Is it time to review the firm’s working capital funding?
As readers will no doubt be aware, tax legislation was introduced in April 2014, known as the Salaried Members rules, to determine whether LLP members are taxed on a self-employed basis. Under those rules, LLP members are self-employed for tax purposes if they fail one or more of three specific conditions. If all of the conditions are met, the member is taxed as if they were an employee of the firm. In brief, the conditions are that the LLP member:
- receives a fixed profit share (Condition A);
- does not have significant influence over the affairs of the LLP (Condition B); and
- has contributed less than 25% of their profit share to the LLP as fixed member’s capital (Condition C).
The rules have been with us for over 10 years now and are well established. HMRC provided clear guidance at the outset as to what was required of firms if their members were to continue to be taxed as self-employed. In our experience, many firms with ‘fixed share members’ required those members to contribute a sufficient amount of capital to the LLP to fail Condition C. This approach was adopted because it is easily measured and offers the greatest degree of certainty.
The Salaried Members rules include a Targeted AntiAvoidance Rule (‘TAAR’), which effectively ignores any steps taken where the main purpose, or one of the main purposes, is to avoid the member being taxed as an employee. However, HMRC were aware that firms would restructure their businesses prior to the rules taking effect in April 2014, and their guidance states “HMRC would not consider that genuine and long-term restructuring that causes an individual to fail one or more of the conditions to be contrary to this policy aim.” and “The capital contribution requirement is fairly prescriptive. A genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk, will not trigger the TAAR.”
However, HMRC have recently made some changes to their guidance, which they refer to as a ‘clarification’ of the application of the TAAR to Condition C. Although their guidance still contains the above two statements, HMRC have qualified this by stating that a genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk, will be disregarded if the main purpose, or one of the main purposes, is to avoid the member being taxed as an employee. They have also added a new example indicating that they consider the TAAR to apply where there is a separate agreement between the member and the LLP that allows the member to increase their capital contribution periodically in response to increases in their profit share, in order that Condition C continues to be failed.
Whilst this feels like a shifting of the goal posts, firms with fixed share members are advised to consider the updated guidance and what it means for them. Options available to firms affected by the change are:
- Treat fixed share members as employees and process their profit share through the payroll. The tax cost of doing so would need to be assessed, and the message given to those affected would need to ensure they do not feel it is a demotion.
- Consider whether Conditions A or B are failed. Arrangements change over time and whilst Condition C may have been the preferred approach in the past, that may not be the only option.
- Consider whether it is an opportune time to review the funding of the firm’s working capital requirements by the members.
A wholesale review of the firm’s working capital funding, encompassing all members of the firm, not just those receiving a fixed profit share, might result in a reappraisal of the level of capital contributed by each member, the outcome of which may be compliant with the Salaried Members rules and HMRC’s updated guidance.
