What are you searching for?
News & Publications

HMRC Announcements and Legal Practices – which way now?

◄  Return to News
12 December 2013

We wanted to report back quickly on the announcements which were released by HMRC during the course of Tuesday 10 December.  This release is not intended to be an in-depth analysis (we will issue one of those later), but an initial view. 

1. Changes to the present automatic self-employed status of LLP members

It is certainly true to say that HMRC have ventured away from quite a lot of the content of their original consultation document issued on 20 May this year, and come in harder than might have been expected in some areas.  They have also not made any attempt to align tax and general employment law, or indeed to take the very long standing self employed ‘badges of trade’ into account.

a) The changes below will take effect from 6 April 2014, as originally set out by HMRC, so there is time to plan – so far so good.
b) The changes only apply to LLP’s, and not to general partnerships.

c) HMRC have introduced a new concept, which they have called ‘Salaried Member’.  Basically, if you are deemed to be a Salaried Member then you will be employed for tax purposes.
d) In order to be treated as a Salaried Member (i.e. employed as opposed to self-employed), you (‘the Individual’) will need to satisfy all three of the following criteria:
   A) Payments made by the LLP to the individual are more akin to those for provision of 
   services to the LLP, and are not calculated by reference to the overall profitability of 
   the LLP; and

   B) The Individual does not have a significant influence over the management/affairs 
   of the LLP as a whole; and 

   C) The individual has made a capital contribution of less than 25% of their total expected 
   profit share for the year. 

Note: we have annotated these A, B and C deliberately as HMRC have badged them this way too in the legislation and their guidance notes.

e) Therefore, in order to remain self-employed, each individual needs to be able to break one (or more) of the three conditions above (but one is sufficient). 

f) In order to fail Condition A:

      i) An individual’s overall remuneration must not be:

  • Fixed/guaranteed in nature
  • Variable, but based on their own or their department’s performance
  • Unrelated to overall LLP profits, or unaffected by overall LLP profits
      ii) Profit shares should not be linked to individual pieces of work or turnover (HMRC 
      use an example of a hand car wash that is set up as an LLP, where all individuals are 
      members of the LLP and each individual’s profit share is calculated by reference to 
      how many cars they wash and not how the LLP performs as an entity).

      iii) HMRC give indicative guidance that they would expect an individual’s profit share to 
      be at least 20% variable in quantum (as opposed to the 5% that was originally set out 
      in the Consultation Document).

      iv) HMRC also state that provisions that are put in place for LLP Agreements relating
      to individuals’ profit shares, and the variability of them, need to be realistic and 
g) In order to fail Condition B, HMRC set out that the individual must either be a member of the LLP’s management board, or otherwise actively and deliberately involved in both management and decision making within the LLP.  They refer back to the basic definition of partnership, ie a group of people who get together in business with a view to profit.

h) In order to avoid Condition C: 

      i) the individual must make a capital contribution of at least 25% of their total expected 
      profit share for the particular year.

      ii) HMRC go on to say that this needs to be permanent capital, as opposed to 
      current accounts or tax reserves that tend to circulate funds around them (although 
      for many there is probably a route around that). 

      iii) The above needs to be tested on 6 April every year, and also on the admission of 
      a new member. 

Clearly, the above changes are going to mean that some LLP’s have some serious thinking to do in respect of ‘fixed share’ type partners. We would re-emphasise though that it is only necessary to fail one of the conditions, A, B or C, in order to retain self-employed status.  Which one you choose will greatly depend on the type, style and size of your individual LLP. 

2. Interaction of limited companies and partnerships

There is a great deal of detail in the draft legislation, but in essence, it seems that practices who already have one or more limited companies in their structure will be able to continue in the way they are operating at present, with no changes for tax purposes, until we get to 6 April 2014. 

After that:

a) Any profit shares going into corporate partners will need to be seen to be commercially defensible;

b) Where profit shares are not seen to be commercially defensible, legislation will step in and reallocate the ‘excessive’ profits going into the limited company back to the appropriate individual partners;
c) Service companies/corporate partners that operate on a commercial basis will remain unaffected (those that operate using transfer pricing have already been quashed (25 October this year), as you may have read).

d) Individuals who have transferred their partnership share into a limited company that is owned by them will be able to continue with those arrangements until 5 April 2014, and for some, beyond that date too.

In addition to the above there is simple but effective anti-forestalling legislation drafted to prevent those affected altering their structure to circumvent the changes.  That legislation has an effective date of 5 December 2013.

So, what next?

Having spent a great deal of time reviewing the detail in the last few days, we now have a strong understanding of what is set to be a major piece of tax legislation so far as legal practices are concerned.  There is already an increasing trend for practices to fully incorporate into limited companies, and this will be another influencing factor for some.