves. There are a number of reasons for this, not least the limited liability for partners, and the fact that LLP status is attractive to potential new partners.
However, another potential advantage of converting to an LLP is the fact that “salaried” or “fixed share” partners are presently automatically deemed self-employed, by virtue of section 118ZA of the 1988 Taxes Act (this deals with the taxation of members of an LLP), thus saving the practice from paying Employer’s National Insurance on the partner’s earnings, and saving the partner a reasonable amount of NI too. From now on I will refer to them as fixed share partners as I prefer that terminology.
As a self-employed individual, each fixed share partner then needs to complete an annual personal tax return and also pay their tax due every January and July. It is up to the practice as to whether the fixed share partner is expected to save for his or her own tax, or whether the practice would save it on their behalf.
Expenses that can be offset against profits
The self-employment regime is more flexible than PAYE. In order to obtain a deduction for expenses as a self-employed person, they need to be “wholly and exclusively” incurred for business purposes. In the case of an employee, the test is “wholly, exclusively and necessarily”. This is a much harder test to overcome.
Therefore, a change in status for a fixed share partner often allows them to claim a proportion of their car running expenses, as opposed to say a 40p per business mile allowance, an allowance for the actual car itself, possibly some home telephone, and also a deduction for “use of home as office”, providing of course that they do carry out some work at home.
State Benefits
The majority of the contributory benefits continue to be available as a self-employed individual. However, there are certain benefits that are only available to employed individuals, as follows:-
- Job Seeker Allowance
- Statutory Sick Pay
- Statutory Maternity, Paternity, Adoption Pay
Arrangements for these items therefore need to be covered in the LLP’s Members’ Agreement.
The change in status should not affect an individual’s state pension entitlements. However, an individual can easily double check with the Contributions Office to see how much entitlement they have built up so far, if they wish to.
What if the LLP makes a loss?
This would have been pretty much unheard of until about a year ago. Unfortunately, now it can be reality.
So far as fixed share partners are concerned, usually, if the LLP makes a loss, their liability is restricted to a very small percentage of it, say 1% or even nil.
You can get into a technically interesting but commercially difficult position, either where losses arise, or where the fixed share partners’ profit share exceeds the total profit. The reason why is that tax law prevents some partners being taxed on a profit (the fixed share ones) and others (equity partners) being able to utilise losses. The partners with losses have to transfer these losses to the partners with profits. Therefore, partners with profits get two benefits – the profit itself, and being taxed on a lesser sum due to the transferred losses.
There are ways to avoid this happening. Tax allowances on capital items can be disclaimed for a year, thereby decreasing the amount of the loss. Also, there are different taxation rules for apportioning client account interest, which are usually advantageous.
The Future
As a result of the clause in the original LLP legislation, many people have taken advantage of the self-employed status in order to avoid the employer’s National Insurance liability. There have been numerous references within the tax press that there may be a change in the future and this automatic self-employment status for an LLP member may cease.
Our advice is to always try and protect yourself from such a change, by ensuring that the arrangements with fixed share partners are set up to satisfy the general self employment badges of trade. This can be quite complicated, and we are well placed to help.
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