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Another year, another status review

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5 March 2015

With the start of the new tax year fast approaching, it is almost time to celebrate (or should that be commiserate!) the anniversary of the new rules for fixed share members of LLPs.  Sadly, for those practices affected, the party takes the form of a further internal review of each member’s status.

The conditions for LLP members to remain self-employed for tax purposes have been with us since 6 April 2014 and readers should now be well versed in the actions required to avoid a member being taxed as an employee.  One of the key features of the rules is the ongoing need to monitor each member’s status to ensure they fail at least one of Conditions A, B or C throughout their time as a member.  For many, the start of the new tax year will mean a fresh assessment and the purpose of this article is to address the actions required and, equally importantly, the documentation practices must have in place to satisfy HMRC, should they come knocking on the door.

As always, each of the conditions must be looked at separately:

Condition A – Variable Profit Share

This test is measured at the start of the ‘relevant period’, rather than the tax year, with the relevant period being the period over which the member’s profit sharing arrangement is in place.  This could of course be the start of the tax year, or more likely 1 April, but will generally be the date on which any pay review takes place (often the start of the firm’s financial year).  Annual reviews will require the test to be reapplied, but an interim review will also require a new assessment if it was not foreseen at the previous review.  The test will need to be applied for members from their admission date, which might be the start of the tax year.

Assuming the test needs to be reapplied at 6 April (or 1 April), the starting point will be the LLP Members’ Agreement, which should clearly set out what element of the member’s profit share is fixed and what element is variable.  It is important to remember that the variable element must be varied with reference to the profits of the LLP as a whole and, in practice, must be affected by the profits of the LLP as a whole.  The second key document for this condition is the profit forecast for the relevant period which, after applying the profit sharing arrangements per the LLP agreement, shows that more than 20% of the members expected profit share for the period will be variable with reference to the LLP’s profits for the period.

Condition B – Significant Influence

The test must be applied whenever a new member joins (so perhaps 6 or 1 April) and whenever there is a change to a member’s rights and responsibilities within the LLP.  This test places the most reliance on the LLP agreement, which must clearly set out the member’s rights and responsibilities and demonstrate that the member is able to exert significant influence over the LLP’s affairs as a whole.  Equally important for this condition are internal records, such as meeting minutes, recording the member’s input to the LLP’s affairs by way of voting on key decisions, commentary on and suggestions for key LLP matters and generally supporting their role as a key member of the LLP, as set out in the LLP agreement.

As with much tax law at present, the courts will focus on the substance of any relationship, so it is important that any documentation maintained by the firm is an accurate reflection of what happens in practice.

Condition C – Capital Contribution

The legislation specifically provides that this test must be applied at the start of each tax year, as well as whenever a member joins, or when there is a change to their capital contribution or profit share.  In our experience, this is by far the most popular condition that practices are relying on and so we expect to see a lot of activity between now and the start of the new tax year to ensure members retain their self-employed status going forward.

Once again, the starting point is the LLP agreement which must set out the members’ profit sharing arrangements and also the requirement for them to make a contribution that is made for the ‘permanent endowment’ of the firm (i.e. it cannot be repaid until the member’s retirement).

As with Condition A, this is a ‘look forward’ test and so profit forecasts may be important to demonstrate that the member has contributed at least 25% of their expected profit share.  Of course, if the profit share is entirely fixed the forecast may not be relevant, but remember that bonuses need to be factored in and forecasts may have a bearing on this.  It is important to note that for Condition C, it is the profit share for the tax year that is measured against the capital contribution, whereas Condition A focuses on the profit share for a ‘pay period’, which will typically be the firm’s financial year.  Where a pay review is scheduled part way through the tax year, any expected increase in the profit share needs to be factored into the calculation performed at 6 April 2015.

The firm’s internal records will be important to demonstrate that the contribution has been made at the right time.  Making the right level of contribution at the wrong time may lead to a member being taxed as an employee for a short period, which has expensive consequences.  Where the contribution is a cash injection, the bank statements will be good evidence.  Where the contribution is by way of a capitalisation of part of the current account, this will need to be recorded in the accounting records with the right date alongside.

Finally, it is important to remember that the three month grace period where contributions due by 5 April 2014 could be made by 5 July 2014 was an introductory offer from the kind people at HMRC.  Sadly there is no such leeway at 5 April 2015 and that is a firm date for any contributions required by then.  The two month grace period for newly appointed members is, however, ongoing.


As you will appreciate, these rules are a continuous burden for practices, with at least an annual requirement to test each member’s status.  Having the appropriate documentation in place is vital to successfully fend off any challenge from HMRC and as each test is applied looking forward, firms must be able to show that they made the correct decision over a member’s status at the relevant time.

The cost of getting it wrong would really spoil the party.